## _cr04215 - 1. Asset Structure of the Financial Sector, 2000-03

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### Overall stability assessment — key findings
- Major reforms produced a more resilient and efficient financial system but infancy of reforms and deeper financial intermediation require continued supervisory vigilance.
- Transformation from a largely state-owned weak banking system to a healthier, primarily privately-owned system achieved through restructuring, consolidation, strengthened regulatory capacity, and improved transparency, corporate governance, and credit culture.
- Increased liquidity led to rapid credit growth to the private sector that could be problematic if sustained; supervisors need to ensure credit quality is not compromised, particularly where banks are inexperienced.
- Securities markets benefited from reforms but face systemic vulnerabilities from highly leveraged/speculative trading through the “badla” system and lack of supervision of market intermediaries; phased elimination of the “badla” system is welcome.
- Credit expansion to consumer, housing, SME, and agricultural sectors expanded markedly; large segments of the economy still operate with little formal credit, requiring promotion of new business models and adaptation of regulations.
- Privatization and legal reforms need to continue; government should divest remaining stakes in banks and expedite privatization of SMEB, IDBP, HBFC, ICP, and NIT; reconsider continued ownership of NBP and three public insurance companies.
- Insurance penetration is very low; further consolidation, liberalization, and a more market/solvency-based regulatory regime are needed.
- Pension issues require attention: financial sustainability and regulatory oversight of civil servants and EOBI schemes, and establishment of a comprehensive legal and regulatory framework for private occupational and personal pensions.
- Improvements in market infrastructure and practices include a transparent framework for liquidity management, flexible market-based monetary instruments, high observance of IMF Code for Good Practices on Transparency in Monetary and Financial Policies, and planned introduction of RTGS to contain systemic payments risks.

### Overall stability assessment — quantified observations
- As of end-September 2003, commercial banks’ assets were 54 percent of GDP; assets for all financial institutions were 57 percent of GDP.
- Credit to the private sector expanded by 28.5 percent in 2003.
- Banks’ average capital adequacy ratio (CAR) improved from 11.3 percent in December 2001 to 13.1 percent as of September 2003, with 22 banks registering ratios above 15 percent.
- Aggregate NPL ratio ranges from 0.4 percent to 35.1 percent across banks.
- Asset quality of the five largest banks is weak, with NPLs to total loans ranging from 15 percent to 35 percent.
- Privatization progress: private banks’ share of total banking system assets increased to 59 percent as of September 2003 from 34 percent at end-1999; subsequent privatization of Habib Bank increased this share to more than 75 percent.
- Largest bank, NBP, has a market share of approximately 20 percent; government sold some 23 percent of its ownership in NBP during 2001–03.
- Minimum capital requirement increases: from PRs 500 million to PRs 750 million as of end-December 2001 and further to PRs 1 billion (around US$17 million) as of end-December 2002.
- Islamic banking accounts for between 1-2 percent of total banking sector assets.

### Key recommendations — banking sector
- Revise the SBP Act and the Banking Companies Ordinance to address concerns in the Basel Core Principles assessment, especially ensuring legal authority of the SBP to conduct consolidated supervision.
- Adopt market risk-related capital charges and consider tightening specific provisioning requirements.
- Develop a strategy to privatize NBP and continue divestiture from the capital of other banks.

### Key recommendations — nonbank financial institutions and markets
- Conduct a formal review to determine whether SECP has adequate resources and capacity to fulfill its mandate; expedite adoption of margin financing rules; review legal provisions governing insider trading.
- Establish a comprehensive legal and regulatory framework for private occupational pensions, providing for, inter-alia, custodial requirements, funding and investment standards, reporting and valuation standards, and prohibitions on self dealing and transactions with related parties.
- Review roles of state-owned insurers and place the State Life Insurance Company (SLIC) on a pari passu basis with the rest of the life insurance sector; clarify legal roles of MOC and SECP in the insurance sector; provide the SECP with on-site inspection capacity and powers to require prompt corrective action.
- Develop a more comprehensive debt policy and related risk management system; make the Debt Policy Coordination Office (DPCO) fully functional.
- Align NSS rates more closely with market rates and develop market-based alternatives to present schemes.
- Resolve IDBP through privatization, merger or closure, in the least cost manner.
- Launch title regularization programs, reform registration services, and lower property and mortgage registration duties.

### Key recommendations — financial infrastructure and information systems
- Establish a clear legal framework for private credit bureaus, enabling them to provide more comprehensive credit information.
- Establish a clear legal mandate for SBP to oversee the payments system and provide rules on netting and real time settlement.
- Promulgate a single law to provide a comprehensive legal framework for Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT).

### Macroprudential environment and vulnerabilities
- Macroeconomic stabilization progress: strengthening Real GDP growth, subdued inflation, markedly reduced overall fiscal deficit and public debt, comfortable current account, large reserve accumulation, and international appetite for sovereign debt; dollarization-related risk diminished.
- Risks include rapid private credit growth (28.5 percent in 2003), expected increase in interest rates and tighter liquidity conditions, potential sharp run-up in oil prices, slowdown of remittance inflows, and possible changes in international political environment that could dry up funds.

### Financial and regulatory structure — institutional roles
- SBP and SECP are largely responsible for regulation and supervision; BCO establishes SBP authority for supervision, regulation, and licensing of commercial banks and DFIs.
- Most other financial institutions are regulated by SECP; stock exchanges operate as self-regulated organizations (SROs).
- Legal and regulatory authority for insurance and pensions is diffused and, in some respects, ineffective.
- Legal and regulatory framework for microfinance banks (MFBs) is provided by the Microfinance Ordinance of 2001.

### Stability, soundness, and development — commercial banks
- Structural changes: private banks’ share of system assets rose to 59 percent as of September 2003 from 34 percent at end-1999; with Habib Bank privatization share rose to more than 75 percent.
- Competition and liberalization: liberalization measures included market-based monetary and exchange rate policies, permission to open private banks, elimination of bank-by-bank credit ceilings, and removal of caps on lending rates; moratorium on licensing new banks imposed in 1995 remains in force except for Islamic banks.
- Islamic banking: accounts for between 1-2 percent of total banking sector assets; SBP is the regulator and applies prudential requirements plus additional requirements adapted to Islamic banking.
- Performance and efficiency:
  - CAR: improved from 11.3 percent in December 2001 to 13.1 percent as of September 2003; 22 banks have CAR above 15 percent.
  - Improvement reflects better profitability, fresh capital injections, increased share of government securities with zero risk weight, and revaluation of assets.
  - Aggregate NPL ratio on a downward trend but remains high and concentrated in largest banks.
  - Flow of new NPLs declined significantly; substantial share of NPLs pertains to loans more than three years overdue.
  - Provisioning against NPLs is improving, but collapse in collateral values (which banks are allowed to use to offset required provisioning) could adversely affect banks’ balance sheets.

### Profitability and loan composition
- Return on equity:
  - Turned around to 13.1 percent in 2002.
  - Increased to 22.1 percent during the first three quarters of 2003.
- Drivers of improved profitability:
  - Increased business volume; retrenchment of personnel; closure of unprofitable branches; higher non-interest income reflecting fee-based activities and capital gains.
- Rapid credit growth and emerging risks:
  - Share of personal loans rose to 12 percent of total bank credit (as of September 2003).
  - SBP regulations require banks to hold general reserves against consumer loans; specific provisioning requirements could be tightened.

### Stress tests — scope and headline results
- Scope:
  - Based on bank balance sheet data as of September 2003.
  - Tests for 12 largest commercial banks (accounting for 83 percent of banking system assets), groups: public sector (5 banks), local private (17 banks), foreign (14 banks), and system-wide.
- Credit risk shocks modeled:
  - 35 percent increase in NPLs bringing NPL ratio to previous historical high.
  - 10 percent additional provisioning from tightened rules.
  - 40 percent decline in value of collateral (mostly real estate).
  - Under the first shock, CAR of 4 banks, representing 16 percent of the system, would fall below minimum regulatory requirements, although remain above 6 percent.
  - Simultaneous occurrence of the three shocks would reduce solvency ratios of many banks, especially public sector commercial and local private banks, to below 8 percent; two banks (including the second largest) would see CAR decline to below 5 percent.
- Market risk:
  - As of September 2003, foreign currency deposits were 8 percent of total deposits; foreign currency loans averaged 15.2 percent for the banking sector as a whole.
  - Net foreign exchange open position of the banking sector was 23 percent of capital.
  - A hypothetical 50 percent stock market crash would reduce the average CAR of the 12 largest banks to 4.9 percent; only four of these banks would have CAR above the required minimum.
  - Note: KSE Index increased by 250 percent between December 2001 and December 2003.
- Combined shocks:
  - Synchronous depreciation by 25 percent; deterioration in quality of 50 percent of unhedged FX loans (100 percent provisions); increase in interest rates of outlying maturities (by 100, 300, and 500 basis points) — would reduce CAR of public sector commercial banks to 4.7 percent.
  - If additionally there is a 40 percent decline of the stock market, sector CAR would fall to 2.9 percent, and capital position of public sector commercial banks would turn negative (-4.8 percent).
  - Government injection of capital equal to 1 percent of GDP would then be required to restore capital adequacy of these banks.
- Liquidity risk:
  - Even a 20 percent run on liquid liabilities would not result in liquidity shortage; liquidity coverage would remain adequate.
- Cautions:
  - Most banks have enough capital to withstand increases in NPLs of more than 70 percent, assuming provisioning rate for these marginal NPLs of 100 percent.
  - Weaker banks experience capital adequacy problems with relatively modest NPL increases.

### Capital markets — structure, risks, and development priorities
- Market capitalization reached US$16.5 billion at the end of 2003, equivalent to about 24 percent of GDP.
- 693 listed shares; trading highly concentrated: just over half in top 10 shares, and 95 percent in top 30.
- Total investor base is less than 0.5 percent of the population.
- Market infrastructure: three mutual stock exchanges, NCSS, CDC, 278 registered brokers, a modest but growing mutual fund industry, and two registered rating agencies.
- KSE-100 index up by 270 percent over past 26 months.
- Risks:
  - COT or “badla” system poses market stability risks: highly leveraged positions financed by brokerages and banks, lack of transparency, speculative transactions, scope for manipulation and systemic risk.
  - SECP instituted rules for “badla” trading and is developing margin financing rules expected to replace COT.
- Recommendations:
  - Rapidly adopt appropriate margin trading rules; obtain independent expert advice on clearinghouse and investor protection funds; strengthen rules for segregation of client assets in brokerage accounts.
  - Further align NSS rates with prevailing yields and consider market-based alternatives (for example, replace NSS instruments with retail marketable securities sold through subscriptions or auctions).
  - Investor education and support services need strengthening.

### Insurance
- Size and comparison:
  - Total premium income: PRs 26 billion in 2002.
  - Total assets: PRs 126 billion as at December 31, 2002.
  - Insurance premiums per capita: $1.0 for life and $1.7 for nonlife; comparisons—India: $11.3 (life) and $3.0 (nonlife); Indonesia: $5.2 (life) and $6.6 (nonlife).
- Key challenges:
  - Sector highly underdeveloped; immediate need to rationalize an overpopulated non-life sector and adjust to new international accounting and solvency norms.
  - Insurance Ordinance 2000 omitted elements key to modern risk-based supervision: limited prompt corrective action power, lack of on-site supervision capacity, and in-house specialist skills.
  - Need to clarify division of responsibilities between MOC and SECP; consensus emerging that regulatory and supervisory responsibility for insurance should lie with SECP and oversight relating to ownership and governance of public sector insurers with MOC.
- Public sector insurers:
  - Consider exit strategy for National Insurance Company (NIC).
  - Limit government exposure to contingent risks at Pakistan Reinsurance Company Limited (PRCL), possibly by finding a private sector partner.
  - For State Life Insurance Company (SLIC), consider arms-length ownership to avoid distorting contractual savings market.

### Pension funds
- Structure:
  - Multi-pillar: (i) civil servants pensions; (ii) EOBI (mandatory defined benefits for private sector enterprises with 10 or more employees); (iii) provident funds and pension schemes by larger private employers; (iv) nascent market in personal pensions through contractual savings and insurance products.
- Fiscal and policy considerations:
  - Civil servants and EOBI entail substantial direct and indirect liabilities for the government that need addressing.
  - Planned introduction of private pension savings accounts presents scope for capital market development but requires proper regulatory safeguards.
- Private employer-sponsored arrangements:
  - No centralized reporting requirement exists.
  - SECP assigned general authority but there is currently no direct oversight or supervision of these schemes.
  - Recommended regulatory elements: custodial requirements; funding and investment standards; reporting and valuation standards; prohibitions on self dealing and related-party transactions.

