regulatory environment for privatization of banks

8/13/2019 Regulatory Environment for Privatization of Banks

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Chapter 7

Regulatory Environment for Privatization of Banks

7.1. Introduction

Banking is sensitive industry. Unlike other corporate entities, the business of banking

requires supervision and vigilance to ensure the safety and soundness of the system and

also to protect the interest of the depositors. Ishrat Husain (2!". #ommercial banks are

also among the most tightly regulated economic institutions in modern economies. $here

are many %ustifications, including preventing contagious liquidity crisis, maintaining

financial stability, protecting small depositors and investors, enhancing efficiency, and

other social purposes (Herring and &antomero, 2' rei)as and *ochet, 2+".

#alomiris and hite (+--!" attribute banking regulation to the capture of the state by

interest groups. espite the tight regulations, banking crisis have been the sources of

economic instability during the last t/o decades of the 2th

century. 0s a result,

inappropriate banking has attracted more criticisms (#aprio, +--1".

$he past history of banks in akistan cannot be ignored. $he case of 3ehran Bank is still

on record. inancial institutions /ere opened in different nature and type, like

cooperative societies, etc. /ith out any proper regulation and vigilance. Huge percentage

of returned /as offered to attract peoples to deposit their savings. 0fter collection of

huge amount they run a/ay and the 4overnment of akistan is still facing to solve this

problem.

Banks are key institutions for attracting savings, in the form of short5term deposits, and

converting them into longer5term investments, in the form of loans. hen private capital

is genuinely at risk, bankers have strong incentives to gather information about the credit5

/orthiness of potential borro/ers, /hich they can then use to determine ho/, and on /hat

terms, credit is allocated. $his ensures that investment is directed to/ards the mostproductive purposes and imposes a hard5budget constraint on firms. (orld Bank, +--6".

Ho/ever, /hen political pressure distorts bankers7 incentives, credit may be directed

/ithout due regard to commercial lending criteria. $hese pressures are likely to be especially

pronounced for state5o/ned banks. In theory, bank8s privati9ation might, therefore, have a large

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effect on financial sector performance and, in turn, on aggregate long5term gro/th.

(emirguc5:unt and ;evine (+--!"

7. Regulatory Reform

roper regulation for corporate governance of banks received immense importance in the

aftermath of several episodes of banking crises in +--s, some of /hich resulted into

banking sector collapses. In an emerging economy like akistan, this issue becomes even

more important. In vie/ of rapidly developing market but slo/ pace of information

dissemination, it is important to reduce the adverse selection and moral ha9ard problems

that may arise due to ne/ entrants in the business of banking. It is in this perspective that

the &tate Bank of akistan issued some guidelines detailing the code of corporate

governance of banks. rivati9ation of banks /ithout proper regulation can create

problems. or e)ample, #hile privati9ed many public banks in the early +-


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Ca)inet Committee on Privatization $CC*P&

#reated in +--+, the ## has operated continuously e)cept for the period

&eptember +--1 to ebruary 2, /hen a rivati9ation Board of akistan headed

by the rime 3inister replaced it. resently, this #ommittee of the #abinet is

headed by the 3inister for inance and includes the 3inisters for rivati9ation,

Industries C roduction, I$ C $elecom, etroleum, ater and o/er, and ;abor.

It also includes the eputy #hairman, lanning #ommission. 0ccording to its

terms of reference issued in ebruary 2, the ## is to'

ormulate the rivati9ation olicy for approval of the 4overnmentD#abinet

0pprove the &tate /ned Anterprises to be privati9ed on the recommendation ofthe rivati9ation #ommission or other/ise

$ake policy decisions on inter5ministerial issues relating to the privati9ation

process

*evie/ and monitor the progress of privati9ation

Instruct the rivati9ation #ommission to submit reportsDinformationDdata relating

to the privati9ation process or any matter relating thereto

$ake policy decisions on matters pertaining to privati9ation, restructuring,deregulation, regulatory bodies and rivati9ation und 0ccount

0pprove the *eference rice in respect of the &tate /ned Anterprises being

privati9ed.

