CHAPTER 2

BANKING HISTORY &

REGULATORY
ENVIRONMENT
Dr. Abidullah Khan
 Contents
- Introduction
- Pakistan Banking History
 Pre-Nationalization Banking
Before nationalization of banking in 1974, there were 14 scheduled banks in Pakistan.
1. National bank of Pakistan
2. Habib bank limited
3. Habib Bank (overseas) Limited
4. United Bank limited
5. Muslim Commercial Bank Limited
6. Commerce Bank Limited
7. Standard Bank Limited
8. Australasia Bank Limited
9. Bank of Bahawalpur Limited
10.Premier Bank Limited
11.Pak Bank Limited
12.Sarhad Bank Limited
13.Lahore Commercial Bank Limited
14.Punjab Provincial Co-operative Bank Limited

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 Nationalization
Having vast network of branches by these banks, still funds were not mobilized
efficiently.

On January 1, 1974, the Government of Pakistan decided to nationalize all Pakistani

scheduled banks.

Promulgation of Nationalization Act 1974 with objectives of:

◦ To enable the government to use the capital concentrated in the hands of a few rich banks
for the purpose of rapid economic development and more urgent social welfare projects
◦ To distribute equitably bank credit to different classes, sectors and regions

◦ To coordinate the banking policy in various areas of feasible joint activities without
eliminating healthy competition among banks

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 Nationalization – Merger of Banks
Banks Merged with
Bank of Bahawalpur National Bank of Pakistan

1. Habib Overseas Bank Limited,

Habib Bank Limited
2. Standard Bank Ltd.

1. Premier Bank Limited,

Muslim Commercial Bank
2. Lahore Commercial Bank Limited

1. Sarhad Bank Limited, Australasia Bank Limited (renamed

2. Pak Bank Limited as Allied Bank Limited)
Commerce Bank Limited United Bank Limited

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 Cont….
At the time of emergence, Pakistan had a serious consideration to stabilize the
country’s economy.

Fund mobilization to nook and corner of the country.

Financing to priority sectors such as agriculture, SMEs and Industry.

However, the economy became dominated by public sector (due to nationalization).

This led to a chronic budget deficit.

Thus, decision made to privatize banks.

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Current Status of Banking

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Bank Status
Albarka Bank Ltd. Subsidiary of Al Baraka Banking Group
Allied Bank Ltd. Listed
Askari Bank Ltd. Listed
Bank Alfalah Ltd. Listed
Bank Al-Habib Listed
Bank Islami Pakistan Ltd. Listed
Faysal Bank Ltd. Listed
Dubai Islamic Bank Pakistan Ltd. Unlisted
Habib Bank Ltd. Listed
Habib Metropolitan Bank Ltd. Listed
Industrial Development Bank Ltd. 57% GOP, 36% SBP, 7% Provincial Governments
JS Bank Ltd. Listed
MCB Bank Ltd. Listed
MCB Islamic Bank Ltd. Unlisted
Meezan Bank Ltd. Listed
National Bank of Pakistan Govt. owned, Subsidiary of SBP
Samba Bank Ltd. Listed
Silk Bank Ltd. Listed
SME Bank Ltd. Unlisted
Samba Bank Ltd. Listed
Soneri Bank Ltd. Listed
Sindh Bank Ltd. Wholly owned by Sindh Govt.
Standard Chartered Bank (Pakistan) Ltd. Listed
Summit Bank Ltd. Listed
The Bank of Punjab Listed
The Bank of Khyber Listed
The Punjab Provincial Co-operative Bank Ltd. Financed by Federal Bank for Cooperatives (fully subscribed by GOP, SBP and Provincial Govts.)
United Bank Ltd. Listed
Zarai Taraqiati Bank Ltd. Unlisted
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 Banking Structure in Pakistan
Commercial Banks

Development Financial Institutions (DFIs)

Microfinance Banks

Exchange Banks

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SBP Regulated
Institutes

Commercial
Banks

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 SBP Regulated Institutes

DFIs

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 SBP Regulated Institutes

MFBs

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 Why Banks are Regulated?
A core principle of the regulation is that regulation is demanded by the industry and
implemented for the benefit of the relevant industry.