### Improving access to financial services
- Progress:
  - Lending to previously underserved markets has risen substantially in the past two years; commercial banks have overtaken public specialized banks in providing agricultural, SME and housing finance.
- Outreach gaps (2003):
  - Bank credit reached 15 percent of all farms.
  - SMEs obtained just over 7 percent of their financing from banks and other financial institutions.
  - Surveys: SMEs received 7 percent of working capital and 7.3 percent of investment finance requirements from banks and other financial institutions (versus 13.3 percent and 23.6 percent respectively for larger firms).
- Measures to scale up lending:
  - Banks and NBFCs need to adopt new products and technology, including programmed lending tools and credit scoring models.
  - Credit information systems can play a key role.
- Microfinance:
  - Regulatory framework for MFIs seems sound; minimum capital requirements for national license are PRs 500 million, or US$8.8 million, which could discourage entry; lower requirements apply to district level banks but are still high.

### Development Finance and Specialized Institutions
- Reforms since late 1990s: a number of DFIs closed or merged; remaining entities to operate on a commercial basis with no new government funding.
- Planned: SMEB, IDBP and HBFC to be restructured and fully privatized; ZTB to be partially privatized.
- Policy recommendations:
  - HBFC should be privatized or its assets sold.
  - IDBP should be resolved (privatized, merged or closed) given mounting operational losses.

### Systemic liquidity, public debt management, crisis management, and safety nets
A. Liquidity Management and Markets
- SBP seeks to “secure monetary stability and the soundness of the financial system.”
- Target: low inflation currently defined as 4 to 5 percent average annual CPI inflation.
- Instruments: discount rate and cut-off rate for government securities auctions serve as implicit policy rates.
- Instruments for managing domestic liquidity are market-based, flexible and relatively well developed.
- SBP considering implications of Islamic banking sector and planned RTGS system.
- Consideration of inflation targeting: adoption of full-fledged inflation targeting would be premature due to need for clear legislative mandate for SBP, greater exchange rate flexibility, robust short-term forecasting, and understood transmission mechanism.
- FX inflows and reserves: SBP accumulated substantial foreign exchange reserves; strategy of partly relying on external managers is appropriate with conservative balance between return and risk.
- Money market development: promote interest rate swaps and preannounce schedule for PIB auctions, especially after prohibition of institutional investment in NSS.

B. Lender-of-Last Resort and Bank Resolution
- Emergency liquidity support handled case-by-case through discount window at penalty rate; SBP might set formal internal procedures and limit acceptable collateral to marketable government securities.
- Bank resolution framework: SBP prepared a Problem Bank Manual; establishment of CIRC helped address NPLs.
  - As of March 31, 2004:
    - Some 738 cases with total outstanding amount of PRs 132 billion had been referred to the CIRC.
    - Of these, it had acquired 234 amounting to PRs 47 billion.
    - Of the latter, 192 involving an outstanding amount of PRs 31 billion had been resolved.

C. Deposit Insurance
- Caution: deposit insurance can reduce depositor flight risk but also reduce discipline and encourage risk taking.
- Design principles: agency should be independent; premium structure and coverage should ensure incentives and viability; membership should be compulsory; insolvent institutions should not be included.
- SBP proposal details:
  - Protect deposits up to PRs 100,000, equivalent to 3.8 times per capita GDP and covering 94 percent of all accounts up to this amount and 52 percent of the total value of deposits.
  - Envisages a flat premium of 0.02 percent of total insurable deposits to be paid by covered institutions.
  - Seed funding of PRs 5 billion to be provided by the government.
- Concerns: establishment of the fund at the SBP could create a conflict of interest; proposed premium appears low by international standards; proposed seed funding is half the required amount estimated by SBP.

D. Public Debt Management
- Strategy focused on debt reduction and lowering interest costs.
- At December 2003, net claims on government constituted 32 percent of net domestic assets, up from about 20 percent in 2000.
- Debt management practices largely follow IMF-World Bank Guidelines but should emphasize risk management (interest lost, currency exposure, cash flows, bunching of maturities).

### Financial Sector Infrastructure
A. Payments System
- NIFT automated check clearing system operational since 1997.
- SBP establishing an RTGS to replace current manual book-entry system.
- Legal framework deficiencies: no legal provisions regarding finality of payment and zero hour rule; recommendation to amend SBP Act to add a chapter on payment systems.

B. Legal Issues
- Need to update SBP Act of 1956 (amended 2002) and address provisions allowing government to supersede central board and liquidate the Bank.
- Issues in Banking Companies Ordinance 1962 (amended 2001) need addressing.
- Debt Recovery Ordinance (2002) permits summary recovery and sale of mortgaged property but creditors reluctant to use summary procedures; insolvency and bankruptcy laws over 80 years old and average time for liquidation ranges from 10–15 years; authorities revamping insolvency laws.

C. Credit Information, Corporate Governance, and Accounting and Auditing
- Credit information: SBP operates an on-line credit information bureau and two private credit registries; in 2001 SBP made credit ratings compulsory for all banks and NBFIs.
- Corporate governance: Company Ordinance contains detailed provisions; SECP issued Code of Corporate Governance in March 2002 and a code for insurance companies in March 2003.
- Accounting and auditing: follow International Accounting Standards; ICAP is an active SRO; SECP proactive in strengthening financial reporting and audit reliability.

### AML/CFT assessment
- A detailed assessment of compliance with the FATF 40+8 Recommendations on AML/CFT scheduled to be conducted by the Asia-Pacific Group on Money Laundering in August, 2004. The APG will prepare a ROSC for Fund/Bank boards.
- Current context:
  - Pakistan has several laws dealing with aspects of AML/CFT; a comprehensive legal and institutional framework is in preparation.
  - SBP has developed two Prudential Regulations in force concerning “Know Your Customer” and “Anti-Money Laundering Measures.”
  - SECP has established an Anti-Money Laundering Unit and taken relevant measures.
- Recommendation: authorities are urged to complete and implement the comprehensive legal and institutional framework for AML/CFT prior to the APG assessment.

### Asset structure of the financial sector (selected Table 1 figures, 2000–2003)
- Aggregate assets (All Financial Institutions):
  - 2000: 2,046
  - 2001: 2,165
  - 2002: 2,432
  - 2003 (As of September 2003): 2,510
- Commercial Banks assets (in billions of rupees):
  - 2000: 1,696
  - 2001: 1,835
  - 2002: 2,127
  - 2003 (As of September 2003): 2,380
- Commercial Banks as percent of total financial institutions:
  - 2000: 82.9 percent
  - 2001: 84.8 percent
  - 2002: 87.5 percent
  - 2003: 94.8 percent
- Memorandum items:
  - Commercial Banks (in percent of GDP): 49.5 (2000), 50.6 (2001), 52.9 (2002), 54.1 (2003)
  - All Financial Institutions (in percent of GDP): 59.8 (2000), 59.7 (2001), 60.5 (2002), 57.0 (2003)

### Financial soundness indicators for the banking sector (selected Table 2, 1999–Sep-03)
- Capital Adequacy:
  - Regulatory capital to risk-weighted assets: 12.2 (Dec-99), 11.4 (Dec-00), 11.3 (Dec-01), 12.6 (Dec-02), 13.1 (Sep-03)
  - Tier I capital to risk-weighted assets: 10.3 (Dec-99), 9.8 (Dec-00), 9.7 (Dec-01), 9.7 (Dec-02), 10.9 (Sep-03)
  - Capital to total assets: 5.0 (Dec-99), 4.9 (Dec-00), 4.6 (Dec-01), 6.1 (Dec-02), 6.2 (Sep-03)
- Asset composition and quality:
  - NPLs to gross loans: 22.0 (Dec-99), 19.5 (Dec-00), 19.6 (Dec-01), 18.0 (Dec-02), 16.1 (Sep-03)
  - Provisions to NPLs: 46.6 (Dec-99), 53.9 (Dec-00), 53.2 (Dec-01), 58.3 (Dec-02), 63.0 (Sep-03)
  - NPLs net of provisions to capital: 117.4 (Dec-99), 96.7 (Dec-00), 100.7 (Dec-01), 54.5 (Dec-02), 41.8 (Sep-03)
- Earnings and profitability:
  - ROA (after tax): -0.3 (Dec-99), 0.0 (Dec-00), 0.0 (Dec-01), 0.8 (Dec-02), 1.4 (Sep-03)
  - ROE (after tax): -6.2 (Dec-99), -0.3 (Dec-00), -0.3 (Dec-01), 13.8 (Dec-02), 22.1 (Sep-03)
  - Net interest income to gross income: 54.3 (Dec-99), 61.2 (Dec-00), 68.9 (Dec-01), 67.4 (Dec-02), 58.2 (Sep-03)
  - Noninterest expenses to gross income: 76.9 (Dec-99), 71.6 (Dec-00), 62.7 (Dec-01), 57.3 (Dec-02), 50.4 (Sep-03)
  - Non-interest income to total income: 17.6 (Dec-99), 16.5 (Dec-00), 14.5 (Dec-01), 18.1 (Dec-02), 30.9 (Sep-03)
- Liquidity:
  - Liquid assets to total assets: 38.7 (Dec-99), 37.5 (Dec-00), 39.9 (Dec-01), 47.0 (Dec-02), 48.6 (Sep-03)
  - Liquid assets to total deposits: 48.2 (Dec-99), 48.0 (Dec-00), 50.3 (Dec-01), 60.2 (Dec-02), 59.4 (Sep-03)

### Summary of stress tests assumptions and results (selected Table 3, end-September 2003)
- Pre-shock Capital Adequacy Ratios (Before Shock):
  - Group 1: 11.9; Group 2: 14.1; Group 3: 10.3; Group 4: 22.3; Group 5: 13.1
- Credit risk shocks — example outcomes:
  - Increase in NPLs of 35 percent: Group 1: 9.5; Group 2: 11.3; Group 3: 8.3; Group 4: 20.1; Group 5: 10.8
  - Combination of three shocks (35% NPLs increase; shift in classified loans; 50% decline in real estate collateral): Group 1: 6.1; Group 2: 6.4; Group 3: 6.0; Group 4: 19.4; Group 5: 7.8
- Equity risk:
  - Decline in equity values by 50 percent: Group 1: 4.9; Group 2: 4.3; Group 3: 4.2; Group 4: 21.1; Group 5: 6.4
- Combined severe scenario:
  - Depreciation of 25 percent + deterioration of 50 percent of unhedged FX loans + increase in interest rates of outlying maturities (100, 300, 500 basis points) + 40 percent decline in equity values: Group 1: 0.8; Group 2: -4.8; Group 3: 4.1; Group 4: 17.1; Group 5: 2.9
- Liquidity shocks:
  - A 10 percent withdrawal in liquid liabilities: Group 1: 46.2; Group 2: 53.5; Group 3: 40.1; Group 4: 37.4; Group 5: 44.9
  - A 20 percent withdrawal in liquid liabilities: Group 1: 39.5; Group 2: 47.7; Group 3: 32.6; Group 4: 29.5; Group 5: 38.1

### Observance of standards and codes — assessments and main findings
- Detailed assessments undertaken: Basel Core Principles (BCP); IOSCO Principles; IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies.
- Overall conclusions:
  - Pakistan’s compliance with international supervisory standards is generally high.
  - SBP has made considerable progress; only few areas show less than full compliance.
  - SECP has achieved a relatively high degree of compliance with IOSCO but requires additional resources and institutional capacity building.
  - Transparency practices regarding monetary policy formulation and implementation and banking supervision are generally in line with best practices.

### Basel Core Principles — main findings and recommended actions
- Legal/institutional framework:
  - BCO establishes SBP as authority responsible for supervision, regulation and licensing of banks and certain NBFCs.
  - Comprehensive revision of the BCO by SBP’s Banking Law Review Commission is underway.
- Preconditions and autonomy:
  - Federal Government retains powers that can direct or supersede SBP in certain circumstances (Sections 17(6A) and 52(1) cited); SBP remains a substantial shareholder in some formerly nationalized banks, creating apparent conflict between regulator and owner roles.
- Capital and NPL reforms:
  - MCCR for banks set at PRs 1 billion; risk-weighted capital adequacy ratio requirement in excess of 8 percent enforced.
  - Result: net NPLs to capital of commercial banks fell from 117.4 percent at December 31, 1999 to 41.8 percent at September 30, 2003.
- Supervisory methods:
  - SBP uses on-site and off-site supervision; standardized “CAMELSS” approach under Uniform Bank Grading System.
- Gaps and recommended action:
  - Provide explicit authority in BCO for sharing information with domestic and foreign supervisors.
  - Consider repealing Sections 17(6A) and 52(1) of SBP Act to enhance autonomy.
  - Consider legislative changes to facilitate consolidated supervision (CP 20) and exchange of confidential information.