0pprove the successful bidders

#onsider and approve the recommendations of the rivati9ation #ommission on

any matter

0ssign any other task relating to rivati9ation to the rivati9ation #ommission.

! #)olition of the Pakistan Banking Council

$he akistan Banking #ouncil, established subsequent to nationali9ation of the

banking sector in the seventies, /as abolished in +--


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( Esta)lishment of CIRC

$he #orporate and Industrial *estructuring #orporation (#I*#" /as established

in 2 for acquiring Fon5performing ;oans of F#Bs. Fon5erforming ;oans

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. 0efinitions

In this 0ct, unless there is anything repugnant in the sub%ect or conte)t'

(a" 4overnment includes both the ederal 4overnment and any rovincial5555555555555555

555555554overnmentG

(b"economic reforms means economic policies and programmes, la/s and regulations

announced, promulgated or implemented by the 4overnment on and after the seventh day

of Fovember, +--, relating to privati9ation of public sector enterprises, and nationali9ed

banks, promotion of savings and 5 investments, introduction of fiscal incentives for

industriali9ation and deregulation of investment, banking, finance, e)change and

payments systems, holding and transfer of currenciesG and

(c" all other e)pressions used in this rdinance shall have the meaning, respectively

assigned to them under the relevant la/s.

!. #ct o *ver"ride other a8s

$he provisions of this 0ct shall have effect not/ithstanding anything contained in the

oreign A)change *egulation 0ct, +-!< (II of +-!


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continue to en%oy immunity against any inquiry from the Income $a) epartment or any

other ta)ation authority as to the source of financing of the foreign currency accounts.

2 $he balances in the foreign currency accounts and income there from shall continue to

remain e)empted from the levy of /ealth5ta) and income ta) and compulsory deduction

of Kakat at source.

@ $he banks shall maintain complete secrecy in respect of transactions in the foreign

currency accounts.

! $he &tate Bank of akistan or other banks shall not impose any restrictions on deposits

in and /ithdra/als from the foreign currency accounts and restrictions if any shall stand

/ithdra/n forth/ith.

9. Protection of iscal Incentives for 5etting"up of Industries

$he fiscal incentives for investment provided by the 4overnment through the statutory

orders listed in the &chedule or other/ise notified shall continue inforce for the terms

specified therein and shall not be altered to the disadvantage of the investors.

7. Protection of ransfer of *8nership to Private 5ector.

$he o/nership, management and control of any banking, commercial, manufacturing or

other company, establishment or enterprise transferred by the 4overnment to any person

under any la/ shall not again be compulsorily acquiredor taken over by the 4overnment

for any reason /hatsoever.

:. Protection of oreign and Pakistan Investment

Fo foreign, industrial or commercial enterprise established or o/ned in any form by a

foreign or akistani investor for private gain in accordance /ith la/, and no investment

in share or equity of any company, firm, or enterprise, and no commercial bank or

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financial institution established, o/ned or acquired by any foreign or akistani investor,

shall be compulsorily acquired or taken over by the 4overnment.

'. 5ecrecy of Banking ransaction

&ecrecy of bonafide banking transactions shall be strictly observed by all banks and

financial institutions, by /hosoever o/ned, controlled or managed.

1;. Protection of inancial *)ligation.

0ll financial obligations incurred, including those under any instrument, or any financial

and contractual commitment made by or on behalf of the 4overnment shall continue to

remain in force, and shall not be altered to the disadvantage of the beneficiaries.

11. Rules

$he ederal 4overnment may make rules for carrying out the purposes of this 0ct.

9. Promulgation of Privatization *rdinance

$o further strengthen the privati9ation process, the government promulgated the

rivati9ation rdinance in 2. $he rdinance strives to ensure that

privati9ation is carried out in a fair and transparent manner.