However, excessive regulation can also have unfavourable impact on the industry or
other stakeholders.

This is also evident from the history of regulations that regulation can hurt the
interest of the industry in the form of profit reduction.

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 Cont….
Banks are regulated for three different reasons.

The first two reasons involve prudential regulations of banks, dealing with their
safety and soundness.

The third reason concerns social goals.

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 Sources of Banking Regulations
The sources of regulation include both domestic/national laws (laws that apply to activities
within the jurisdiction of a sovereign country) and international laws (agreements between
sovereign nations).

National Laws

Each county has its own hierarchy of laws including banking regulations which are regulated
and supervised by the central bank of the country.

International Laws

International standards have become increasingly important in the regulations of banks. Not
only are such standards important to the operations of internationally active banks, but
international standards have also begun to influence domestic-oriented regulations as well.
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 Cont….
The Basel Committee addressed various concerns relating to globalization of banking in 1992
by issuing the “Minimum Standards for the Supervision of International banking and their
cross-border establishment. The Minimum Standards established four main principles:
1) All international banks should be supervised by a home country authority that capably performs
consolidated supervision.

2) The creation of cross-border banking establishments should receive the prior consent of both the
host country and home country authority.

3) Home country authorities should possess the right to gather information from the cross-border
establishments.

4) If the host country determines that any of these three standards is not being met, it can impose
restrictive measures or prohibit the establishment of banking offices.

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 Cont….
Following are the major international groups and financial institutions that are involved in setting standards &
regulations for the banking & financial industry:
◦ Basel Committee on Bank Supervision (BCBS or Basel Committee)
◦ International Organization of Securities Commission (IOSCO)
◦ International Association of Insurance Supervisors (IAIS)
◦ International Association of Deposit Insurer (IADI)
◦ Committee on Payment & Settlement Systems (CPSS)
◦ International Accounting Standards Board (IASB)
◦ Organization for Economic Cooperation & Development (OECD)
◦ Financial Action Task Force (FATF)
◦ International Monetary Fund (IMF)
◦ Financial Stability Board (FSB)
◦ Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
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 Legal Framework
Under Legal Framework, the banks are entrusted with necessary power and
mandate.
◦ State Bank of Pakistan Act, 1956

◦ Banking Companies Ordinance, 1962

◦ Microfinance Institutions Ordinance 2001

◦ Foreign Exchange Regulation Act, 1947

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 Regulatory Framework
The regulatory framework comprises a set of policies, guidelines, prudential
standards and allied processes which cover the following key areas:
a) Licensing Regime
◦ Licensing of new Commercial (Conventional & Islamic) and Microfinance banks and facilitate
local and overseas Branch Expansion of Banks/DFIs/MFBs.
◦ Privatization of Public Sector Banks and requests for the schemes of amalgamation/mergers
of banks are processed.
b) Prudential Regulations*
◦ Prescribe the minimum standards for risk management, operations, and fair treatment to the
customers.
◦ Cater the unique features and underlying risks of respective business sectors i.e. large
Corporate financing, Small and Medium Enterprise (SME) financing, Consumer financing,
Micro financing and Agriculture financing.
◦ A comprehensive regulatory framework on Branchless Banking is in place which aims to
promote access to finance on sustainable basis.
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 Regulatory Framework
c) Corporate Governance Regime
◦ Policy formulation and its enforcement to ensure good Corporate Governance standards in
the banking industry and application of Fit & Proper criteria for key executives and board of
directors.

d) Capital Adequacy Regime

◦ Effective implementation of capital adequacy regime in line with Basel Accord, and
development and strengthening of related policies and instructions for the banking sector.

e) AML/CFT Regime
◦ Anti-money Laundering Act and Countering the Financing of Terrorism
◦ Develop, review and update regulatory framework on AML/CFT as per international
standards and practices.

f) Policy Environment & Market Discipline

◦ Issuance and review of guidelines on risk management, internal controls, financial disclosure
and other key areas, and the panel of approved auditors (who are eligible to audit the banks
and DFIs) is ensure quality of statutory audit and strengthen the market discipline.
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 Supervisory Framework
SBP supervises activities through supervisory teams, which encompass off-site
supervision, on-site assessments and enforcement actions.