### Market risk and capital charges
- Market-risk related computations and capital charges are not in force in Pakistan.
- Risk-weighted capital adequacy requirements are applied on both a “solo” and consolidated basis.
- As of February 27, 2004:
  - only three specialized banks (all government owned) together with one bank recently transferred to new ownership failed to meet the required minimum 8 percent risk-weighted capital ratio.
  - only the three specialized banks, together with a few small, foreign-owned banks had a capital base of less than PRs 1 billion.
  - the small, foreign-owned banks are in final stages of transfer to new owners; such transfers and capital injections are to occur by June 30, 2004.
- Recommendation: SBP to issue circular on market-risk related computations and capital charges (BSD drafting based on Basel Committee recommendations).

### Securities regulation — SECP assessment and recommended actions
- SECP is "an active and energetic regulator" with extensive powers and a high degree of compliance with IOSCO Principles.
- Immediate challenges:
  - SECP combines law preparation, surveillance, enforcement and adjudication; must maintain transparency and plan resource allocation.
  - SECP should undertake a formal review of processes and resources, commence regular on-site supervision, and consider issuing further guidance notes and policy statements.
- Key gaps and recommendations:
  - Enhance mechanisms for sharing non-public information with foreign counterparts.
  - Review adequacy of insider trading laws and rules for segregation/protection of client money and assets.
  - SECP and exchanges should enter into an MOU for coordination and information exchange.
  - SECP should review rules for valuation and pricing of CISs and the adequacy of protection for holders of debt securities and trusteeship arrangements.

### Broker back-office records, segregation and proprietary trading
- Brokers required to maintain back office records of securities held in omnibus/group accounts and reconcile daily activity with book-entry holdings.
- CDC conducts periodic audit of broker back office records under CDC Regulations to monitor compliance with CDA 1997 and ensure proper authorization for handling of client securities.
- Draft Margin Financing Rules, 2004 propose client margin deposits in separate bank accounts.
- SECP drafting Regulations for Proprietary Trading to ensure explicit segregation of client accounts and broker/proprietary accounts.

### Monetary policy transparency — main findings and recommended improvements
- SBP observes most good practices on transparency in monetary policy.
- Annual monetary program publicly disclosed; inflation objective defined as 4 to 5 percent average annual CPI inflation.
- SBP issues a monetary policy statement every six months and quarterly and annual reports; market transactions reported the same day; weekly balance sheet summary disclosed.
- Remaining issues and recommendations:
  - Clarify definition of “monetary stability” and establish hierarchy of policy objectives in SBP Act.
  - Modify SBP Act to eliminate or clarify Federal Government prerogative to supersede SBP Central Board of Directors (recommendation: modify SBP Act).
  - Fully disclose terms and conditions, including maturity and interest rates, of individual SBP advances to federal, provincial, and local governments in an annex to the quarterly report.

*Source: _cr04215 - 1. Asset Structure of the Financial Sector, 2000-03 (PDF).*

### 1. Asset Structure of the Financial Sector, 2000-03 ................................................................25

### 1. Asset Structure of the Financial Sector, 2000-03

### Overall stability assessment — key findings
- Major reforms have resulted in a more resilient and efficient financial system better placed to absorb significant macroeconomic shocks, but infancy of reforms and deeper financial intermediation underscore the need for continued supervisory vigilance.
- Transformation from a largely state-owned and weak banking system to a healthier, primarily privately-owned system has been achieved through restructuring, consolidation, strengthened regulatory capacity, and improved transparency, corporate governance, and credit culture.
- Increased liquidity has led to rapid credit growth to the private sector that could be problematic if sustained; supervisors need to ensure credit quality is not compromised, particularly where banks are inexperienced.
- Securities markets have benefited from reforms but face systemic vulnerabilities from highly leveraged/speculative trading through the “badla” system and lack of supervision of market intermediaries; phased elimination of the “badla” system is welcome.
- Credit expansion to consumer, housing, SME, and agricultural sectors has expanded markedly; large segments of the economy still operate with little formal credit, requiring promotion of new business models and adaptation of regulations.
- Privatization and legal reforms need to continue to consolidate gains and protect against policy reversals; government should divest remaining stakes in banks and expedite privatization of SMEB, IDBP, HBFC, ICP, and NIT; reconsider continued ownership of NBP and three public insurance companies.
- Insurance penetration is very low relative to countries at Pakistan’s income level; further consolidation, liberalization, and a more market/solvency-based regulatory regime are needed.
- Pension issues require attention, including financial sustainability and regulatory oversight of present schemes (civil servants and EOBI), and establishment of a comprehensive legal and regulatory framework for private occupational and personal pensions.
- Improvements in financial market infrastructure and practices include a transparent framework for liquidity management, flexible market-based monetary policy instruments, high observance of IMF Code for Good Practices on Transparency in Monetary and Financial Policies, and planned introduction of RTGS to contain systemic payments risks.

### Overall stability assessment — quantified observations
- As of end-September 2003, commercial banks’ assets were 54 percent of GDP; assets for all financial institutions were 57 percent of GDP.
- Credit to the private sector expanded by 28.5 percent in 2003.
- Banks’ average capital adequacy ratio (CAR) improved from 11.3 percent in December 2001 to 13.1 percent as of September 2003, with 22 banks registering ratios above 15 percent.
- Aggregate NPL ratio ranges from 0.4 percent to 35.1 percent across banks.
- Asset quality of the five largest banks is weak, with the ratio of NPLs to total loans ranging from 15 percent to 35 percent.
- Privatization progress: share of private banks in total banking system assets increased to 59 percent as of September 2003 from 34 percent at end-1999; subsequent privatization of Habib Bank increased this share to more than 75 percent.
- The largest bank, NBP, has a market share of approximately 20 percent; the government sold some 23 percent of its ownership in NBP during 2001–03.
- Minimum capital requirement increases: from PRs 500 million to PRs 750 million as of end-December 2001 and further to PRs 1 billion (around US$17 million) as of end-December 2002.
- Islamic banking accounts for between 1-2 percent of total banking sector assets.

### Key recommendations — banking sector
- Revise the SBP Act and the Banking Companies Ordinance to address concerns noted in the Basel Core Principles assessment, especially ensuring legal authority of the SBP to conduct consolidated supervision.
- Adopt market risk-related capital charges and consider tightening specific provisioning requirements.
- Develop a strategy to privatize NBP and continue divestiture from the capital of other banks.

### Key recommendations — nonbank financial institutions and markets
- Conduct a formal review to determine whether SECP has adequate resources and capacity to fulfill its mandate; expedite the adoption of margin financing rules; review legal provisions governing insider trading.
- Establish a comprehensive legal and regulatory framework for private occupational pensions, providing for, inter-alia, custodial requirements, funding and investment standards, reporting and valuation standards, and prohibitions on self dealing and transactions with related parties.
- Review the roles of the state-owned insurers and place the State Life Insurance Company (SLIC) on a pari passu basis with the rest of the life insurance sector; clarify legal roles of MOC and SECP in the insurance sector; provide the SECP with on-site inspection capacity and powers to require prompt corrective action.
- Develop a more comprehensive debt policy and related risk management system; make the Debt Policy Coordination Office (DPCO) fully functional.
- Align NSS rates more closely with market rates and develop market-based alternatives to the present schemes.
- Resolve IDBP, through privatization, merger or closure, in the least cost manner.
- Launch title regularization programs, reform registration services, and lower property and mortgage registration duties.

### Key recommendations — financial infrastructure and information systems
- Establish a clear legal framework for private credit bureaus, enabling them to provide more comprehensive credit information.
- Establish a clear legal mandate for SBP to oversee the payments system and provide rules on netting and real time settlement.
- Promulgate a single law to provide a comprehensive legal framework for Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT).

### Macroprudential environment and financial structure — context and vulnerabilities
- Considerable macroeconomic stabilization progress: strengthening Real GDP growth, subdued inflation, markedly reduced overall fiscal deficit and public debt, comfortable current account, large reserve accumulation, and international appetite for sovereign debt; dollarization-related risk diminished.
- Risks include rapid private credit growth (28.5 percent in 2003), expected increase in interest rates and tighter liquidity conditions, potential sharp run-up in oil prices, slowdown of remittance inflows, and possible changes in international political environment that could dry up funds.

### Financial and regulatory structure — institutional roles
- SBP and SECP are largely responsible for regulation and supervision; the Banking Companies Ordinance (BCO) establishes SBP authority for supervision, regulation, and licensing of commercial banks and DFIs.
- Most other financial institutions are regulated by SECP; stock exchanges operate as self-regulated organizations (SROs).
- Legal and regulatory authority for insurance and pensions is diffused and, in some respects, ineffective.
- Legal and regulatory framework for microfinance banks (MFBs) is provided by the Microfinance Ordinance of 2001.

### Stability, soundness, and development — commercial banks
- Structural changes: divestiture of state ownership substantially changed sector structure; private banks’ share of system assets rose to 59 percent as of September 2003 from 34 percent at end-1999; with Habib Bank privatization share rose to more than 75 percent.
- Competition and liberalization: liberalization measures included market-based monetary and exchange rate policies, permission to open private banks, elimination of bank-by-bank credit ceilings, and removal of caps on lending rates; moratorium on licensing new banks imposed in 1995 remains in force except for Islamic banks.
- Islamic banking: introduced in parallel with conventional banking in response to Shariat and Supreme Courts; SBP pursues a three-pronged strategy (licensing fully fledged Islamic banks; allowing conventional banks to carry out Islamic banking through separate dedicated subsidiaries; permitting dedicated branches). Islamic banks account for between 1-2 percent of total banking sector assets. SBP is the regulator and applies prudential requirements applicable to commercial banks plus additional requirements adapted to Islamic banking; SBP is developing framework for supervision, audit and accounting standards, and monetary operation instruments for Islamic banks.
- Performance and efficiency:
  - Banks’ average CAR improved from 11.3 percent in December 2001 to 13.1 percent as of September 2003; 22 banks have CAR above 15 percent.
  - Improvement reflects better profitability, fresh capital injections, increased share of government securities carrying zero risk weight, and revaluation of assets.
  - High NPLs have constrained earnings and posed capital threats; aggregate NPL ratio is on a downward trend but remains high and concentrated in largest banks.
  - Improvements in NPLs aided by recovery drives, foreclosure law, loan restructuring, write-off settlement guidelines, and takeover of some large NPLs by the Corporate and Industrial Restructuring Corporation (CIRC).
  - Flow of new NPLs has declined significantly; substantial share of NPLs pertains to loans more than three years overdue.
  - Provisioning against NPLs is improving, but collapse in collateral values (which banks are allowed to use under strict rules to offset required provisioning) could adversely affect banks’ balance sheets.

*Source: _cr04215 - 1. Asset Structure of the Financial Sector, 2000-03 (PDF).*

### 21.      Profitability indicators show improvement. After being negative in 2000 and 2001,

### _cr04215 - 21.      Profitability indicators show improvement. After being negative in 2000 and 2001,

### Profitability and loan composition
- Return on equity:
  - Turned around to 13.1 percent in 2002.
  - Increased to 22.1 percent during the first three quarters of 2003.
- Drivers of improved profitability:
  - Increased business volume.
  - Substantial retrenchment of personnel.
  - Closure of numerous unprofitable branches.
  - Higher non-interest income reflecting fee-based activities and capital gains.
- Rapid credit growth and emerging risks:
  - Bank lending to small- and medium-sized enterprises and households has been increasing rapidly.
  - Share of personal loans (primarily auto loans, mortgages, and credit cards) rose to 12 percent of total bank credit (as of September 2003).
  - Concerns: lax credit evaluation and loan quality problems associated with rapid credit growth; legacy issues in former nationalized banks (developing credit evaluation culture for housing and consumer lending, timely recovery of defaulted loans, maintenance of loss-making branches in “unbanked” areas).
  - SBP regulations: banks required to hold general reserves against consumer loans; current specific provisioning requirements are not as stringent as in many other countries and could be tightened.

