Living in a new era of rules and regulations


May 23 - 29, 2005




The 9/11 incident made the world think and take corrective steps to check, monitor and control movement of money from one country to another country. It was the global consensus that undocumented flow of funds to the undesirable elements has to be checked and money laundering business has to be stopped. Pakistan could not afford to be left behind and let the world raise a finger. Among the various measures introduced to check flow of funds, the government took steps to bring money changers' business under stringent control.

The government took serious note of the irregularities in the money changing business in 2001. A taskforce was set up to come up with recommendations to overcome the weaknesses in the system. A dire need was felt to rationalize money changers business and remove the existing distortions inhibiting inflow and regulate the unchecked outflow of foreign exchange. Regulators reached the conclusion that the regularization of money changers business would also help in containing the kerb market and the difference between official and kerb market exchange rate.

While it is not easy to make any objective assessment of the performance of exchange companies, the available data suggests increase in their transaction volumes. Since most of this increase occurred in the early stage of transition, it can be argued that the higher volumes mainly reflect the impact of new exchange companies adding to the reporting list of State Bank of Pakistan (SBP). However, encouragingly, more of the transactions are routing through exchange companies' nostro accounts.

According to SBP, the exchange companies purchased US$6.6 billion and sold around US$ 5.7 billion during financial year 2003-04. According to SBP regulations, companies are required to limit their exposure at the close of business each day at a level not higher than 50 percent of their capital base; any excess amount is sold to authorized dealers. The exchange companies sold US$ 288 million to banks during last financial year.

According to Syed Nabeel Ahmed of Khanani & Kalia International, "In total there were 469 money changers throughout Pakistan, which held the SBP licenses. There were many more that had no license but had been working smoothly as all the efforts to crackdown upon them had failed. The highest number of 150 such entities was operating in Karachi, followed by 78 in Lahore and 71 in Rawalpindi."

In March 2001, the then Economic Advisor of the SBP, Dr. Mushtaq Ali Khan, and former Foreign Exchange Advisor, Hanif Akhai floated the idea on creating exchange companies. They co-authored a confidential paper suggesting measures to overcome menace of illicit foreign exchange business. This included conversion of money changers business into exchange companies. The suggestion was also endorsed by the International Monetary Fund. The fund also contributed its input. It also wanted from the SBP to formulate rules in such a manner that these entities could not indulge in money laundering business.

According to anther SBP report, prior to the introduction of exchange companies, there were around 375 authorized money changers (AMCs) in Pakistan. These AMCs have allegedly been acting as a conduit for informal forex market flows and operating in parallel with banks by dealing in traveler's checks and transfers. Moreover, their businesses were inadequately capitalized, and the monitoring was limited. With the aim to address these issues, State Bank of Pakistan (SBP) in July 2002 proposed a plan to replace AMCs by exchange companies having following characteristics:

* The exchange companies can deal in foreign currency notes, coins, postal notes, money orders, bank draft, traveler's cheques and transfers; but are prohibited to engage in deposit taking, lending activities directly or indirectly.

* They are required to maintain the paid up capital of Rs100 million with the central bank including 25 percent as Statutory Liquidity Reserve (SLR).

Presently, most of the exchange companies are located in large cities. Thus, people living in remote areas cannot access the services provided by the exchange companies. To overcome this problem, SBP has directed exchange companies to form 'payment booth'.

Pressure on exchange rate was evident in the form of growing premium charged by exchange companies over the inter-bank rate, particularly during the second half of last financial year. At the same time, there were also reports of rising capital outflows through undocumented channels. Anecdotal evidence also suggests some capital outflows to Dubai to capitalize on the real estate investment opportunity there. An unusual increase in the premium for undocumented outflows could further exacerbate pressures on exchange companies.


As a result of decision to follow free market economy, it was also decided to develop a market place where the people can buy and sell foreign exchange. This led to calling applications for the establishment of money changers. The invitation by the central bank to submit application for setting up such a business got tremendous response. As a result an open currency market came into being, with Khanani & Kalia being the first entity coming in operation.