The intensity of supervisory activities commensurate with the risk profile of

supervised institutions.

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 Supervisory Framework
Key Principles of SBP’s Supervisory Approach
Forward-Looking Judgement Based
• Risk Assessment is forward looking and dynamic. • Risk profiling of institution is supervisory
• Take account of activities of institution and judgement based, supported by evidence and
external environment. analysis.
• Helps in early identification and prompt • May differ from institutions own analysis
intervention.

Structured Assessment Risk Focused

• Distinct evaluation of risks and risk management • Supervisory focus is on key issues that pose
processes including controls and governance, which greatest risk to the safety and soundness of the
enables identification of high risk or weak control individual institutions and the stability of the
areas. financial system.

Proportionality Ongoing Supervision

• Supervisory intensity and allocation of resources • Risk-based supervision emphasizes on evaluation
is sensitive to both, level of risk within and of risks in a continuum.
amongst regulated institutions. • It involves monitoring how risks are evolving,
identifying emerging risks and engaging with FI
for prompt corrective actions

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 Supervisory Framework
SBP’s Risk Based Supervision Framework
Identification of Significant Activities
◦ The risk assessment process starts with identification of individual activities that are
material to the institution and are known as “Significant Activities (SA)
◦ A significant activity is fundamental to the institution’s business model and its ability to
meet its overall business objectives.
◦ The assessment of dynamic environment also acts one of the factors for identification of
SAs of financial institutions.

Inherent Risks
◦ Inherent risk is intrinsic to an activity or process in the absence of any mitigating control.
◦ . It is the probability of loss to current and potential future exposure/position, of significant
activity, due to any adverse events.
◦ The relevant inherent risk(s) of significant activities are identified and assessed as Low,
Moderate, Above Average or High.
◦ The categories of risks include Credit, Market, Operational, Strategic and Legal &
Regulatory risk
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 Control & Governance Structure
QUALITY OF CONTROLS AND GOVERNANCE
Operational Management
◦ Operational management (OM) is the first line of defense for risk mitigation and controls in a financial institution
and is also known as the ‘day-to-day controls.
◦ Operational Management is responsible for planning, directing and controlling day-to-day operations for
business/operational activities of a FI.
◦ The essence of an effective and efficient operational management function is that it is “self-sufficient” in people,
policies, processes and systems to adequately conduct the day-to-day business of an activity

Control Functions
◦ Internal Audit, Compliance and Risk Management are referred as entity level control functions, while Finance has
a key role to play in financial reporting and supporting both business and control functions.
◦ Compliance and Risk Management are considered second line of defense, while Internal Audit is considered as
third line of defense.
◦ Assessment of control functions focuses on both Characteristics and Performance of the respective functions.
◦ Characteristics include factors such as mandate, structure, resources, policies and practices, reporting and
coordination.
◦ Overall effectiveness of any control function is evaluated on the basis of characteristics and performance.

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 Cont ….
Governance Functions
◦ Effective Governance is pivotal in helping the financial institution to achieve its objectives
while generating sustainable shareholders value and balancing competing demands of other
stakeholders.
◦ It evolves around the basic principles of fairness, integrity, transparency and accountability
with prime focus on the role of the Board of Directors and Senior Management.
◦ Akin with internal control functions, assessment of Board of Directors and Senior Management
focus largely on assessment of Characteristics and Performance of Governance Functions.

Each control and governance function will be assessed as Effective, Acceptable, Needs
Improvement or Weak.
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 The Process of Risk Valuation

Quality of
Net Risk/
Inherent Risk Mitigated by Controls & Equals
Direction of Risk
Governance

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 Supervisory Intervention
Intervention Level Supervisory Response
• Regular supervisory activities as per supervisory
Normal strategy developed for the FI would be conducted.
• Enhanced frequency and intensity of normal
Enhanced supervisory activities along with increasing reporting
requirements.
• Use of more coercive powers communicating
Mandated Action mandated actions along with imposition of certain
restrictions.
• More severe invasive actions and restrictions to
Remediation address material risks.

• Measures to restructure, wind up or liquidate the FI

Resolution using legal powers vested with SBP

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