### Stress tests — scope and headline results
- Methodology:
  - Sensitivity to credit, market, and liquidity risk assessed using bank balance sheet data as of September 2003.
  - Tests performed for: each of the 12 largest commercial banks (accounting for 83 percent of the banking system in terms of assets); three groups of commercial banks—public sector (5 banks), local private (17 banks), and foreign (14 banks); and the banking system as a whole.
- Credit risk shocks modeled:
  - 35 percent increase in NPLs bringing NPL ratio to previous historical high.
  - 10 percent additional provisioning from tightened loan classification/provisioning rules.
  - 40 percent decline in the value of collateral (mostly real estate) held against NPLs.
  - Under the first shock, the CAR of 4 banks, representing 16 percent of the system, would fall below the minimum regulatory requirements, although it would remain above 6 percent.
  - Simultaneous occurrence of these three shocks would reduce solvency ratios of many banks, especially public sector commercial and local private banks, to below 8 percent; two banks (including the second largest) would see CAR decline to below 5 percent.
- Market risk:
  - As of September 2003, foreign currency deposits were 8 percent of total deposits; foreign currency loans averaged 15.2 percent for the banking sector as a whole.
  - Net foreign exchange open position of the banking sector was 23 percent of capital.
  - Equity price shock: a hypothetical 50 percent stock market crash would reduce the average CAR of the 12 largest banks to 4.9 percent; only four of these banks would have CAR above the required minimum.
  - Note: KSE Index increased by 250 percent between December 2001 and December 2003.
- Combined shocks:
  - Scenario: synchronous depreciation by 25 percent; deterioration in quality of 50 percent of unhedged loans in foreign currencies (100 percent provisions); increase in interest rates of outlying maturities (by 100, 300, and 500 basis points) — would reduce CAR of public sector commercial banks to 4.7 percent (assuming shocks are additive and enduring).
  - If additionally there is a 40 percent decline of the stock market, sector CAR would fall to 2.9 percent, and capital position of public sector commercial banks would turn negative (-4.8 percent).
  - Government injection of capital equal to 1 percent of GDP would then be required to restore capital adequacy of these banks.
- Liquidity risk:
  - Even a 20 percent run on liquid liabilities would not result in liquidity shortage; liquidity coverage (ratio of liquid assets to liquid liabilities) would remain adequate.
- Cautions and interpretation:
  - Most banks have enough capital to withstand increases in NPLs of more than 70 percent, assuming a provisioning rate for these marginal NPLs of 100 percent.
  - Weaker banks experience capital adequacy problems with relatively modest NPL increases—banks at the lower end of capital adequacy and asset quality require closer supervisory attention.
  - Sensitivity analysis based on historical experience may have reduced accuracy in a newly privatized, private sector–dominated banking environment.

### Banking supervision
- SBP progress and capacity:
  - SBP has made major strides in enhancing supervisory capacity; broadly in line with Basel Core Principles for Effective Banking Supervision.
  - SBP has powers to control risks, issued appropriate prudential regulations, adopted sound methods for on-site and off-site supervision, and can require a wide range of remedial measures.
  - SBP has adequate resources and significantly upgraded staff quality.
- Remaining issues:
  - Recent supervisory upgrades remain to be tested over a longer period.
  - Areas of less than full compliance: certain legal provisions regarding independence of the regulator, arrangements for consolidated supervision, and provisions for country risk.
  - Few banks belong to complex financial groups, so current deficiencies do not pose a major systemic risk.
  - Recommendation: pending comprehensive review of the BCO by a Law Review Commission should be used to address deficiencies in full compliance with the Basel Core Principles concerning legal provisions.

### Capital markets — structure, risks, and development priorities
- Market structure and recent trends:
  - Market capitalization reached US$16.5 billion at the end of 2003, equivalent to about 24 percent of GDP.
  - There are 693 listed shares; trading is highly concentrated: just over half in the top 10 shares, and 95 percent in the top 30.
  - Total investor base is less than 0.5 percent of the population.
  - Market infrastructure: three mutual stock exchanges, a National Clearing and Settlement System (NCSS), a Central Depositary Company (CDC), 278 registered brokers, a modest but growing mutual fund industry, and two registered rating agencies.
  - KSE-100 index up by 270 percent over the past 26 months.
- Risks:
  - Importance of COT or “badla” system poses market stability risks: highly leveraged positions financed by brokerages and banks, lack of transparency, speculative underlying transactions, scope for market manipulation and systemic risk.
  - SECP has instituted rules for “badla” trading and is developing margin financing rules expected to replace COT shortly.
  - Recommendation: rapidly adopt appropriate margin trading rules; obtain independent expert advice on clearinghouse and investor protection funds; strengthen rules for segregation of client assets in brokerage accounts.
- SECP capacity and recommended actions:
  - SECP demonstrates commitment to high regulatory standards (assessment against IOSCO Principles).
  - SECP’s mandate expanded to cover most nonbank financial institutions but does not currently conduct routine on-site inspections of regulated entities absent indications of malpractice.
  - Recommendation: commence a regular program of on-site supervision and undertake a formal review of resources to perform functions.
- Market development opportunities:
  - More developed equity and debt markets can reduce systemic vulnerabilities in a bank-dominated financial system.
  - Mutual fund industry potential: currently dominated by two public sector fund managers; privatization of one and announced intention to privatize National Investment Trust (the largest collective investment scheme) are welcome.
  - Corporate bond market hampered by distortions from high yields on National Savings Schemes (NSS); authorities introduced a formula linking NSS yields to Pakistan Investment Bonds (PIBs).
  - Recommendation: further align NSS rates with prevailing yields and consider market-based alternatives (for example, replace NSS instruments with retail marketable securities sold through subscriptions or auctions).
  - Contractual savings underdevelopment inhibits capital market development; planned introduction of private pension savings accounts presents significant scope but requires proper regulation.
  - Investor information and support services need strengthening: investors often lack adequate information on duties of investment advisers, rights of security holders, and complaint services; SECP, stock exchanges, and broker dealers should enhance investor education.

### Insurance
- Size and comparison:
  - Total premium income: PRs 26 billion in 2002.
  - Total assets: PRs 126 billion as at December 31, 2002.
  - Insurance premiums per capita: $1.0 for life and $1.7 for nonlife; comparisons—India: $11.3 (life) and $3.0 (nonlife); Indonesia: $5.2 (life) and $6.6 (nonlife).
- Key challenges and reform needs:
  - Sector is highly underdeveloped; scope for substantial development within an appropriate regulatory framework.
  - Immediate challenges: rationalization of an overpopulated non-life sector; adjusting to new international accounting and solvency norms.
  - Insurance Ordinance 2000 introduced reforms but omitted elements key to modern risk-based supervision: limited prompt corrective action power, lack of on-site supervision capacity, and in-house specialist skills.
  - Need to clarify division of responsibilities between MOC and SECP; consensus emerging that regulatory and supervisory responsibility for insurance should lie with SECP and oversight relating to ownership and governance of public sector insurers should rest with MOC.
  - Public sector insurers:
    - Consider exit strategy for National Insurance Company (NIC) given little benefit from government monopoly.
    - Limit government exposure to contingent risks at Pakistan Reinsurance Company Limited (PRCL), possibly by finding a private sector partner.
    - For State Life Insurance Company (SLIC), consider arms-length ownership that does not distort the contractual savings market given SLIC’s role in mobilizing long-term funds.

### Pension funds
- Structure:
  - Multi-pillar pension system comprises: (i) civil servants pensions; (ii) EOBI (mandatory defined benefits for private sector enterprises with 10 or more employees); (iii) provident funds and pension schemes by larger private employers; (iv) nascent market in personal pensions through contractual savings and insurance products.
- Fiscal and policy considerations:
  - Pension system for civil servants and EOBI entails substantial direct and indirect liabilities for the government that need to be addressed.
  - Planned introduction of private pension savings accounts presents scope for capital market development but requires proper regulatory safeguards.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04215.pdf*

### 39.      The scope of private employer sponsored pension arrangements is not clear, as

### 39.      The scope of private employer sponsored pension arrangements is not clear, as 

### Private employer-sponsored pension arrangements
- No centralized reporting requirement exists for private employer-sponsored pension arrangements.
- Although the SECP is assigned general authority, there is currently no direct oversight or supervision of these schemes, pointing to a potential regulatory gap.
- Recommended regulatory elements to be ensured include:
  - custodial requirements,
  - funding and investment standards,
  - reporting and valuation standards,
  - prohibitions on self dealing and transactions with related parties.

### Improving Access to Financial Services
- Historical context and recent improvements:
  - Until the late 1990s, credit to underserved markets was channeled through public DFIs or directed credit, which were largely unsuccessful.
  - Liberalization, a better regulatory environment, increased liquidity and competition have produced more encouraging results.
  - Lending to previously underserved markets has risen substantially in the past two years, and commercial banks have overtaken public specialized banks in providing agricultural, SME and housing finance.
- Remaining outreach gaps and requirements:
  - In 2003, it is estimated that bank credit reached 15 percent of all farms.
  - SMEs obtained just over 7 percent of their financing from banks and other financial institutions.
  - Surveys of SMEs indicated they received 7 percent of their working capital and 7.3 percent of investment finance requirements from banks and other financial institutions (versus 13.3 percent and 23.6 percent respectively for larger firms). By far the greatest source of finance for both small and large firms was retained earnings.
- Measures to scale up lending sustainably:
  - Banks and Non-Bank Finance Companies (NBFCs) need to adopt new products and technology, including modern programmed lending tools and credit scoring models, particularly in the SME sector.
  - Credit information systems can play a key role.
- Microfinance institutions (MFIs) and poverty alleviation:
  - Access to financial services for the poor through MFIs is an important component of the government’s poverty alleviation strategy.
  - Increasing access on a sound, sustainable basis requires building retail capacity, performance based funding with appropriate incentives, and greater transparency.
  - The regulatory framework for MFIs seems sound—MFIs are not subject to any interest rate caps and applicable prudential rules are generally in line with best practice.
  - Minimum capital requirements for national license are PRs 500 million, or US$8.8 million, which could discourage entry; lower requirements apply to district level banks, but they are still high.

### Development Finance and Specialized Institutions
- Background and reforms:
  - Prior to 2000 Pakistan had an extensive network of government owned and managed specialized banks and development finance institutions (DFIs) that suffered from corruption, mismanagement and inefficiency.
  - Since the late 1990s the government accelerated reforms: a number of DFIs have been closed or merged, others are being restructured.
  - Remaining entities have mandates to provide funding to underserved areas and are to operate on a commercial basis with no new funding from government.
  - It is planned that SMEB, IDBP and HBFC are to be restructured and fully privatized and the Zarai Taraqiati Bank (ZTB) is to be partially privatized.
- Policy stance and recommendations:
  - The general policy on DFIs is commendable and rapid implementation of specific plans for individual institutions is encouraged.
  - HBFC should be privatized, or its assets sold.
  - IDBP should be resolved (privatized, merged or closed); given its mounting operational losses, a quick resolution is important.
  - Remaining DFIs are small, accounting for only a small share of the financial system.
- Housing finance:
  - Measures taken include new simplified foreclosure procedures; relaxation of restrictions on bank lending to the sector; and tax incentives.
  - Despite recent surge in mortgage loans, total lending in this area remains low—at under 1 percent of GDP.
  - Obstacles:
    - Banks’ limited experience (addressable through training as banks gain experience).
    - Weaknesses in property and security rights administration (more deeply rooted and harder to resolve).

### Systemic Liquidity and Public Debt Management, Crisis Management, and Safety Nets
A. Liquidity Management and Markets
- Framework and objectives:
  - The SBP seeks to “secure monetary stability and the soundness of the financial system.”
  - A publicly disclosed monetary program is designed to achieve low inflation, currently defined as 4 to 5 percent average annual CPI inflation.
  - At the operational level, interest rates and the nominal exchange rate play important roles; the discount rate and the cut-off rate for government securities auctions serve as implicit policy rates.
  - Exchange rate fluctuations are kept within tight limits; a variety of exchange and capital controls allow authorities a degree of independence in affecting interest rates given the managed exchange rate.
- Instruments and modernization:
  - Instruments for managing domestic liquidity are market-based, flexible and relatively well developed for an emerging market at Pakistan’s stage of development.
  - The monetary policy framework and operations of the SBP are publicly disclosed and explained regularly.
  - SBP is considering implications for monetary operations of the growing, but still small, Islamic banking sector and the planned RTGS system.
- Consideration of inflation targeting:
  - Authorities might explore introducing some form of inflation targeting.
  - Adoption could provide additional discipline for consolidating gains in reducing inflation.
  - Adoption of a full-fledged inflation targeting would be premature due to requirements for a clear legislative mandate for the SBP, greater exchange rate flexibility, robust short-term inflation forecasting methods, and a well understood transmission mechanism.
- FX inflows and reserves management:
  - SBP has effectively managed sizeable inflows of foreign exchange; inflation has remained low though partially sterilized intervention accelerated money growth.
  - Inflows have led to substantial accumulation of foreign exchange reserves at the SBP.
  - Authorities’ strategy of partly relying on external managers is appropriate, but requires a conservative balance between rate of return and risk.
  - Authorities might consider developing a strategic plan for orderly liberalization of remaining capital controls.
- Money market development:
  - The money market can be further developed by promoting a market for interest rate swaps and preannouncing a schedule for PIB auctions, especially following the prohibition of investment by institutional investors in NSS.