7.( 5tate Bank of Pakistan $5BP&

$he &tate Bank of akistan in itself is a regulatory authority, monitoring banks and

financial institutions. $here is a separate department, Banking olicy and *egulation

epartment specific for this purpose. In +--+5-2, the financial sector reforms /ere going

on at a rapid speed. rivati9ation of the banking sector has been an important component

of these reforms. It is motivated by the intention to increase the competitiveness and

efficiency of the banking system. In +--2, &B issued ne/ cautious regulations to

enhance the supervision and regulation of the banking system. $he ne/ guidelines

include more strict limits on credit concentration and on conditional liabilitiesG rigid

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guidelines on the separation of bank o/nership and managementG tighter margin

requirements on equity5based advancesG and a strong system of classification and

provisioning for non5performing assets. In addition, amendments /ere also made to the

banks Fationali9ation 0ct of +-

role of the akistan banking #ouncil in commercial banking. In +--@, through an

amendment in the &tate bank 0ct, +-6E, the &tate bank of akistan has been given

operational independence to conduct monetary policy and regulate and supervise the

banking sector. *ecently, an ordinance called inancial Institutions (*ecovery of

inances" rdinance 2+ has been promulgated. 0ccording to this ordinance a financial

institution or the customer may fill a suit in the banking court, /ith regard the any default

in the finances. (0.*. :emal, et al, 22"

7.+ egislative #genda for Economic Reforms

or the implementation of economic reform program, the government has as a matter of

policy, formulated an e)tensive legislative agenda cutting across the various sectors of

economy, including the banking and financial sector.

7.+.1 Banking and inancial 5ector

3indful of the magnitude of the defaulted loans, the Banking companies8 loan

recovery la/ is being strengthened to facilitate the process of mortgage,

foreclosure and e)peditious settlement of banking disputes. urther more, a

banking ;a/ *evie/ #ommission has been formed to revie/ all the banking la/s

and regulations /ith a vie/ to updating, consolidating and rationali9ing the same.

;egal measure to build confidence, /hich had eroded after the free9ing of foreign

currency accounts, are also being introduced to prevent such occurrences in the

future.Industrial finance is being revived through a restructuring of the banking and

financial sectors, riority /ill be given to the needs of small and medium industry

/ith in e)port orientation. Afforts /ill be focused to promote small and medium

industries, having high labor intensity.

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0s a follo/ up of its poverty alleviation program, the 4overnment has, through an

enabling legislation, established a ne/ bank for enhancing poor peoples8 access to

credit.

0 ne/ insurance la/ has been promulgated to provide for deregulated,

competitive and safe environment for insurance business.

0 ne/ la/ has also been framed to provide for easy mergers, acquisitions, take

over and liquidation of public listed companies.

#hanges in monopoly control authority la/ are also under consideration.

&tate Bank of akistan, during the last decade has implemented policies to reform the

banking sector in akistan, as part of the overall financial sector reform package initiated

in early +--s. 0lthough, slo/ in pace until recently, the reforms have been consistent

and continuous. 0s a result of these reforms, the commercial banking industry in akistan

has taken a ne/ shape and is /orking on a ne/ vision. art of these reforms is also

related to the issue of corporate governance of banks in akistan.

#orporate governance is a ne/ phenomenon not only in akistan but in general. $he

ma%or reason of corporate governance is the recent episodes of banks failures in different

parts of the /orld especially in the aftermath of the +--< 0sian financial crisis. $he issue

of corporate governance of banks in akistan received special attention because akistan

embarked on measures of banking sector restructuring and privati9ation at the same time

/hen deliberations /ere under/ay to devise some code of ethics for corporate

governance of the financial and corporate sector including banks. 0 ma%or step to/ards

this /as a %oint pro%ect by the &ecurities and A)change #ommission of akistan and the

UF (&A#5UF" in collaboration /ith the Aconomic 0ffairs ivision (A0" of the

3inistry of inance. $he pro%ect /as launched in 0ugust 22 /ith the ob%ective to

design, develop and implement a #ode of #orporate 4overnance. $hough this pro%ect had

some discussion on corporate governance for banks but its main focus /as the corporatesector in akistan and issued measures to create stakeholder a/areness, capacity building

and net/orking /ith other emerging economies. $o address the problems of banking

sector, the &tate Bank of akistan (&B" issued a LHandbook of #orporate 4overnance8

in 2@. $he ob%ective of this handbook is to provide guidelines

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for Board of irectors, managers and shareholders. 3ost of the recommendations and

guidelines stated in the handbook are directly dra/n from the recommendations made by

