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Critical appreciation of prudential regulations.

OVERVIEW

Regulation according to Oxford Concise Dictionary means authoritative direction and prudential means marked with prudence or discreetness. As such prudential regulations stand for authoritative directions marked with prudence or discreetness.

Regulation can be written, spoken, implicit or explicit. Even when we talk about deregulation, it is in fact about regulation to deregulate. Regulations, nevertheless, are imperative for the running of any mechanism which may be biological, social, political or economic in nature and all embracing, comprehensive or limited in scope. In other words there is no escape from regulations.

Regulation when evaluated objectively and/or subjectively can be found as being beneficial or harmful, good or bad varying from person to person, time to time and place to place. It rather sounds conceited that a set of regulations is qualified as prudential by their very perpetrators. The prudence or discreetness as a quality or property can hardly be evaluated by the one who is infected with the same and hence some third party is needed to pronounce its existence or absence.

Regulation for being good and effective must have certain characteristics; a few of which are being enumerated below to be used as rods to admeasure the prudential regulations pronounced by the State Bank of Pakistan relating to financial institutions of the country.

Characteristics of Regulations Clarity

Sufficient information about each regulation must be available if the same is meant to produce desired results. This should be easily understandable to a person having average intelligence and education. Sometimes lingo and technical terminology is used to cover the lack of substance and even if otherwise it defeats the very purpose of regulation.

Objectivity

The psyche and the general attitude of those whom the regulation is going to effect must be taken into consideration. It is to be seen that what are the objective conditions, whether the regulators and regulations are held in esteem or in contempt and lest the flouting of the regulations has gain respectability in a specific set of people at a given place.

Simplicity

Regulations may have innate qualities for effective monitoring. As without monitoring a regulation is spurious and its very nature frustrates its end use.

Implementality

Regulations may have the quality to be implemented thoroughly being in consonance with the objective conditions and specific environments.

Adaptability

Regulations may possess sufficient elasticity to adapt to the changes in socio-economicy set-up and environment relating to a given community.

Solidity

Regulation may be solid enough, having very few loopholes, so that the same is applied with uniformity. Required behavior from those required to follow the same must be known and sanctions for non-compliance precisely enumerated.

Authority

Source is very important for the legitimacy of a regulation, the track record and effectiveness of the authority are directly related to the perception of the regulations by those concerned.

Responsibility

Responsiveness of enforcement agency which frames regulations shows that the same are to be taken seriously and punishment for the violation is likely due to the strength of accountability system in vogue.

Attributes of Regulations

To sum up it can be said that regulations ought to be efficacious and the implementation of the same is based on power for enforcement; power which may be any or combination of the following:

1. Reward Power 2. Referent Power 3. Co-elective Power 4. Expert Power

The concept of Power is in turn related to legitimate authority, which can be any or combination of the following and wields influence on both action and attitude.

1. Traditional 2. Charismatic 3. Rational

The foundation and binding force however remains the awareness and consciousness by most of the people of the existence of the regulations.

Moreover regulations may emanate from prospective policy making or positive policy making. Prospective policy is based on negative sanctions, while positive policy making is based on negative sanction and positive rewards.

To bring forth changes in economic system i.e. patterns of economic behavior, positive policy making proves more effective supported by education and persuasion.

General Comments

Against the perspective of over view, general characteristic and attributes, on the whole 17 prudential regulations issued by the State Bank of Pakistan on January 7, 1992, suffer from a number of infirmities.

More than half of these regulations directly relate to the advances and risk exposure. The others relates to administrative and functional matters.

These prudential regulations have been issued by the State Bank of Pakistan which is the central bank of the country and is as such regulatory body for the financial institutions. Its authority is not traditional or charismatic, it is purely rational. It is as such mainly subject to the attitude of effectees to the regulations of this nature which is mostly negative. First of all efforts are made to get the application of such regulations postponed as long as possible, as very well evidenced in this case. Secondly when the application will commence all sort of methods and tricks will be used not only for avoidance, but also for evasion purposes by the major portion of effectes.