B. Lender-of-Last Resort and Bank Resolution
- Emergency liquidity provision and procedures:
  - Authorities have been effective in lender-of-last resort functions and dealing with distressed banks.
  - Emergency liquidity support is considered case-by-case; occasional liquidity needs of banks with acceptable collateral are handled through the discount window at a penalty interest rate.
  - The SBP might consider setting out formal internal procedures for providing emergency liquidity support, specifying terms and conditions and limiting acceptable collateral to marketable government securities.
- Bank resolution framework:
  - The SBP has prepared a Problem Bank Manual setting out progressive actions from Memorandum of Understanding (MOU) on remedial actions to liquidation.
  - Establishment of the CIRC with legal powers to takeover NPLs of NCBs and DFIs has helped address banks’ balance sheet difficulties.
  - As of March 31, 2004:
    - Some 738 cases with a total outstanding amount of PRs 132 billion had been referred to the CIRC.
    - Of these, it had acquired 234 amounting to PRs 47 billion.
    - Of the latter, 192 involving an outstanding amount of PRs 31 billion had been resolved.

C. Deposit Insurance
- Cautionary approach:
  - Plans to establish a formal deposit insurance scheme need to be approached with caution because deposit insurance can reduce depositor flight risk but also reduce discipline on insured institutions and encourage risk taking.
- Design principles and concerns:
  - Deposit insurance agency should be run independently, free from political interference.
  - Premium structure and coverage should ensure appropriate incentives and financial viability.
  - Membership should be compulsory to prevent adverse selection; insolvent institutions should not be included.
- Technical considerations of SBP’s proposal:
  - Establishment of the fund at the SBP could create a conflict of interest between SBP’s lender-of-last-resort role and fund manager; avoiding this requires appropriate firewalls in the fund’s corporate structure.
  - Proposed coverage seems generous while the proposed premium is influenced heavily by banks’ profitability and appears low by international standards.
  - Proposed seed funding is at half the required amount estimated by the SBP and needs to be considered in context of limited fiscal space.
  - There is potential for an expansion of the scope of the scheme.
  - Proposal details noted by SBP:
    - Protect deposits up to PRs 100,000, equivalent to 3.8 times per capita GDP and covering 94 percent of all accounts up to this amount and 52 percent of the total value of deposits.
    - Envisages a flat premium of 0.02 percent of total insurable deposits to be paid by the covered institutions.
    - Seed funding of PRs 5 billion to be provided by the government.

D. Public Debt Management
- Strategy and assessment:
  - Authorities’ public debt management strategy is focused on debt reduction and lowering interest costs.
  - Pakistan’s high debt to GDP ratio and high interest expenditure to revenue ratio make both objectives necessary.
  - Debt management practices largely follow the IMF-World Bank Public Debt Management Guidelines but can benefit from greater emphasis on risk management and implications for financial stability.
  - A comprehensive risk-based approach should account for interest lost, currency exposure, cash flows and bunching of maturities.
  - Authorities are developing a risk management system to address these considerations.
- External and domestic debt risks:
  - Risks related to external debt are contained since this debt is largely long-term, concessional multilateral or bilateral.
  - Banking sector exposure to domestic government debt is significant and growing: at December 2003, net claims on government constituted 32 percent of net domestic assets, up from about 20 percent in 2000 (but well below levels observed in emerging market countries that have experienced banking crises stemming from government insolvency).
  - Part of banks’ exposure to government reflects excess liquidity and insufficient alternative lending opportunities.

### Financial Sector Infrastructure
A. Payments System
- Modernization efforts:
  - An automated check clearing system (NIFT) has been operational since 1997.
  - SBP is establishing an RTGS to replace the current manual book-entry system for settlement of interbank lending, net settlement of checks, and settlement of cash leg of government securities transactions.
  - FSAP did not undertake a formal assessment of the CPSS Core Principles for Systemically Important Payment Systems as RTGS is being introduced.
- Legal framework deficiencies:
  - No provisions in law regarding finality of payment and zero hour rule, which are important for safety and soundness of the payments system.
  - These issues become important with RTGS introduction and expansion of participating institutions’ membership.
  - Recommendation: SBP Act should be amended to add a chapter to deal with payment systems.
  - SBP’s liquidity management facilities would need adaptation for proper functioning of RTGS.

B. Legal Issues
- Need for legislative updates:
  - Government efforts to update laws continue but repeal, amendment and updates are still needed.
  - The State Bank of Pakistan Act of 1956, amended in 2002, contains provisions that authorize the government to supersede the central board and allow the Federal Government to liquidate the Bank; revamping the SBP Act to better reflect current functions, powers and objectives of SBP is desirable.
  - Issues in the Banking Companies Ordinance 1962, amended in 2001 (BCA), need to be addressed to enhance the legal framework.
- Debt Recovery Ordinance and insolvency:
  - Debt Recovery Ordinance (2002) allows banks to recover debt through summary procedure and sell mortgaged property without court intervention; creditors have been reluctant to use summary procedures citing difficulties registering mortgaged property in new owners’ names and injunctions obtained by borrowers.
  - Insolvency and debt restructuring provisions need updating:
    - No stay on secured creditors for debt workout and court approval for debt workout is cumbersome, making restructuring unpopular.
    - Liquidation and winding up governed by Companies Ordinance; bankruptcy rules are more than 80 years old.
    - Average time for liquidation ranges from 10–15 years.
    - Authorities are in the process of revamping insolvency laws.

C. Credit Information, Corporate Governance, and Accounting and Auditing
- Credit information systems:
  - Pakistan has relatively well developed credit information systems.
  - In 2001, SBP made credit ratings compulsory for all banks and NBFIs and required them to disclose ratings to the public.
  - Main sources: an on-line credit information bureau operated by the SBP and two privately operated credit registries.
  - Information sharing now prevents loan defaulters from receiving credit from banks.
  - Rapid growth in consumer lending may require broader credit information sharing (utilities, retailers) and development of products such as identity verification and credit scoring.
- Corporate governance:
  - Regulations are extensive and comprehensive.
  - Company Ordinance contains detailed corporate governance provisions.
  - Securities Commission of Pakistan issued a detailed Code of Corporate Governance in March 2002 for all listed companies (broadly in line with OECD Principles) and a code for insurance companies in March 2003.
  - Prudential Regulations for Commercial Banking by SBP prescribe detailed standards for boards, management and shareholders of banks and DFIs.
- Accounting and auditing:
  - Accounting and auditing standards are of a high and internationally acceptable quality at least in larger corporations and financial institutions.
  - Accounting framework follows International Accounting Standards.
  - All registered companies are required to have accounts audited and submit statutory returns promptly.
  - Institute of Chartered Accountants of Pakistan (ICAP) is a SRO and plays an active role in ensuring quality.
  - SECP has been proactive in strengthening financial reporting and reliability of audits; there is close collaboration between SBP bank examiners and bank auditors.

*Source: _cr04215 - 39.      The scope of private employer sponsored pension arrangements is not clear, as*

### 65.      A detailed assessment of compliance with the FATF 40+8 Recommendations on

### _cr04215 - 65.      A detailed assessment of compliance with the FATF 40+8 Recommendations on

### AML/CFT assessment
- A detailed assessment of compliance with the FATF 40+8 Recommendations on AML/CFT is scheduled to be conducted by the Asia-Pacific Group on Money Laundering in August, 2004.
- The APG will prepare a ROSC which will be presented for the information of the Fund/Bank boards.
- Current legal and institutional context:
  - Pakistan currently has several laws that deal with various aspects of anti money laundering and combating the financing of terrorism.
  - A comprehensive legal and institutional framework is currently in preparation.
  - The SBP has developed two Prudential Regulations now in force concerning “Know Your Customer” and “Anti-Money Laundering Measures.”
  - The SECP has established an Anti-Money Laundering Unit and taken a number of relevant measures.
- Recommendation:
  - The authorities are urged to complete and implement the comprehensive legal and institutional framework for AML/CFT currently under preparation prior to the APG assessment.

### Asset structure of the financial sector (high-level highlights from Table 1, 2000–2003)
- Aggregate assets (All Financial Institutions):
  - 2000: 2,046 (in billions of rupees)
  - 2001: 2,165 (in billions of rupees)
  - 2002: 2,432 (in billions of rupees)
  - 2003 (As of September 2003): 2,510 (in billions of rupees)
- Commercial Banks assets (in billions of rupees):
  - 2000: 1,696
  - 2001: 1,835
  - 2002: 2,127
  - 2003 (As of September 2003): 2,380
  - Commercial Banks as percent of total financial institutions:
    - 2000: 82.9 percent
    - 2001: 84.8 percent
    - 2002: 87.5 percent
    - 2003: 94.8 percent
- Memorandum items:
  - Commercial Banks (in percent of GDP): 49.5 (2000), 50.6 (2001), 52.9 (2002), 54.1 (2003)
  - All Financial Institutions (in percent of GDP): 59.8 (2000), 59.7 (2001), 60.5 (2002), 57.0 (2003)

### Financial soundness indicators for the banking sector (Table 2, 1999–Sep-03)
- Capital Adequacy:
  - Regulatory capital to risk-weighted assets: 12.2 (Dec-99), 11.4 (Dec-00), 11.3 (Dec-01), 12.6 (Dec-02), 13.1 (Sep-03)
  - Tier I capital to risk-weighted assets: 10.3 (Dec-99), 9.8 (Dec-00), 9.7 (Dec-01), 9.7 (Dec-02), 10.9 (Sep-03)
  - Capital to total assets: 5.0 (Dec-99), 4.9 (Dec-00), 4.6 (Dec-01), 6.1 (Dec-02), 6.2 (Sep-03)
- Asset composition and quality:
  - NPLs to gross loans: 22.0 (Dec-99), 19.5 (Dec-00), 19.6 (Dec-01), 18.0 (Dec-02), 16.1 (Sep-03)
  - Provisions to NPLs: 46.6 (Dec-99), 53.9 (Dec-00), 53.2 (Dec-01), 58.3 (Dec-02), 63.0 (Sep-03)
  - NPLs net of provisions to capital: 117.4 (Dec-99), 96.7 (Dec-00), 100.7 (Dec-01), 54.5 (Dec-02), 41.8 (Sep-03)
- Earnings and profitability:
  - ROA (after tax): -0.3 (Dec-99), 0.0 (Dec-00), 0.0 (Dec-01), 0.8 (Dec-02), 1.4 (Sep-03)
  - ROE (after tax): -6.2 (Dec-99), -0.3 (Dec-00), -0.3 (Dec-01), 13.8 (Dec-02), 22.1 (Sep-03)
  - Net interest income to gross income: 54.3 (Dec-99), 61.2 (Dec-00), 68.9 (Dec-01), 67.4 (Dec-02), 58.2 (Sep-03)
  - Noninterest expenses to gross income: 76.9 (Dec-99), 71.6 (Dec-00), 62.7 (Dec-01), 57.3 (Dec-02), 50.4 (Sep-03)
  - Non-interest income to total income: 17.6 (Dec-99), 16.5 (Dec-00), 14.5 (Dec-01), 18.1 (Dec-02), 30.9 (Sep-03)
- Liquidity:
  - Liquid assets to total assets: 38.7 (Dec-99), 37.5 (Dec-00), 39.9 (Dec-01), 47.0 (Dec-02), 48.6 (Sep-03)
  - Liquid assets to total deposits: 48.2 (Dec-99), 48.0 (Dec-00), 50.3 (Dec-01), 60.2 (Dec-02), 59.4 (Sep-03)

