Objectives of State Bank of Pakistan

Submitted To:
Mr. ISHTIAQ AHMED (Chief Manager)

Submitted By:

Salman Ayyaz
&
Noreen Ghulam Haider
(Gomal University D.I.Khan)

1
Acknowledgments
We are sincerely gratified by the courtesy of The State Bank of Pakistan/BSC, D.I.Khan to
offer internship program and for making us part of their family.

We are thankful to Mr. Ishtiaq Ahmed (Chief Manager) for his rent less and captivating
behaviour and amazing ability to see things from two points of view, his own and that of
another throughout our journey to make us remarkable.

We owe a bigger debt of gratitude to Ms. Fareena Hameed, Internship Coordinator who has
believed in us from day one and has always been there for time, patience, amity, and
precious contributions.
We are thankful to entire team of SBP BSC (Bank) D.I.Khan for devoting their time,
knowledge, and friendly environment.

Kind regards,

Salman Ayyaz, BBA (Hons)

Noreen Ghulam Haider, BBA (Hons)

2
 TABLE OF CONTENTS

Sr# Title Page No.

1. Introduction

2. Objectives of State Bank of Pakistan

2.1 Maintaining Price Stability with Growth

1.2 Monetary Policy Statement

1.3 Open Market Operations (OMOs)

1.4 Interest Rate trends/Yield curve

2 Segregation of Debt and Monetary Management

2.1 Government Bonds Market

2.2 Broadening Access to financial

2.2.1 Overview

2.3 SME

2.3.1 SME Credit Profile

2.4 Microfinance

2.4.1 Progress on Microfinance programs

2.4.2 Housing and Infrastructure finance

2.4.3 Housing finance market in Pakistan

3 Infrastructure finance market

3.1 SBP Initiative to Housing and Infrastructure financing infrastructure

finance
3.1 Ensuring Soundness of Financial sector

3.1.1 overview

4 Ensuring stability of the banking system

4.1 Changes in CRR/SLR and Changes in CRR/SLR on F.E. 25

4.2 Exchange Rates and Reserve Management

4.3 Overview

3
4.4 Advance Payments against Imports:

4.5 Remittance of Surplus Funds by Foreign Airlines

4.6 Advance Payments against Imports on L/C Basis
4.7 Home Remittances
5 Exchange Companies
Export of permissible FCYs by exchange companies through
Lahore Airport
Strengthening Payment Protocol
bibliography

4
Introduction

Vision
To transform SBP into a modern and
dynamic central bank, highly professional
and efficient, fully equipped to play a
meaningful role, on sustainable basis, in
the economic and social development of
Pakistan.
Mission
To promote monetary and financial stability
and foster a sound and dynamic financial
system, so as to achieve sustained and
equitable economic growth and prosperity in
Pakistan.

The State Bank of Pakistan is the central bank of the country. Usually the starting point
for a central bank is a banking system that is already in place - the banking system
necessitates the presence of a central bank. But the State Bank of Pakistan (SBP) is
unique in the sense that it started its function in a newly born country, where it also had
to shoulder responsibilities of developing and rehabilitating a banking system and the
economy, in addition to the traditional central banking functions. Performance of the
Bank since its inception in 1948, as reviewed in subsequent pages, shows that it has
faced all the challenges with a great zeal and commitment. Most of the banks had their
head offices in India. Out of 3,496 branches of the scheduled banks, only 631 were
situated in Pakistan. To complete the picture of misery, the entire banking structure was
dominated by Hindus. With the announcement of the Partition Plan of June 3, 1947, the
Hindu started to withdraw their deposits from the banks located in Pakistan. As a result,
many banks had to close down their operations. The founders of the Bank set a multi-
dimensional target before it that included not only regulation of the monetary and credit
system but also the growth of this system. The vision of its founders was a stable

5
monetary system in Pakistan with fuller utilization of the countrys productive resources
(SBP Act, 1956). At the time of its formation, the State Bank of Pakistan neither had any
building for housing its offices nor was there sufficient time for purchase and
construction of new premises. Therefore, Victoria Museum Building at the Ingle Road
was rented from the Karachi Municipal Corporation and swiftly refurbished. The Bank
was inaugurated on July 1, 1948 by Quaid-e-Azam Muhammad Ali Jinnah, who thus
observed on the guiding principles of the newly-created central bank:
I need hardly dilate on the important role that the State Bank will have to play in
regulating the economic life of our country. The monetary policy of the bank will have a
direct bearing on our trade and commerce, both inside Pakistan as well as with the
outside world and it is only to be desired that your policy should encourage maximum
production and a free flow of trade.

