LECTURE 3:

THE IMPACT OF
GOVERNMENT POLICY AND
REGULATION ON BANKING
AND THE FINANCIAL
SERVICES INDUSTRY
Bank Regulation- Pros and Cons
of Strict Rules
• To protect the public's savings
• To control the money supply
• To ensure adequate supply of loans and to ensure fairness
• To maintain confidence in the system
• To avoid monopoly powers
• To provide support for government activities
• To support special sectors of the economy
 Legal & Regulatory Framework

Primary laws/legislations:
•Prudential Regulations (Corporate/Commercial, SME, Consumer,
•Agriculture and Microfinance)
•Guidelines (Licensing, Risk Management, Customer Complaints,
•Branchless Banking etc.)
•Circulars and Instructions (Capital Requirements-MCR-CAR,
•Disclosure of Financial Statements, Customer Facilitation)
•A comprehensive supervisory mechanism (CAMEL system)
•Consumer Protection
 Major bank laws in Pakistan

• Banking Companies Ordinance 1962 ( As modified upto 02 April 2011): Under the Banking
Companies Ordinance, 1962 the State Bank of Pakistan is fully authorized to regulate and
supervise banks and development finance institutions. During the year 1997 some major
amendments were made in the banking laws, which gave autonomy to the State Bank in the area
of banking supervision.
• The State Bank has framed Prudential Regulations for banks and Rules of Business for DFIs
(Development Finance Institutions) that present a prudent operating framework within which
banks and DFIs are expected to conduct their business in a safe and sound manner taking into
account the risks associated with their activities.
• The State Bank is empowered to determine Statutory Liquidity and Cash Reserve Requirements
for banks/DFIs. Presently the Cash Reserve Requirement is 5% on weekly average basis subject
to daily minimum of 4% of Time & Demand Liabilities (overdue, accruals, credit items)
• Legal Framework The SBP Act, 1956 ,The Banks (Nationalization) Act, 1974, Microfinance
Institutions Ordinance, Licensing of banking companies (section 27 of BCO and 13 of MFIO),
Power of the State Bank to Microfinance Institutions Ordinance, give directions (section 41 of
2001(MFIO), Payment System & Electronic Fund Transfer Act, 2007, The Financial Institutions
(Recovery Of Finances) Ordinance, 2001, Anti Money Laundering Act, 2010, Foreign Exchange
Regulations Act
 CAMEL- supervisory system
• CAMELS are an effective rating system for evaluating the soundness of financial institutions on a
uniform basis and for identifying these institutions requiring special attention or concern
• CAMELS stands for, Capital adequacy, Asset quality, Management, Earning, Liquidity, and Sensitivity
to market risk. Capital adequacy represents the relationship between equity and risk weighted assets,
how to rise equity and measure the ability to which the 24 organization observe the loan losses. Asset
quality, the quality of a portfolio, assesses the portfolio risk and shows the productivity of long term
assets. Management, to know the board of directors functions whether they are performing well or not
and its decision making ability. It also evaluates the performance of human resource management
whether they give support and clear guidance to staff, all the facilities which staff needed i.e. incentive
system for personnel, training, etc. Computerized information system also takes into consideration
whether the systems are operating well and provide accurate and timely reports to the management.
Earning; quantifies the performance of the institution to increase and maintain the total worth through
earnings from operations. It also assesses the interest rate policy, management examine and adjust
the interest rate on micro finance loans and evaluate the adjusted return on assets that how well the
assets are utilized (Sarker, 2005, p. 7). Liquidity Management; scrutinizes institution liabilities like
interest rate, payment terms, tenor etc. It also evaluates fund availability to meet its credit demand and
cash flow requirements (Sarker, 2005, p. 8). Sensitivity, to assess the risk of the market primarily
based on adverse changes in commodity price, interest rate, foreign exchange rate, fixed assets and
the ability of management to identify and control these risks (Trautmann, 2006, p. 43).
• Rating on a scale of 1-5. 5 being high rating and 1 being poorly rated
 Regulated Nonbank Financial
Service Firms
• Credit Unions (Citi bank) (Credit unions are not-for-profit
organizations that exist to serve their members)
• Savings Associations (Zarai Taraqiati Bank)
• State Savings Banks (National savings)
• Money Market Funds (that invests in short-term T-Bills, bank
deposits and money market instruments) (MCB-Arif Habib Savings)
• Life and Property/Casualty Insurance Companies (EFU Life
Assurance LTD)
• Finance Companies (Wallstreet Exchange company)
• Mutual Funds (UBL Growth and Income Funds) (an investment
programme funded by shareholders that trades in diversified
holdings and is professionally managed)
• Security Brokers and Dealers (trading securities for its own account
or on behalf of its customers- Zafar Securities PVT Ltd)
• Financial Conglomerates (Union Bank- offers both banking and
security options)
 Regulated Nonbank Financial
Service Firms
• Non-Banking Finance Companies and Notified
Entities Regulations, 2008
• Private Fund Management Regulations, 2015
• all non banking financial institutions except
Modarabas have to register afresh with the SECP.
The law covers Investment Finance Services, Asset
Management Companies, Venture Capital
Investment Firms, Leasing and Housing Finance
Companies
• It controls the deposits, lending, housing finance
services, discounting services, micro financing,
investment advisory services, responsibility of
corporate governance, registration of trusts etc
 Regulations for Islamic Banks
• Instructions for Shariah Compliance in Islamic banking institutions
• Appointment of Shariah Advisor
• Shariah Advisor shall have access to all records, documents and information from all sources
including professional advisors and IBI employees in discharge of his duties
• Based on review conducted in terms of aforementioned para B(2), the Shariah Advisor shall
prepare a report
• Shariah Compliant Modes of Banking and Finance: (examples)
• Mudaraba (Mudaraba means an arrangement in which a person participates with his money
(called Rabbulmal) and another with his efforts (called Mudarib) for sharing in profit from
investment of these funds in an agreed manner)
• Ijarah (Ijarah is a contract whereby the owner of an asset, other than consumables, transfers its
usufruct to another person for an agreed period for an agreed consideration)
• Qard (Qard is a contract of loan between two parties in which borrower is required to pay back
only the principal amount borrowed. The Qard shall be repayable on demand)
• Wakalah (Wakalah is a contract of agency in which one person appoints another person to
perform a certain task on his behalf on agreed terms and conditions, usually against a certain
fee)
 Comparison between Pakistan and UK
corporate governance laws