The establishment of free foreign exchange market led to run trade and related affairs without any un-necessary exogenous and endogenous regulatory as well as physical barrier. The general public found easy access to trade foreign exchange as per their requirement. The macro and micro-economy also found the free flow, contributing towards overall progress of the country. The entrepreneurs were considered to be in a better condition to make business decisions. The legal system given by the SBP stood adequate to adjudicate between parties and ensured law that established market and economic activity as a legitimate sector of the national economy.

Mainly, the buyers of foreign exchange from the open market can be divided into various groups. These are: 1) Individuals with genuine savings and people who need foreign exchange for legal purpose, 2) business and 3) financial sector and corporate purchasing foreign exchange from the open market with SBP permission. However, apart from the above, people with black money are also became part of the open market.

According to a SBP report, those who smuggled goods into Pakistan had contacts with unauthorized and legal money changers. They need foreign exchange to pay of their suppliers aboard. The report estimated they accounted for 40 percent of what it called foreign exchange leakage in Pakistan. Businessmen who either want to avoid documentation or lack creditworthiness also resort to the open market. Their buying accounted for 10%. The category of the buyers comprising business etc. consumed 50% of foreign exchange inflow into the open market whereas the individual savers who wanted to retain the value of their saving bought 7% of the total stocks of foreign exchange with the money changers, whereas the holders of back money use to buy up to 20%.

They had to purchase foreign exchange to convert their ill-gotten money into foreign exchange and send it abroad. Normally they paid rupees to authorized money changer in Pakistan and against that, took away cash dollar or receive credit in some off-shore accounts. Also the individuals who buy foreign exchange from the open market for traveling aboard or performing Hajj and Umrah or meeting educational or medical expenses outside Pakistan also stand as major buyers and their buying is estimated at 6% of the total leakage.

The SBP itself and the business that were allowed by SBP to meet part of their foreign exchange requirement through purchases from the open market were also the buyers. The report estimated that SBP buying account for 15% of the total inflows in the open market and that of the business allowed by it just 2%. The State Bank started buying dollar from the open market in a big way after the May 1998 crisis. After the 1998 crisis the central bank also had to become more liberal in allowing corporate to buy a part of their foreign exchange requirement from the open market.

It is unfortunate that the money changing business in Pakistan became vulnerable to a number of flows and a keeping a side only a few money changers, the branded names which still hold the privilege of running their business honestly in the past and money changer and within the frame work given by the SBP. It is feared that a large number indulged into activities forbidden by their code of conduct. Some of the reason which gave rise to substitute the money changer with Exchange Companies are as under:

•Many private institutions come into the business of currency and most of them had no background, expertise and education regarding the trade.

•Many money changers build strong contacts with overseas currency dealers and smuggling of foreign exchange continued.

•Many/Unauthorized money changer did not maintain any sort of record or documents supporting the transaction that they make on behalf of their customers. This event gave birth to an undocumented economy in the country.

•Many money changers did not disclose their actual transactions.

•Due to the irresponsible conduct of some money changers, the open market became a safe paradise for the customer to transfer their illegal funds out of their country to wherever they desire. This involved less time, less charges and most of all, no documentation. These activities posed the serious threat for Pakistan after 9/11 and subsequent events.

•The monitoring and regulatory system suffered from certain weaknesses.

•Some foreign private companies did not use to declare their foreign exchange reserves and earning which was a great loss to the country.

•The spread between the inter bank and the open market continued to grow. It encouraged remittances through "hawala" or "hundi". The inter bank and kerb market spread was comparatively big at one stage, when the open market was offering a better exchange rate for the dollar. Therefore, it was necessary for the inter bank rate to move up. The narrowing down of the spread between the two markets was aimed through the official banking channels and bidding farewell to "hawala" and "hundi".