Basel #ommittee on corporate governance and A#. $hese guidelines cover four

important areas, namely, Board of irectors, 3anagement, inancial isclosure, and

0uditors. It is to be noted that this is the only document available at this point. &ome

important features of this Handbook are highlighted here'

a. he Board of 0irectors

Basel committee places ma%or responsibility on the board of directors and senior bank

management to fully understand the risk e)posure. 0s such, it is recommended that the

composition of the board of directors and senior management in a bank should include

individuals /ho are highly skilled and e)perienced in determining the risk e)posure

given the si9e and nature of the bank8s activities and should be able to take certain steps

if a need arise to reduce a high risk e)posure. *egulators and supervisors have an

important responsibility to determine the adequacy of the internal control measures

including the responsibilities of the board of directors in dealing /ith organi9ational

structure, accounting principles, checks and balances and safety of investment and

compliance of abiding by the given la/s and required disclosure. 0nother important part

of the recommendations issued by different committees such as Basel and A# deals

/ith the Business ethics, specifically to make sure that the rights of shareholders

stakeholders are /ell protected. 0ccordingly, these shareholders and stakeholders have a

right to adequate and timely information and appropriate forms of participation in the

decision making process of the bank.

#ppoint of Board of 0irector

rior clearance of the &B is needed for the appointment of B. $he potential

nomineeDappointee for the post of a irector should have substantial interest (no less than

2 per cent shares" and should be /orking in a management capacity for the bank.

0nyone holding at least + per cent shares can become irector sub%ect to &B8s

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approval. &B requires that the incumbent should also qualify the standard Lfit and proper

test8 for appointment. 0 minimum of 6 years of senior businessDmanagement level

e)perience for the post of directors /hile potential candidate for residents or #A of

banks need to have spent +6 years in banking career /ith a minimum of @ years in senior

level. $hese individuals should also have impeccable record in the their professional

capacities, should not have been involved in any bank insolvency or should not be a

defaulter of any kind and should not be a director in any other financial institutions

creating a conflict of interest.

$he &B may also ask any banking company to call a general meeting of the

shareholders to elect a ne/ director. Banking #ompanies rdinance (B#", +-E2 and

#ompanies rdinance (#", +-1! specify the procedure for the election of a director.

0ccording to the #ompanies 0ct, +-+@ the &B may also appoint no more than one

person to be a director of a banking company. In either case, the total number of directors

should not be less than seven and the tenure of a director is restricted to be no more than

si) consecutive years.

Responsi)ilities of the Board of 0irectors

$he responsibilities of the B are specified in the &B code of corporate governance.

&ome important ones are highlighted here'

$he Board shall approve and monitor the ob%ectives, strategies and overall

business plans of the institution and /ill ensure that all activities are carried out

prudently /ithin the frame/ork of e)isting la/s and regulations.

$he Board shall clearly define the authorities and key responsibilities of both the

irectors and the senior management /ithout delegating its policymaking po/er

to the management.

$he Board shall approve and ensure the implementation of all policies related to

audit and internal management of risk and resources and /ill be responsible for

the revie/ and update of e)isting policies.

$he Board /ill ensure an effective L3anagement information system8 to cater to

the needs of changing market conditions.

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$he Board should meet frequently (preferably on a monthly basis but at least

quarterly", and the individuals directors should attend at least half of the meetings

held in a financial year. $he &B requires that all akistani scheduled banks in

akistan should not hold their ordinary B meetings outside the country.

Holding such meeting abroad leads to /astage of resources /ithout any benefit to

depositorsDcustomers.