### Summary of stress tests assumptions and results (Table 3, based on end-September 2003 data)
- Groups defined:
  - Group 1 comprises the 12 largest commercial banks.
  - Group 2 comprises the public sector commercial banks.
  - Group 3 comprises the local private banks.
  - Group 4 comprises foreign banks.
  - Group 5 comprises all commercial banks.
- Selected pre-shock ratios (Capital Adequacy Ratio Before Shock; Liquidity Ratio Before Shock):
  - Group 1: 11.9 (Capital), 51.6 (Liquidity)
  - Group 2: 14.1 (Capital), 58.2 (Liquidity)
  - Group 3: 10.3 (Capital), 46.1 (Liquidity)
  - Group 4: 22.3 (Capital), 43.6 (Liquidity)
  - Group 5: 13.1 (Capital), 50.5 (Liquidity)
- Credit risk shocks — Capital Adequacy Ratio After Shock examples:
  - An increase in NPLs of 35 percent:
    - Group 1: 9.5; Group 2: 11.3; Group 3: 8.3; Group 4: 20.1; Group 5: 10.8
  - A shift in categories of classified loans:
    - Group 1: 11.3; Group 2: 12.6; Group 3: 10.2; Group 4: 22.2; Group 5: 12.5
  - A 50 percent decline in the value of real estate collateral:
    - Group 1: 10.2; Group 2: 11.1; Group 3: 9.3; Group 4: 22.3; Group 5: 11.5
  - Combination of the above three shocks:
    - Group 1: 6.1; Group 2: 6.4; Group 3: 6.0; Group 4: 19.4; Group 5: 7.8
- Exchange rate risk:
  - A depreciation of 25 percent:
    - Group 1: 12.8; Group 2: 15.8; Group 3: 10.6; Group 4: 22.5; Group 5: 13.9
  - An appreciation of 20 percent:
    - Group 1: 11.1; Group 2: 12.7; Group 3: 10.1; Group 4: 22.2; Group 5: 12.5
- Interest rate risk:
  - An increase by 300 basis points:
    - Group 1: 11.0; Group 2: 11.0; Group 3: 10.8; Group 4: 21.1; Group 5: 12.1
  - An increase in rates of outlying maturities (by 100, 300, and 500 basis points):
    - Group 1: 10.7; Group 2: 9.0; Group 3: 11.5; Group 4: 20.1; Group 5: 11.7
- Equity risk:
  - A decline in equity values by 20 percent:
    - Group 1: 9.2; Group 2: 10.4; Group 3: 7.9; Group 4: 21.8; Group 5: 10.5
  - A decline in equity values by 50 percent:
    - Group 1: 4.9; Group 2: 4.3; Group 3: 4.2; Group 4: 21.1; Group 5: 6.4
- Combined scenarios:
  - A depreciation of 25 percent and a deterioration in quality of 50 percent of unhedged FX loans (100 percent provisions):
    - Group 1: 8.3; Group 2: 10.2; Group 3: 7.8; Group 4: 20.5; Group 5: 10.2
  - Add an increase in interest rates of outlying maturities (by 100, 300, and 500 basis points):
    - Group 1: 7.0; Group 2: 4.7; Group 3: 9.1; Group 4: 18.2; Group 5: 8.8
  - Further add a 40 percent decline in equity values:
    - Group 1: 0.8; Group 2: -4.8; Group 3: 4.1; Group 4: 17.1; Group 5: 2.9
- Liquidity shocks — Liquidity Ratio After Shock:
  - A 10 percent withdrawal in liquid liabilities:
    - Group 1: 46.2; Group 2: 53.5; Group 3: 40.1; Group 4: 37.4; Group 5: 44.9
  - A 20 percent withdrawal in liquid liabilities:
    - Group 1: 39.5; Group 2: 47.7; Group 3: 32.6; Group 4: 29.5; Group 5: 38.1

### Observance of financial sector standards and codes — summary assessments (ANNEX)
- Detailed assessments undertaken:
  - Basel Core Principles for Effective Banking Supervision (BCP) — by Mr. Keith Bell and Ms. Faizah Hashim.
  - IOSCO Objectives and Principles of Securities Regulation — by Mr. John Farrell and Mr. Muddasir Khan.
  - IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies — by Mr. Jorge-Ivan Canales Kriljenko, Mr. Keith Bell, and Ms. Faizah Hashim.
- Overall conclusions:
  - Pakistan’s compliance with international supervisory standards is generally high.
  - The SBP has made considerable progress in recent years toward achieving and maintaining high regulatory standards; only few areas show less than full compliance.
  - The SECP has achieved a relatively high degree of compliance with the IOSCO principles but requires additional resources and institutional capacity building to carry out its broad mandate.
  - Transparency practices regarding monetary policy formulation and implementation and banking supervision are generally in line with best practices.

### Basel Core Principles — main findings and sectoral reforms
- Legal and institutional framework:
  - The BCO establishes the SBP as the authority responsible for supervision, regulation and licensing of banks and certain designated NBFCs.
  - Governing statutes include: State Bank of Pakistan Act, 1956 (as amended); the Bank’s Nationalization Act, 1974; the Financial Institutions (Recovery of Finances) Ordinance, 2001; the Companies Ordinance, 1984; and Statutory Regulatory Orders (SROs).
  - A comprehensive revision of the BCO by the SBP’s Banking Law Review Commission is currently underway.
- Preconditions for effective supervision (CP1):
  - The SBP has been restructured, separating core central bank functions from non-core functions (transferred to a subsidiary under the SBC Banking Services Corporation Ordinance, 2001).
  - The Federal Government retains powers that can direct or supersede the SBP in certain circumstances (Section 17(6A) and Sec. 52(1) cited).
  - The SBP remains a substantial shareholder of record in some formerly nationalized banks, creating an apparent conflict between regulator and owner roles.
- Capital and NPL reforms:
  - Amendment to the BCO established a Minimum Continuing Capital Requirement (MCCR) for banks of PRs 1 billion.
  - A required risk-weighted capital adequacy ratio in excess of 8 percent and strict enforcement of Prudential Regulations were implemented.
  - An asset management company, Corporate and Industrial Restructuring Corporation (CIRC), was established to clean up banks’ balance sheets.
  - Result: net NPLs to capital of commercial banks fell from 117.4 percent at December 31, 1999 to 41.8 percent at September 30, 2003.
- Other structural measures:
  - DFIs reduced from twelve to four; remaining DFIs work in SMEs, agriculture, industrial investment and housing finance.
  - Financial Institutions (Recovery of Finances) Ordinance, 2001, promulgated to facilitate mortgage foreclosures and settlement of banking disputes.
  - Government restructured PSCBs by introducing professional management and independent Boards of Directors.
- Market discipline and supervisory capacity:
  - Market discipline is described as fairly effective due to greater efficiency of Local Private Banks and Foreign Banks.
  - SBP has exclusive and extensive authority to license, supervise and inspect institutions and appears to possess sufficient staff and infrastructure for timely on- and off-site supervision.
  - Regulatory anomaly: entities in the same group may be supervised by different regulators (e.g., bank by SBP, leasing and investment banking subsidiaries by SECP), warranting consideration.
- Legal protection:
  - Legal protection for employees of a bank regulator performing their functions in good faith is present in Pakistan legislation.
- Licensing and structure (CPs 2–5):
  - BCO defines permissible activities of “banking companies”; all institutions using the term “bank” must be regulated by the SBP.
  - SBP has authority to review and approve proposed significant corporate acquisitions by banks and to require prior review for proposed acquisition of a significant shareholder interest in an established bank.
  - No statutory requirement that incorporation of a subsidiary by a bank must be brought to the attention of the regulator, although standard procedure is for banks to advise the SBP.

*Source: SBP; SBP and staff estimates.*

### 75.      Market-risk related computations and capital charges are not in force in Pakistan.

### _cr04215 - 75.      Market-risk related computations and capital charges are not in force in Pakistan.

### Market risk and capital adequacy
- Market-risk related computations and capital charges are not in force in Pakistan.
- Risk-weighted capital adequacy requirements are in place (applied on both a “solo” and consolidated basis).
- As of February 27, 2004:
  - only three specialized banks (all owned by the federal or provincial governments) together with one bank recently transferred to new ownership (which has committed to contribute the necessary capital) failed to meet the required minimum 8 percent risk-weighted capital ratio.
  - only the three specialized banks, together with a few small, foreign-owned banks had a capital base of less than PRs 1 billion.
  - the small, foreign-owned banks are all in the final stages of transfer to new owners; such transfers—together with the necessary capital injection to meet the MCCR—are to occur by June 30, 2004.

### Supervisory framework and risk management (CPs 7–14)
- SBP rules and regulations provide instructions and requirements for lending and investment policies and procedures for banks and related internal control systems.
- Specific credit-related directives establish policies and procedures for:
  - asset quality classification and provisioning,
  - credit concentrations,
  - connected lending (CPs 7–11).
- SBP has recently provided guidance to banks and will determine via on-site inspections in the current year whether risk management processes are in place for market and other material risks (CPs 12 and 13).
- SBP reviews:
  - membership of a bank’s policy and executive bodies,
  - procedures for decision-making and delegation,
  - quality and resourcing of internal control,
  - procedures for informing decision-making bodies (CP 14).

### Money laundering (CP 15)
- Presently, there is no law that specifically and comprehensively addresses money laundering (and the financing of terrorism).
- A comprehensive legal and institutional framework is in preparation; the draft law now being finalized will incorporate a comprehensive definition of money-laundering guided by best practice internationally.
- The SBP has issued two Prudential Regulations now in force concerning “Know Your Customer” and other Anti-Money Laundering Measures (CP 15).

### Methods of ongoing supervision (CPs 16–20)
- Four departments deliver SBP’s banking supervision program:
  - Banking Supervision Department (BSD) — reinforces on-site inspections,
  - Bank Inspection Department (BID),
  - Banking Policy Department (BPD),
  - Islamic Banking Department.
- BSD structure and functions:
  - Off-site Monitoring Division assesses overall soundness and provides an early warning system; produces pre-inspection packages and periodic reports based on unconsolidated financial statements and standard ratios.
  - Risk Management Division monitors inherent risk across business lines, liquidity, cash reserves, existing capital and adequacy of capital standards, sensitivity in changing scenarios, and issues guidance to banks.
- BID conducts comprehensive and targeted on-site inspections using standardized procedures from a comprehensive inspection manual (published in 1999).
- SBP uses a standardized “CAMELSS” approach (Capital; Assets; Management; Earnings; Liquidity; Sensitivity to Market Risk; Systems) under its Uniform Bank Grading System (CP 16).

### Supervisory contacts, information access, and consolidated supervision (CPs 17–20)
- Prudential Meetings:
  - Historically, meetings between SBP and bank management were held on an “as required” basis within a supervisory cycle (usually approximately 12 to 18 months).
  - Reports of inspections are always delivered to all members of a bank’s Board of Directors.
  - From January 2004, practice instituted to hold meetings at least once per calendar year with Boards of Directors and Senior managements and more frequently with banks/DFIs accorded an “unsatisfactory” rating (CP 17).
- SBP authority and information systems:
  - SBP has full authority to request any information needed; prudential reports submitted primarily in machine-readable form to Off-site Monitoring Division and promptly reviewed.
  - Work is well advanced on a system to receive institutions’ data centrally by electronic (on-line) means (CP 18).
  - SBP has legal right of full access to all bank records or information; can utilize external auditors’ reports; licensees must produce audited financial statements; SBP maintains a panel of auditing firms (currently numbering 33) for approval purposes (CP 19).
- Consolidated supervision:
  - Consolidated supervision has yet to be developed in Pakistan.
  - Recommendation: consider legislative changes to facilitate SBP’s effective supervision on a consolidated basis and to permit express exchange of confidential information with other governmental and foreign supervisory authorities (CP 20).

### Accounting, remedial measures, and exit (CPs 21–22)
- Information requirements (CP 21):
  - Banks must prepare financial statements and various reports in SBP formats.
  - Annual audited financial statements required to follow accounting standards issued by the International Accounting Standards Board (IASB) and interpretations by the Standing Interpretations Committee of the IASB as adopted in Pakistan.
  - International Accounting Standard 39 and International Accounting Standard 40 are not applicable to banks in Pakistan.
  - Accounting Standards are modified as required for Islamic financial institutions; SBP verifies information periodically through on-site inspections.
- Remedial measures and exit (CP 22):
  - State Bank of Pakistan Act provides wide corrective measures including:
    - imposition of a directive;
    - replacement of directors and senior managers;
    - imposition of a moratorium pending restructuring;
    - removal of a bank’s license;
    - seeking a winding-up order.
  - SBP can seek monetary penalties for willful infringement of legislation and regulations; SBP has acted to remove three smaller banks in recent years.

### Cross-border banking (CPs 23–25)
- SBP authority:
  - SBP can supervise overseas activities of locally-incorporated banks but has not recently conducted inspections of overseas branches due to limited operations and cost.
  - Such inspections have occurred in isolation given limited international activity of Pakistan banks (CP 23).
  - Neither the BCO nor the State Bank of Pakistan Act provides express power to share confidential supervisory information with other government authorities and host country supervisors (CP 24).
  - Local branches of foreign banks are subject to same prudential, inspection, and reporting requirements as domestic banks (CP 25).