• UK is also unitary board system whereas, Pakistan is unitary Board system but
Islamic banking companies have dual system
• In Pakistan banking sector cannot exceed more than 25 percent executive
directors, While in UK half of the board consists of directors
• Suggestions:
• Improve the internal control system especially Pakistan should these practices.
• Board of directors does not misuse of powers.
• Pakistan should be strict check and balance.
• Number of non executive should be increase so, that Individual decision does
not influence.
• Notice of Meeting is necessary before the time so, that directors attend meeting
timely.
• Fine should be increase from 10,000.
• Board of directors should avoid developing fiduciary relationship.
 Assessment of regulations
• Agriculture, the largest sector of economy, which the commercial banks had
neglected, has now begun to receive large allocations
• Credit cards, debit cards, personal loans and consumer durable loans are
catching up fast
• For the poor, who don’t have anything to mortgage, we have established
microfinance banks where no collateral is required
• The customer base of the banks has more than doubled during the last few
years and covers almost 2 million households in agriculture, SMEs,
Microfinance, Credit Cards, consumer loans, mortgage and auto loans, etc
• Unless there is credit available, except the millionaire/billionaire, the
common man doesn’t have enough money to build a house for himself
• One of the adverse effects of lower interest rates in the country has been
erosion of rates of returns on bank deposits.
 What is monetary policy
• Monetary policy consists of regulation and
control over the growth of money and
credit in an attempt to pursue broad
economic goals such as full employment,
avoidance of inflation, and sustainable
economic growth. Its principal tools are:.
 Monetary policy tools
1. The Open-Market Policy Tool
2. The Discount Rate Policy Tool
3.Changing Reserve Requirements on
Deposits and Other Bank Liabilities
These tools aim at keeping unemployment
low, inflation low and to ensure high
economic growth
 Open market operations
• consist of the buying and selling of securities by
the central bank in an effort to influence and
shape the course of interest rates and the
growth of money and credit.
• therefore, affect bank deposits -- their volume
and growth -- as well as the volume of lending
and the interest rates attached to bank
borrowings and loans as well as the value of
bank stock.
 Discount rate tool
• The Discount Window is the department in
each Federal Reserve Bank that receives
requests to borrow reserves from banks
and other depository institutions which are
eligible to obtain credit from the Fed for
short periods of time. The rate charged on
such loans is called the discount rate.
 Reserve requirement
• Reserve requirements are the amount of
cash and deposits at the Federal Reserve
banks that depository institutions raising
funds from sources of reservable liabilities
(such as checking accounts, business
CDs, and borrowings of Eurodollars from
abroad) must hold