$he Board is required to prepare a formal summary of the proceedings of the

general meetings and meeting of its directors and committee of directors for

inspection duly signed by the chairman and makes it available for inspection by

members free of charge. Under an amendment to the B#, +-E2, the &B starting

Manuary 2, required all banks incorporated in akistan to furnish copies of the

minutes of the meeting of their respective Bs /ithin seven days of the meetingto the irector, B*, &B.

$he activities of the Board should be transparent to the e)ternal auditors and

supervisors to form a %udgment on its /orking and decision5making performance.

$he Board /ill ensure that appropriate actions are taken, in consultation /ith the

audit committee of the Board, to rectify any /eaknesses and lack of controls /ith

a copy of the letter submitted to the &B for monitoring purposes.

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same family no more than 26N (as compared to 6N allo/ed earlier". $he B#, +-E2

also restrict a person to be a director of t/o companies simultaneously. $o reduce

political influence, any ederal, or rovincial 3inister or the 3inister of &tate or a civil

servant cannot be appointed as the director of the banking company.

Under prudential regulation guidelines of the &B, the banking is not allo/ed to make

loans or advances to any of its directors, chief e)ecutive, individuals, or their family

members or firms or companies /hich the banking company or any of its director is

interested as partner holding more than 6 per cent of the share capital or make loans and

advances on the guarantee of the above individuals. $he banking company is also not

allo/ed to make loans and advances against the security of its o/n share. $he prudential

regulation circular issued in +--2 also forbids banks to enter, /ithout a prior approval of

the &B, into a lease, rent or saleDpurchase agreement /ith their directors, officers,

employees or any individual (or their family member" /ith o/nership of + percent or

more of the equity of the bank

henever deemed necessary, the &B has the authority to supersede the Board of

directors and may continue to do so for period determined by the &B. $he & guidelines

also detail the procedure for the removal, retirement or prosecution of director(s" or chief

e)ecutive officers.

). 4anagement

$he appointment criterion of the #hief A)ecutive fficer (#A" is the same as the

irector of the B. Fo prior approval of the &B is required for such appointments.

Ho/ever, the banks are required to adhere to the &B8s guidelines containing the =it

and roper $estO for the appointment of key e)ecutives, especially very senior level

officials non5compliance to /hich /ill result into punitive actions against the banking

company. $he key criterions of the Lit and roper test8 include'

$he incumbent should have a track record of LHonesty, integrity and reputation8,

not convicted of any criminal offence including fraud or financial crime.

&hould be competent and capable of fulfilling hisDher duties, having adequate

qualification and e)perience.

&hould not have been removedDdismissed from service in the capacity of an

employee, director or chairman on account of financial crime or moral conduct.

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&hould not be defaulter of payment(s" due to any financial institutions or ta)

office.

&hould not supervise more than one functional area that give rise to conflict of

interest /ithin the banking company and should not hold directorship of a

company that is a client to the bank.

c. inancial 0isclosure

Under the B#, +-E2, all banking companies incorporated in akistan or foreign

banks /ith branches in akistan are required to furnish a balance sheet and profit

and loss account to the &B at the end of the calendar year.

$he #, +-1! requires that the directors shall attach a report /ith the balance

sheet to report the state of the company8s affairs, the details of dividend

distribution, and details of any reserve accounts

isclose any material changes and commitments affecting the financial position

of the company.

isclosure of any observations or negative remarks made in the auditor8s report.

&tate details of holding of share, earning per share, reasons for incurring loss (if

any" and any defaults (if any".

Foncompliance to the above /ill result in to punitive actions by the relevant

authorities.

d. #uditors

0nother principal of effective bank supervision is the effective internal audit. Internal

audit helps to identify the problem areas and to avoid a ma%or collapse. Ho/ever, to have

an effective internal audit, it is important that the bank should have sufficient resources

and qualified and an appropriate methodology to undertake this task. 0gain, supervisors

have to make sure that banks have an appropriate audit function and satisfy the above

criterion. *eporting of these reports in an accurate and timely manner is essential for

evaluation of the bank8s status and need for any necessary strategy. &upervisors have the

authority to hold management responsible for the release of all such information and

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reports and that these reports are accurate and produced in a timely manner. &ome

recommendations from the &B8s handbook are stated here'

Under #, +-1!, the banking company is required to appoint an auditor in its

annual general meeting for a period of one year. $he first auditor of a ne/ly

incorporated company should be appointed /ithin E days of the incorporation of

the company.