### Recommended Action Plan (selected entries)
- Objectives, Autonomy, Powers, and Resources (CP1 (1) and CP1 (3)):
  - Provide explicit authority in the BCO for sharing information with domestic and foreign supervisory agencies.
  - Consider repealing Sections 17 (6A) and 52 (1) of the SBP Act that reduce the autonomy of the SBP.
- Investment Criteria (CP 5):
  - Consider introducing regulation explicitly requiring a banking company to seek SBP approval for making investment in a subsidiary in the financial sector and that defines the rules for acquisitions for major investments in Pakistan or abroad.
  - Establish criteria for the approval/rejection of such investments.
- Country Risk (CP 11):
  - Consider issuing guidelines requiring banks to have information and management systems to identify, monitor and control country and transfer risk.
- Consolidated and Globally Consolidated Supervision (CP 20 and CP 23):
  - Consider providing SBP explicit authority to conduct consolidated supervision and to review overall activities of a bank conducted through subsidiaries, both domestic and overseas.

### Authorities’ response
- Authorities broadly agreed with the assessment.
- Areas for further strengthening such as revision of the SBP Act to strengthen SBP autonomy are being addressed by the Banking Law Review Commission; a draft revised SBP Act is under active consideration of the MoF.
- Regarding Principle 5 requirements, authorities note BCO is supplemented by SBP guidelines issued in March 2003 on due diligence for merger/amalgamation and by BPD Circular 7 on setting up of subsidiaries by banks.
- Regarding market risk related computations and capital charges:
  - authorities note the SBP’s (BSD) is working on this issue and a circular in this regard, based on the recommendations of the Basel Committee, has been drafted and will be issued shortly.
- Authorities observed that some areas of non-compliance, such as country risk, are not highly relevant at present due to low exposure of domestic banks and other limitations on investments abroad.

### Securities regulation: institutional and market structure (selected statistics)
- SECP is statutory regulator for securities, insurance and companies; member of IOSCO.
- Stock exchanges and market capitalization (as of December 31, 2003):
  - KSE market capitalization PRs 951.5 billion (US$17.2 billion), equivalent to around 23.7 percent of GDP.
  - LSE market capitalization PRs 937.3 billion (US$16.9 billion), equivalent to around 23.3 percent of GDP.
  - Note: There may be overlap between data for KSE and LSE due to companies being listed on both exchanges.
- Listings and trading:
  - There are 278 registered brokers: 130 corporates and 148 individuals (not all active).
  - Of the 702 KSE listed securities, 394 are described as “actives.”
  - Of these actives, some 60 are in default.
  - On average in 2003 the 10 most active securities accounted for 53 percent of turnover by volume; the 30 most active accounted for 95 percent of turnover.
- New issuance and derivatives:
  - In 2003 the value of new shares issued to the market was PRs 44.9 billion (say US$775 million–US$110million in 2002).
  - There are 14 one-month single stock futures contracts traded on the KSE (open interest as at December 31, 2003 PRs 5.3billion).
  - SECP has approved regulations for a national commodities market and an over-the-counter securities market but neither is yet operational.
- Debt instruments and collective investment schemes:
  - There are 28 listed debt instruments (term finance certificates (TFCs)) with a total face value of PRs 27 billion and a market value slightly larger.
  - There are 9 open-ended funds administering assets valued at some PRs 40 billion (US$700 million).
  - There are 37 closed-ended funds administering some PRs 4.1 billion (US$72 million).
- Market participation:
  - Of a total population of 140 million people in Pakistan no more than 200,000 have invested in a public market for securities.

*Source: _cr04215 - 75.      Market-risk related computations and capital charges are not in force in Pakistan.*

### 103.     SECP is an active and energetic regulator. It has extensive powers to monitor market

### _cr04215 - 103.     SECP is an active and energetic regulator. It has extensive powers to monitor market

### Regulator (Principles 1–5)
- SECP is described as "an active and energetic regulator" with "extensive powers to monitor market institutions and market practice."
- SECP "has achieved a high degree of compliance with the IOSCO Principles."
- A "robust program of review of relevant law and practice is underway" and the authorities are "strongly committed to achieving and maintaining high regulatory standards."
- Immediate challenges:
  - SECP combines roles in preparing and promoting new law, surveillance and monitoring for compliance, enforcement, adjudication on offences, appeals (possibly to the exclusion of the courts), and may have a financial interest as beneficiary in its own adjudications involving monetary amounts. SECP "must be assiduous in maintaining high degrees of transparency in all its operations" to demonstrate decisions are backed by good communications and are taken in a "fair and open-minded way."
  - SECP has "very important and very extensive responsibilities" and "must be able to demonstrate" planning for the use of its powers, allocation of necessary resources, reporting on performance by reference to its plans, and that it "has adequate resources and makes good use of them."
- Assessment findings:
  - Responsibilities are "clear and objectively stated, generally in the law."
  - "SECP is operationally independent and accountable in the exercise of its functions and powers."
  - "The assessors do not consider that the Policy Board intrudes on the operational independence of SECP."
  - SECP "has adequate powers to perform its functions," although available information did not permit concluding it had "proper resources and capacity."
  - Recommendation: "More formal and transparent processes for planning and accounting for SECPs regulatory work, including the allocation of appropriate resources are recommended."
  - SECP "adopts clear and consistent regulatory processes" but "should undertake a formal review of its processes and consider whether there are further opportunities to issue useful guidance notes and policy statements."
  - "SECP staff are expected to observe high professional standards."

### Self-regulatory organizations (Principles 6–7)
- The regulatory regime "makes appropriate use of SROs" which are "subject to SECP oversight and observe standards of fairness and confidentiality."
- Recommendations:
  - SECP and the exchanges should "enter into an MOU relating to the coordination of work, cooperation, and the exchange of information."
  - The exchanges should have "more formal and more transparent processes for planning and reporting on their regulatory work," similar to SECP.

### Enforcement (Principles 8–10)
- SECP "has comprehensive inspection, investigation and surveillance powers" and "comprehensive enforcement powers."
- Finding: SECP "has not demonstrated that it has ensured an effective and credible use of these powers."

### Cooperation (Principles 11–13)
- SECP "has wide powers to share both public and non-public information in its possession with domestic and foreign counterparts."
- Status:
  - SECP "has not yet established the necessary mechanisms for sharing non-public information, at least with foreign counterparts, but is working on this."
  - SECP appears to have the power to undertake inspections or investigations at the request of foreign counterparts; otherwise it "can merely communicate information already in its possession from inspections or investigations undertaken in accordance with the law."

### Issuers (Principles 14–16)
- Law provides for "full, accurate and timely disclosure of financial results and other information to shareholders of companies and interest holders in collective investment schemes."
- Gaps and issues:
  - "There is no equivalent requirement to disclose information to holders of debt securities such as corporate bonds."
  - "The obligation of an issuer of debt securities to the public to appoint a trustee is incomplete."
  - Powers of minority shareholders under the Companies Ordinance "may be difficult to exercise."
  - Laws about company takeovers "are not yet effective as the necessary statutory regulations have not yet been enacted."
  - "Substantial security holder disclosure laws are not particularly effective."
  - Evidence of "shareholding concentrations among listed companies, cross-shareholdings and inter-company debt."
- Strength: "Accounting and auditing standards are of a high and internationally acceptable quality."

### Collective Investment Schemes (CISs) (Principles 17–20)
- Regulatory system "sets standards for the eligibility and regulation of those who wish to market or operate a CIS."
- Rules govern legal form and structure of CISs and "the segregation and protection of client assets."
- Requirements ensure disclosure "as necessary for the particular investor to evaluate the suitability of a CIS" and a "disclosed basis for asset valuation and the pricing and redemption of units."
- Recommendation: "SECP review the adequacy of the valuation and pricing rules and practices. Prices may not necessarily reflect the value of the underlying assets of a scheme."

### Market Intermediaries (Principles 21–24)
- Regulation provides "minimum entry standards for market intermediaries" including initial and ongoing capital and other prudential requirements.
- Gap: "There are no rules for the segregation and protection of the assets and money of clients in the hands of intermediaries."
- SECP "does not have a mature system for planning its monitoring and surveillance work and assessing its performance at the end of the planning period."
- Subject to the two matters above, intermediaries "must comply with standards for internal organization and operational conduct to protect the interests of clients and ensure proper management of risk."
- Assessment: Assessors "do not consider that Pakistan has adequate procedures for dealing with the failure of a market intermediary, at least in the case of intermediaries that are not members of a stock exchange."

### Secondary Market (Principles 25–30)
- Establishment of trading systems is "subject to regulatory authorization and oversight" with ongoing supervision "to ensure that the integrity of trading is maintained."
- Regulation "promotes transparency of trading" and "is designed to detect and deter manipulation and other unfair trading practices."
- Assessors "are unable to form a view on the adequacy of resources committed to these four matters."
- Concern: Whether insider trading law is adequate to deal with those who benefit from insider trading but are not insiders as defined, "in particular, tippees of insiders."
- Regulation aims to ensure management of "large exposures, default risk and market disruption," but client money and assets "are not segregated and protected in the hands of intermediaries" and procedures for dealing with the failure of a market intermediary are questioned.
- Recommendation: "SECP and the exchanges take independent advice on the adequacy of financial arrangements for managing the failure of an intermediary or market disruption."

### Recommended actions (summary of CP recommendations)
- Principles Relating to the Regulator (CP 1–5)
  - CP2: "FG should review its procedures for the appointment of commissioners and PB members with the aim of making them more transparent and so assisting FG to ensure that appointments meet the expectations of the SECP Act."
  - CP 2: "The annual report and statement of accounts of SECP should both be readily available to the general public. There should be a formal statement of accounts for the statutory fund."
  - CP 3: "SECP should have formal plans for its monitoring and surveillance work and for its investigation work into incidents of market malpractice, formal plans for the allocation of staff to undertake this important work, and procedures for assessing performance at the end of the financial year." SROs, particularly stock exchanges, should have equivalent plans and procedures.
  - CP 4: "SECP should undertake a review of its regulatory processes and identify areas in which it would be helpful, in support of its commitment to clear and consistent regulatory processes, to issue a guideline or make a public statement."
  - CP5: "SECP should establish a formal procedure for assuring itself of employee and commissioner compliance with the rules of law and provisions of the Service Manual about professional standards."
- Principles of Self-Regulation (CP 6–7)
  - CP 6: "The exchanges, like SECP, should have formal plans for their monitoring, surveillance and investigation work and formal procedures for assessing performance and reporting publicly on this."
  - CP 6: "SECP should consider formalizing its relationship with the exchanges by entering into an MOU on cooperation and the exchange of information, which would be publicly available."
  - CP 6: "SECP should clarify the statutory authority under which the National Clearing Company acts if it is to continue to exercise self-regulatory powers including the power to make regulations."
- Principles for Cooperation in Regulation (CP 11–13)
  - CP 11: "SECP should take early action to finalize its detailed arrangements for entering into information-sharing arrangements with foreign counterparts. It should conclude the necessary arrangements for gaining access to confidential client information of the banks where this is material to its responsibility as a securities regulator."
  - CP 13: "SECP should seek the necessary statutory authority to assist foreign counterparties in their inquiries, in particular, to use its powers of inspection and investigation at the request and for the purposes of a foreign counterpart."
- Principles for Issuers (CP 14–16)
  - CP 14: "SECP should as time allows review the law with a view to updating the financial reporting obligations of issuers."
  - CP 14: "Provision should be made in the Ordinance for the appointment of a trustee for debt security holders, whether or not the securities are secured, to receive information and otherwise to act for security holders. Explicit provision should also be made in the Ordinance for the disclosure of information about the trustee and the trust deed in the prospectus."
  - CP 15: "SECP should review the provisions of the Listed Companies (Substantial Acquisition of Voting Shares and take-overs) Ordinance 2002 about the disclosure of shareholding in a listed company and consider whether with amendments they could better achieve their statutory purpose."
  - CP 15: "SECP should take early action to propose rules under the takeovers provisions in the Ordinance about such matters as the content of a public offer, mode of payment and minimum price."
- Principles for Collective Investment Schemes (CP 17–20)
  - CP 20: "SECP should review the rules and practices of the market relating to the valuation of assets and pricing and redemption of interests in a CIS."
- Principles for Market Intermediaries (CP 21–24)
  - CP 21: "SECP should review the law about the regulation of non-corporate providers of investment services to the public in Pakistan."
  - CP 23: "SECP should review the status of client money and assets held by intermediaries and consider what additional protection is needed."
  - CP 24: "SECP should review the procedures available to it for dealing with the failure of a non-bank finance company, particularly where the new prudential regulations apply."
- Principles for the Secondary Market (CP 25–30)
  - CP 28: "SECP should review the rules about insider trading to ensure that they can be enforced effectively in particular cases."
  - CP 29: "SECP should secure the enactment of appropriate rules of law about the segregation and protection of client money and assets held by intermediaries."
  - CP 30: "SECP should seek confirmation of the statutory authority of the National Clearing Company to act as a self-regulator with the power to make, with SECP approval, and to enforce regulations."
  - CP 30: "SECP should in due course address the status of those listed issuers which stand outside the national clearing and settlement system."