The past history as to how the regulations have been enforced by the authority previously does not lead to wholesome perception of these regulations.

These regulations are the product of prospective policy making as the same do not carry positive rewards or incentives, while in case the same were really meant for bringing forth economic changes the same should have been the product of positive policy making to be really effective.

Now applying the yard-stick of characteristics for good and beneficial regulations, it is observed that:

* These regulations lack clarity, the language like unimpaired capital and reserve has been found confusing even for the top brass of financial institutions, what to speak of lower ranking functionaries. It shows either it has been done intentionally to cover the lack of substance or copycating has been done without considering the addressee who have to implement these regulations.

* The prevalent psyche having dominating strains of aversion to have due deference to law and system is well known in this country. Particularly the interference on the part of politicians and bureaucrats based on lack of any heed to regulations is almost norm and not exception overhere. As such these regulations conform very little to the objective conditions or in other words the same do not possess objectivity.

* The main problem with these regulations is that of monitoring. Some of the regulations require so much detailed information and intricate data that it is going to be real hard to keep the tabs. Even the devising of monitoring system for them appears to be an uphill task, what to speak of implementing the same. The said regulations however, seem to have ample adaptability in a sense that with the passage of time, the shape of these regulations is bound to change. Further although the required behaviour from those required to follow these regulation is clearly spelled out yet sanctions for non-compliance have not been precisely enumerated.

SBP Prudential Regulations

Now the prudential regulations are subjected to analysis one by one.

Regulations-I

It relates to per party exposure which states that the same shall not at any point of time exceed thirty per cent of Bank's unimpaired capital and reserve with a ceiling of 20% on fund based facilities and loan on accommodating Bank's directors and executive and shareholders with share holding of 5% or more. This is apparently is meant to avoid the concentration of credit in a few hands and to ensure accommodation of a greater number of people.

However, at the first place in the economic scenario obtaining in the country it is hardly possible to implement the same, as the monitoring due to the intricacies involved and loopless available can not properly be done. Secondly, it is against the spirit of free market economy, where financial institutions must be independent choice for loanees and they should not be subjected to such regulations. It is a well known experience in third world countries that the compulsive spreading of credit has done more harm than good.

Regulation-II

This regulation states that the contingent liabilities of a bank should not exceed 10 times of its unimpaired capital and reserve. This regulation can be easily monitored being related to the overall position of the bank and perhaps the regulation-I should have been also restricted to a quantum of overall bank's exposure as regards fund based liabilities only.

Regulation-III

It pertains to the restriction of unsecured financing upto Rs. 50,000 per borrower and overall exposure equal to the bank's unimpaired capital. Lending in our country is security oriented, while in advanced countries the track record of the borrower and revenue generation aspect of investment is given more importance. It is more appropriate if instead of restricting unsecured advances, suitable changes are affected in lending rationals and arrangements are made to shift the emphasis accordingly. The moth-eaten approach as such underlies this regulation which requires to be discarded. If banks total fund based and non-fund based exposure is regulated, this regulation will become redundant.

Regulation-IV

It relates to linkage of borrowers equity and total borrowing from bank to 10 times the unimpaired capital and reserve of the borrower as disclosed in the audited report. This regulation lacks objectively, the low literacy level in general and a very little understanding of GPAs by the business class are very well known facts. Any regulation which does not take into consideration the factual position is destined to flop. It does not require Jean Dixon to predict that eventually this regulation will be diluted if not withdrawn due to practical difficulties in the way of its implementation.

Regulation-V

It provides for 1:1 ratio in current liabilities and current assets and 60:40 in case of long term liabilities and fixed assets.

Its position is not very different from that of regulation No. IV and being unrelated to the objective conditions is likely to meet the same fate.

Regulation-VI

This regulation is perhaps most relevant to the present extra-ordinary interest in the shares and securities market and is based on normal margin setting exercise, which can be monitored very conveniently.