According to Dr. Ishrat Husain, the establishment of the exchange companies was not only to fully document the transactions but also curb the activities of unauthorized money changers and hundi business. The major objectives are to: 1) usher in documentation in the economy, 2) have a close a check on the inflow and outflow of foreign exchange from the country, 3) curb the activities of the unauthorized money changers and 4) to discourage the use of Hundi as a mode of transferring of funds.

According to the rules and regulations laid down by the SBP, all money changer required to case their business by 30th June 2004 and to transform themselves into exchange companies. The SBP gave two-year time to all money changers to apply for getting a license of an exchange company and to fulfill all other legalities necessary for this transformation. Banks are also allowed to run this business. National Bank of Pakistan and PICIC were prompt in starting their operations. The reason National Bank decided to set up a subsidiary to act as an exchange company because it had the experience of running one such company with local partnership in Dubai and it handled, on behalf of the State Bank, export of non-dollar currencies in Dubai by the money changers. The exchange companies are allowed to franchise their business as well. It implies that the money changers which due to insufficient funds for meeting the paid up capital requirement to set up an exchange company, may take the advantage of getting their business regularized by taking franchise of already existing exchange company in the country.

As of end October 2004, the central bank had issued 22 licenses to exchange companies in 'A' category. These exchange companies have further granted franchises to 172 money changers. The SBP has also issued 33 licenses to exchange companies under 'B' category. These companies in turn opened 244 retail branches throughout the country. This suggests that in overall terms, the service coverage to the customers at the retail level has increased in comparison to the branch network of old authorized money changers. At the same time, this will facilitate spread of corporate culture in the foreign exchange business of the country, while improving the documentation, reporting and inspection by SBP. Franchise is the authorization granted to someone to sell or distribute a company's goods or services in a certain area.

Though, the SBP is striving hard to regulate money changing business, a lot remains to be done. The central bank cannot achieve the target alone. While the banks and exchange companies are playing their due role, it is also the responsibility of people to avoid using informal channels. Saying this it is also imperative on banks to extend the best services. Poor service was the key reason forcing people to use the informal channels.

One of the major benefits of having exchange business industry in the country is proper documentation. Earlier, the illegal money changers did not maintain any records of their transactions whether it was buying or selling of currencies form the customers or illegal transfer of funds. There was no such record to reveal the true volume and nature of business of these illegal money changers and hundi operators. But it was certain that they were hurting the national economy to a great extent. Now all exchange companies have to report all transactions they make to the SBP and have to maintain all records of their transactions. The special audit team of SBP regularly visits the exchange companies and checks their records. This maintenance of proper record is certainly giving rise to a documented economy.

Close check on the inflow and outflow of foreign exchange is also yielding positive results. It is lot easy for the central bank to monitor the inflow and outflow of foreign exchange through a few exchange companies. Still there may be some money changers, who do not have license but have been working smoothly. This indicates that how difficult it is/was for SBP to monitor the inflow and out flow of foreign exchange through these entities.



Now with the number of exchange company limited to a few, mainly leading names, doing business professionally and honestly it will be easier for the SBP to monitor inflow and outflow of foreign exchange from the country. The figures indicate that SBP is closely monitoring the movement of foreign exchange in and out of the country.




Exchange Companies of Type (A)


Franchise With EC (A)


Branches with EC (A)


Exchange Companies of Type (R)


Licenses to branches


Authorized money changers


In addition, 22 hotels were also granted 'restricted authorization' to deal in foreign exchange.



(million US dollar)



O4 FY04



Purchase/ Receipts

Sale/ Payments

Purchase/ Receipts

Sale Payments

Purchase/ Receipts

Sale/ Payments









With other exchange companies







Against sales/purchase of other currencies







Sales to authorized dealers







Branch transaction adjusted















From resident against payments in rupee







From non-resident against payments in rupee







With other exchange companies







For credit to FCA of resident







Sales to authorized dealer







Contra to import/ export of foreign currency


















EC (B)

EC (A)

Franchise with EC (A)

Total branches




Located in big 5 cities




Share (in percent)




Includes Karachi, Lahore, Islamabad, Rawalpindi and Quetta