### Authorities’ response (summary)
- On CP 2: The Federal Government "exercises a transparent procedure for appointments" and the law "provides for release of annual report to the public and submission of the same to the Federal Government." The statement of accounts is furnished to the Federal Government which "subsequently makes both the documents public by Gazette notification." "The annual report is of interest to the public and is placed on the Commission’s Website."
- On CP 3: "The SECP has inspection, investigation, surveillance and enforcement systems in place and is constantly upgrading these to ensure compliance with the laws."
- On CP 4: "The regulatory processes are under constant review."
- On CP 5: "A Code of Ethics and Conduct for employees of the Commission has been prepared and it lays down the professional standards that Principle No. 5 states."
- On CP 6 (MOU with exchanges): Legal framework "facilitate timely exchange of information and cooperation between the SECP and the stock exchanges. Thus there is no bar on sharing information and as such no formal requirement on the part of the two parties to sign an MOU. However, the same may be considered."
- On CP 6 (statutory authority of National Clearing Company): "The SECP will look into this suggestion."
- On CP 11: SECP "has signed a MOU with Sri Lanka." "Arrangements with other foreign counterparts will be entered into as well." Jurisdictional note on bank records: under Section 33A of the Banking Companies Ordinance 1962 banks are prohibited from divulging customer affairs "except as required by law." Banks can be ordered to produce documents under Section 21 (4) (b) of the Securities and Exchange Ordinance 1969 by the person appointed under Section 21 of that Ordinance.
- On inter-regulator cooperation: SECP and the SBP "have signed a MOU" defining coordination parameters for supervision of banks, DFIs and NBFCs, including information sharing and assistance.
- On CP 13: "The regulatory system allows for assistance to be provided to foreign regulators" via MOUs on a case-by-case basis; provisions are "similar to the IOSCO MOU."
- On CP 14: "The Companies Ordinance has been amended in 2002 and the financial reporting obligations have been further strengthened. Moreover, the SECP ensures that disclosures of financial results are timely and imposes penalties for defaults."
- On CP 21: "An Investment Adviser has to be a corporate entity licensed by the SECP. No individual/firm is authorized to render such services."
- On CP 23: Arrangements exist "to keep client assets separate at all times from the assets of the market intermediary (broker)." Market intermediaries may open sub-accounts on behalf of sub-account holders; clients may use "Investor Account Services (IAS) of the Central Depository Company" and open separate investor accounts. Brokers can only enter client-owned book-entry securities in their own account on "written authorization of his clients."
- Legal protection: Section 24(2) of the Central Depositories Act, 1997 places an obligation on the market intermediary "not to handle or authorize or permit any handling of book-entry securities beneficially owned by such clients and entered in his account without the authority of his client."

*Source: IMF mission document.*

### 130.     Moreover the broker is required to maintain back office records of securities held in

### _cr04215 - 130.     Moreover the broker is required to maintain back office records of securities held in

### Broker back-office records and reconciliation
- Paragraph 130: The broker is required to maintain back office records of securities held in the group account (“omnibus account”) on behalf of his clients.
- Paragraph 130: The broker must verify/reconcile the activity taking place during that business day with reference to any holding of book-entry securities entered in any holding forming part of the account family (including the group account) of the broker.
- Paragraph 131: Under chapter 13 of Central Depository Company of Pakistan Limited Regulations (CDC Regulations), Central Depository Company conducts a periodic audit of back office records of the broker to monitor compliance with the CDA 1997 and the CDC regulations.
- Paragraph 131: The periodic audit ensures that securities held in group account are reconciled with the back office record showing the transactions conducted and securities held in the group account and that proper authorization for handling of securities has been obtained from the client.

### Segregation of client money and proprietary trading regulations
- Paragraph 132: The draft Margin Financing Rules, 2004 (forwarded to the Federal Government for approval) propose that deposit of margin of client in form of cash by the market intermediary (broker) shall be kept in a separate bank account.
- Paragraph 133: The SEC is drafting Regulations for Proprietary Trading; once in place, the regulations will ensure explicit segregation of client accounts and broker/proprietary accounts.

### Recommendations and cross-references
- Paragraph 134 (Recommendation on CP 28): The SECP has started the review of legal provisions pertaining to insider trading and security disclosure.
- Paragraph 135 (Recommendation on CP 29): Refer to the comments on CP 23 on segregation and protection of client money and assets held by intermediaries.

### Observance of IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies—Monetary Policy: General and mission
- Paragraph 136: The SBP observes most of the good practices on transparency in monetary policy recommended by the IMF.
- Paragraph 136: Assessment conducted as part of the Financial Sector Assessment Program (FSAP) during a joint IMF–World Bank mission visiting Pakistan during February 16–27, 2004, and April 7–15, 2004.
- Paragraph 136: Monetary policy transparency assessment conducted by Mr. Jorge Canales-Kriljenko (IMF); financial policies assessment by Mr. Keith Bell.

### Monetary policy — Main findings
- Paragraph 137:
  - Most good practices about clarity of roles, responsibilities, and objectives of the monetary authority are observed.
  - The SBP Act establishes that the SBP’s Central Board of Directors shall “secure monetary stability and the soundness of the financial system.”18
  - The SBP Act preamble states SBP will be constituted to secure monetary stability and “fuller utilization of country’s productive resources.”
  - The term “monetary stability” is not precisely defined in the Act, giving leeway to adopt differing frameworks over time.
  - The annual monetary program, publicly disclosed, is designed to achieve low inflation, currently defined as 4 to 5 percent average annual CPI inflation.19
  - Monetary policy also seeks to smooth exchange rate fluctuations, support economic growth, and maintain financial sector stability, but the track record in disinflation indicates these objectives are subordinated to the inflation objective.
  - Institutional relationship between monetary and fiscal operations and agency roles performed by the SBP on behalf of the government are clearly defined.
- Paragraph 138: Transparency would be improved by clearly defining “monetary stability” and establishing a hierarchy of the multiple objectives of monetary policy in the SBP Act.
- Paragraph 139:
  - The process for formulating and reporting monetary policy is open and transparent; good practices observed.
  - Monetary framework, instruments, and any targets are publicly disclosed and explained.
  - Composition, structure, and functions of permanent monetary policy making bodies are publicly disclosed.
  - Changes in monetary policy instruments are publicly announced and explained in a timely manner.
  - SBP issues periodic public statements, including a monetary policy statement every six months as well as quarterly and annual reports.
  - Public consultations occur for substantive technical changes to monetary regulations and for regulations on data reporting by financial institutions to the SBP.
- Paragraph 140:
  - A wide array of information on monetary policy is publicly available.
  - Pakistan joined the IMF’s General Data Dissemination System in November 2003 and published comprehensive information on statistical production and dissemination practices on the IMF’s Dissemination Standards Bulletin Board.
  - SBP discloses a summary of its balance sheet every week and detailed audited balance sheet annually in SBP annual report.
  - Market transactions (monetary operations) are reported on the same day.
  - The Corporate and Media Affairs Department (CMAD) maintains public information services and SBP has a Chief Spokesman.
  - All regulations issued by the SBP since 1992 in the form of circulars and notices are readily available on the SBP’s website; older regulations are available upon request.
- Paragraph 141: SBP follows good practices on accountability and assurances of integrity:
  - SBP is accountable to Parliament and subject to reviews by Senate Banking Committee and National Assembly Banking Committee.
  - SBP Governor makes periodic appearances in Parliament and submits quarterly and annual reports.
  - SBP’s audited financial statements under international accounting standards are disclosed in the annual report, including balance sheet and profit and loss account, identifying dividend to the Government of Pakistan and balance transferred to government.
  - Standards for personal financial conduct of officials and staff are established in the SBP Act and SBP Staff Regulations; both publicly disclosed.

### Monetary policy — Remaining issues and recommended improvements
- Paragraph 142:
  - The conditions under which the government may override SBP decisions in exceptional circumstances are not specified in legislation.
  - The Federal Government can override SBP decisions by superseding the Central Board of Directors with an agency chosen by the Federal Government (SBP Act, section 52) if, in its opinion, the SBP fails to carry out obligations under the SBP Act.
  - The decision will be disclosed in the Official Gazette and the government must prepare a report for Parliament within three weeks explaining its decision.
  - Specific conditions for removal of the SBP decision-making body are not specified in the SBP Act and are left to arbitrary judgment of the Federal Government.
  - Recommendation: Modify the SBP Act to either eliminate the prerogative of the Federal Government to supersede the SBP’s Central Board of Directors or clarify the instances where the SBP would fail to reach its objectives.
- Paragraph 143:
  - The actual terms of SBP advances to the federal, provincial, and local government are not publicly disclosed.
  - Under the SBP Act, maturity of advances to government cannot exceed three months and the range of interest rates on these advances are disclosed in notes to audited financial statements in the annual report.
  - The detailed terms, including maturity, are not disclosed.
  - Recommendation: Fully disclose the terms and conditions, including maturity and interest rates, of individual SBP advances to the federal, provincial, and local governments on a regular basis.

### Table 2 — Recommended Action Plan (selected entries)
- If, in exceptional circumstances, the government has the authority to override central bank policy decisions, the conditions under which this authority may be invoked and the manner in which it is publicly disclosed should be specified in legislation.
  - Recommended Action: Modify the SBP Act to either eliminate the prerogative of the Federal Government to supersede the SBP’s Central Board of Directors or clarify the instances where the SBP would fail to reach its objectives.
- The amounts and terms of credits, advances, or overdrafts to the government by the central bank and those of deposits of the government with the central bank should be publicly disclosed.
  - Recommended Action: Publicly disclose the terms and conditions, including maturity and interest rates, of individual SBP advances to the federal, provincial, and local governments in an annex to the quarterly report.

### Authorities’ response
- Paragraph 144: The authorities generally agreed with the assessment, but did not provide written comments.

### Banking Supervision — Main findings and transparency practices
- Paragraph 145: The SBP observes most of the good transparency practices in banking supervision.
- Paragraph 146:
  - The institutional framework and objectives of the SBP and the SECP are clearly defined in the Banking Companies Ordinance 1962, SBP Act 1956 and Companies Ordinance 1984.
  - SBP regulates and supervises the entire banking sector; NBFCs are supervised by the SECP.
  - SBP is the sole payment systems authority in the country.21
  - SBP regulates clearing houses for scheduled banks and can enter into clearing and payment arrangements with other countries.
  - SBP and SECP have formal arrangements to share information, exchange views before formulating new regulations, and assist each other in developing supervisory resources; they meet quarterly or more frequently.
  - This relationship is formalized through an MoU which was publicly disclosed.
- Paragraph 147:
  - Policies and policymaking processes are well-defined and transparent.
  - SBP consults with Pakistan Banks Association (PBA), Institute of Chartered Accountants of Pakistan and other stakeholders on regulation and supervision matters.
  - Draft regulations are placed on SBP web site for comments; comments received are considered in amendments.
  - Significant changes are disclosed in quarterly and annual reports and through circulars.
- Paragraph 148:
  - Information on financial policies is publicly available via Banking System Review, Quarterly and Annual reports, SBP website, CMAD, and a monthly Statistical Bulletin.
  - Prudential regulations, directives, and guidelines are available in print and on the SBP website.
- Paragraph 149:
  - Deposit protection on publicly owned banks is codified under the Banks (Nationalization) Act (1974).
  - There is no explicit deposit insurance guarantee scheme for private banks.
  - Arrangements for handling bank complaints are publicly known.
- Paragraph 150:
  - Mechanisms for accountability exist: parliamentary standing committees may call SBP officials; SBP has an independent Board of Directors; Monetary and Fiscal Policies Coordination Board coordinates SBP objectives and government policies.
  - SBP’s audited financial statements under international accounting standards are included in the annual reports.
- Paragraph 151:
  - Laws and regulations guide conduct of personal financial affairs of SBP officials and staff.
  - Section 46 of SBP Act declares SBP employees public officers and subject to public servant laws.
  - Section 53 binds officers and servants of SBP to maintain secrecy.
  - Employees are required annually to submit a statement detailing assets and liabilities.
- Paragraph 152: Authorities observe good practices on transparency in banking regulations; the mission did not make specific recommendations in this area and SBP agreed with the assessment.

*Source: _cr04215 - 130. Moreover the broker is required to maintain back office records of securities held in (IMF PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04215.pdf_