Regulation-VII

This regulation relates to dealing of a bank with its directors, officers, employees and major share holders is very sound in spirit and if implemented effectively can prove beneficial to avoid damage to the interests of general shareholders, but being more likely to be flouted is just another number.

Regulation-VIII

It contains guidelines for provisioning and classification of assets. This regulation is very well thought out. Particularly the fixation of percentages on the difference resulting from outstanding balance of principal and the amount of liquid assets, realiseable without recourse to the court of law will reasonably lessen the drain on available funds for lending.

However, clarification is needed in respect of running finance wherein the determination of outstanding balance of principal will be hard if the principle of FOFI (first out, first in) is applied.

Regulation-IX

It is about the restriction on directors for holding any position other than CEO and non-payment of perks to them.

This regulation is however silent regarding payment of perquisites to 25% directors who can be paid directive of the bank.

Regulation-X

This regulation giving free hand in fixing charges from its services reflects the spirit of market economy. But the same is partly restricted by Regulation-XIII which says that no bank levy any charge in any form on the credit balance held by it on PLS basis. As such regulation-X and regulation-XIII are contradictory.

Regulation-XI

This regulation is rather superfluous as no bank in private sector is going to pay any dividend to its shareholders in near future. As normally in this country, the practice of paying dividend is very limited.

This regulation is likely to be used as an excuse even where these could have been a little possibility for such a payment.

Regulation-XV-XVI & XVII

These regulations are routine ones and were already in vogue in one form or another and do not need any comment.

Suggestions

The main regulations having conceptual flaws appear to be incapable of delivering, hence it is imperative that suitable modifications, alterations, deletions and additions are affected so that the same commensurate with the prevalent environments and objective conditions.

In this behalf the following suggestions are being made, which may be of used to formulate more realistic regulations:

1. One of the most important purpose of the regulations is to safeguard the interest of the depositors, who repose their trust in the banking system and keep their savings with the banks. In this case the Deposit Insurance Scheme may be introduced forthwith. Each financial institution which is allowed to solicit deposits from public must be made to pay premium to an agency nominated for this purpose, to guarantee safety of deposit to a given limit say Rs. 100,000 per depositor or per account holder. The public may be informed about those institutions who are covered under the scheme accordingly.

In this way those depositors, who out of their sheer greediness go for the institutions not covered under this scheme, will not be in a position to blame the Government or its functionaries as happened in case of investment companies in Karachi or Co-ops in Punjab.

Bankruptcy law although available is not being enforced effectively as so little is heard about the organisations, firms or individuals going bust. It will lead to maturity if these laws are used whenever or wherever warranted and stigma attached with the same will be mitigated with the passage of time.

In case of advances, the law of supply and demand should be allowed to work and institutions must be given free hand, in choosing its borrowers, which means that so-called social objectives should not be used as an excuse for unnecessary interference which often carry ulterior motives.

Nontheless fiscal measures and monetary policy tools available to the regulatory agency may be used to affect and achieve desired economic objectives, while the deregulation is desirable in other spheres of economy, why this sector should be made to suffer excessive regulatory measures.

Regulations which are hard to monitor or implement ought to be withdrawn to avoid making a mockery of the same and driving the institutions to resort to avoidance and evasion or forcing the effectees to raise hue and cry. Moreover, presence of misfits will keep even the desirable regulations also away from implementation.

Regulations must provide some incentives for those who comply with them and precise sanctions for non-compliance should be pronounced.

Central Credit Information Bureau is being established by SBP, but the efforts appears to be lukewarm. It may be appropriate if some private agency is inducted to take up the job in a more comprehensive and effective manner so that the credit is linked to credit ratings and track records and the present position of dependence on personal whims is changed for the better.
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Title Annotation:banking regulations in Pakistan
Author:Choudhry, Maher Elahi
Publication:Economic Review
Date:Oct 1, 1992
Words:2479
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