Rules for more prudent banking

The State Bank of Pakistan’s latest upgradation of prudential regulations for corporate and commercial banking enables banks to seek more opportunities, but do so in a professional and transparent manner to avoid future risks. One important aspect of the revised regulations is that after more than seven years, the central bank has again imposed a limit on bank financing to the housing sector. In April 2007, the SBP had advised banks to keep their housing finance up to 10pc of their net advances. The purpose was to enable banks to develop their housing finance portfolio ‘to a reasonable level’. Now, this limit has been re-imposed with two key changes. Banks’ financing to the real estate sector will now be up to 10pc of their advances and investment (minus investment in government securities). However, the limit will not apply on financing to government-sponsored low-cost housing schemes. Bankers say whereas prudential regulations for corporate and commercial banking have been in place for a long time, the SBP has now come up with a complete set of regulations in one document which will make their implementation easier. Banks have been ignoring credit demand from genuine borrowers for some time, encouraging concentration of credit in a few sectors The updated regulations require banks to ensure that their respective credit policies prescribe a minimum current ratio and a linkage between the borrower’s equity and its total financing facilities from all financial institutions. The policy must also have explicit provisions for circumstances and conditions under which a bank can still lend in breach of the prescribed limits. But in all situations, the credit report of a borrowing company or group of companies issued by the Credit Information Bureau must be assigned due weight. Banks are also required to ensure that clean financing — or financing without guarantees or issued against just personal guarantees — do not exceed Rs2m. On the other hand, banks issuing guarantees will also have to be more disciplined. All their guarantees need to be fully secured — or at least up to 50pc in specific cases, the details of which have been annexed to the revised regulations. Even such waivers in the laid down conditions will be subject to the condition that banks have at least 20pc of the guaranteed amount in the form of liquid assets as security. For quite some time, banks have been ignoring credit demand from genuine borrowers, and have been content with lending to customers of their choice. This encourages concentration of bank credit in a few sectors, adversely affecting financial inclusion and chocking economic growth. This compels a large number of borrowers to turn to informal sources of borrowing. Banks, on their part, argue that lending to too many new borrowers carries the risk of a buildup in non-performing loans (NPLs). More importantly, detecting the potential buildup isn’t possible unless the loans actually fall into the well-known categories of NPLs, each based on the period during which the loans are not serviced. To address this issue, the upgraded regulations now allow banks to classify loans on the basis of their subjective evaluation as non-performing, even if those loans are performing. “Such evaluations shall be carried out on the basis of the credit worthiness of the borrower, their cash-flow, operation in the account and adequacy of the security inclusive of its realisable value and documentation covering the advances.” As per the revised regulations, banks can free up some resources for lending by reducing their actual resource allocation for provisioning against bad loans. Banks have been allowed to take greater benefit of forced sale value (FSV) of pledged stocks, plant and machinery, and mortgaged properties held as collateral for calculating their provisioning requirement. A separate formula will be used for making such calculations for each class of collateral or security held by banks. Each formula, however, assigns different percentages of FSV that can be counted towards provisioning against NPLs. And the percentages are in descending order, which means banks can use a greater portion of FSV in initial years of the holding of collateral and a lesser value in later years. Under the revised regulations, banks will continue to underwrite term finance certificates, commercial papers and other debt instruments of non-bank financial companies, and issue guarantees in favour of NBFCs. But they “shall not issue any guarantee or letter of comfort nor assume any obligation whatsoever in respect of deposits, sale of investment certificates, issue of commercial papers or borrowings” of any NBFC. This will introduce more transparency in banks’ dealings with NBFCs, which has become all the more important because of overlapping interests of banks and NBFCs in cases where a business group has big stakes in both of them. In order to ensure that banks remain sufficiently liquid in the foreign currency market to finance eligible operations, and that the interbank forex markets do not dry up (putting pressure on forex rates), the revised regulations also reemphasise that no bank will invest forex deposits in foreign currency or rupee-denominated instruments below investment grade. Banks will also not be allowed to place or invest such deposits in fund management schemes of other banks, DFIs and NBFCs in Pakistan or abroad. Published in Dawn, Economic & Business, July 7th, 2014