0ll banking companies are required to appoint auditors from the panel of auditors

maintained by the &B. $his panel consists of auditors /ho satisfy certain

minimum criteria based on their qualification and e)perience. 0ny individual /ho

is a director of the company or has any kind of employment /ith the company or

any of hisDher family member is employed by the company cannot be appointed

as the auditor of the same company. 0ny individual or hisDher family member/ho is appointed the e)ternal auditor is not allo/ed to hold, purchase, or sale

shares of the company.

$he B#, +-E2 states that the balance sheet and profit and loss account prepared

by the company shall be audited by the banking company8s auditor.

$he auditor is required to furnish an audit report stating the authenticity of the

information and e)tend of cooperation provided by the banking company /hile

conducting the company audit. $hese /ill include verification of the sources of

funds generated and investments made by the banking company during the audit

period.

$he auditor shall adhere to the guidelines or any amendments to the guidelines issued by

the &B for the audit of the banking company. $he auditors /ill furnish a special report

to the irector, Banking &upervision epartment (B&" of the &B and a copy to the

concerned bank. (&tate Bank of akistan (2!", raft 4uidelines on Internal #ontrols,

&tate Bank of akistan, :arachi."

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P#R = #

0 E I % I I * % 5

+. Bank means a banking company as defined in the Banking #ompanies rdinance,

+-E2.

2. Borro8er means an individual to /hom a bank D I has allo/ed any consumer

financing during the course of business.

@. Consumer inancing means any financing allo/ed to individuals for meeting their

personal, family or household needs. $he facilities categori9ed as #onsumer inancing

are given as under'

(i" Credit Cardsmean cards, /hich allo/ a customer to make payments on credit.

&upplementary credit cards shall be considered part of the principal borro/er for the

purposes of these regulations. #orporate #ards /ill not fall under this category and shall

be regulated by rudential *egulations for #orporate D #ommercial Banking or

rudential *egulations for &3As inancing as the case may be. $he regulations for credit

cards shall also be applicable on charge cards, debit cards, stored value cards and B$

(Balance $ransfer acility".

(ii" #uto oansmean the loans to purchase the vehicle for personal use.

(iii" 3ousing inancemeans loan provided to individuals for the purchase of residential

house D apartment D land. $he loans availed for the purpose of making improvements in

house D apartment D land shall also fall under this category.

(iv" Personal oansmean the loans to individuals for the payment of goods, services and

e)penses and include *unning inance D *evolving #redit to individuals.

!. 0I means evelopment inancial Institution and includes the akistan Industrial

#redit and Investment #orporation (I#I#", the &audi ak Industrial and 0gricultural

Investment #ompany ;imited, the ak :u/ait Investment #ompany ;imited, the ak

;ibya Holding #ompany ;imited, the ak man Investment #ompany (vt." ;imited

and any other financial institution notified under &ection @50 of the Banking #ompaniesrdinance, +-E2.

6. 0ocuments include vouchers, cheques, bills, pay5orders, promissory notes, securities

for leases D advances and claims by or against the bank D I or other papers supporting

entries in the books of a bank D I.

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++. 5ecuredmeans e)posure backed by tangible security /ith appropriate margins (in

cases /here margin has been prescribed by &tate Bank of akistan, appropriate margin

shall at least be equal to the prescribed

defined as clean.

+2. angi)le 5ecuritymeans liquid assets (as defined in these rudential *egulations",

mortgage of land and building, hypothecation or charge on vehicle, but does not include

hypothecation of household goods, etc.

P#R = B

4I%I424 RE@2IRE4E%5 *R C*%524ER I%#%CI%

regulatory environment for privatization of banks

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