Functions of SBP

In order to achieve the goals set before it, the State Bank of Pakistan performed all the
traditional and non-traditional functions. The traditional functions, which are generally
performed by central banks all over the world, are classified into two groups primary
functions & Secondary functions

Primary Functions including issue of notes, regulation of the financial system,

lender of the last resort, and conduct of monetary policy,

Secondary Functions including management of public debt, management of foreign

exchange, advising the Government on policy matters, anchoring payments system,
and maintaining close relationships with international financial institutions.

The central bank operations can also be categorized into macroeconomic function and
microeconomic function. The macroeconomic function is to preserve the value of the
currency, that is, maintain price stability and the microeconomic function is to maintain
stability in the banking system.

The non-traditional or promotional functions performed by the State Bank include

development of financial framework, provision of training facilities to bankers, and
provision of credit to priority sectors. The State Bank has also been playing an active part
in the process of Islamization of the banking system.

6
Objectives of SBP
The State Bank of Pakistan Act defines SBPs statutory objectives. The central bank of a nation
is a cornerstone of the economy. SBP is no exception. It has responsibilities for monetary policy,
financial stability, regulation of payments systems, supervision of the banking sector, and
currency management. Unlike most Western central banks, SBP is given an explicit
responsibility for economic growth.
1. Implementation of monetary Policy
2. Broadening access to financial sector.
3. Insuring soundness of financial sector.
4. Exchange rates and reserve management.
5. Strengthening payment protocol.

1) Implementation of Monetary Policy

Monetary policy is the process by which the monetary authority of a country controls
the supply of money, often targeting an inflation rate or interest rate to ensure price
stability and general trust in the currency. SBP being a central bank is responsible for
maintaining the Monetary stability.
Monetary policy makes the use of several instruments in order to achieve its core
objectives. A few are mentioned below:-

Open Market Operation

Reserve Requirements
Tight Monetary Policy
Easy monetary Policy
Expansionary Monetary Policy
Contractionary Monetary Policy

1.1 Overview

FY15 was a challenging year for SBP in terms of achieving its prime objective of price
stability. Due to the deteriorating domestic macroeconomic imbalances, worsening
global economy, and rising international commodity prices, inflation rose to its historic
high levels. Bringing inflation down was an uphill task given the rising expenditures on
account of domestic political situation and meager domestic resources. Availability of
7
foreign resources was uncertain due to the global downturn and subdued foreign
investors interest. The weakening of the economic conditions also led to turbulence in
the financial markets resulting in severe liquidity shortages in both the money and
foreign exchange markets. In these circumstances, SBP endeavored to contain inflation
more aggressively with policy rate hikes and took corrective actions to ease the liquidity
conditions in the financial markets.
Moreover, SBP decided for more frequent reviews of the economy.

Later on, when towards the end to the first half of FY15, the economy stared to pick a
positive turn and the outlook of the economy appeared encouraging, SBP reviewed its
policy and decided not to continue with the further tightening of monetary policy. By
the end of third quarter of FY15, the macroeconomic situation improved further and
allowed the SBP to initiate an easing of monetary policy. The year culminated with a
significant improvement in the fiscal deficit and external current account deficit and a
substantial reduction in inflation. Foreign exchange reserves have once again reached
to a decent level and confidence in the economy appears to be improving.

While addressing the economic issues, SBP also focused on improving its capacity to
handle the ever changing economic environment and emerging policy challenges. In
this regard, it took a number of steps during the year. First, to improve vigilance of the
economy, SBP increased the frequency of issuing monetary policy statements from bi-
annual to quarterly basis. Second, the decision making process was further streamlined
by regular meetings of the Monetary Policy Committee. Third, decision making was
made more prudent and forward looking by supporting it with improved information
content, analysis of economic developments, and forecasts of key macroeconomic
indicators.

Further, to improve the effectiveness of monetary policy, the decision making

responsibility regarding the cut off rate for T-bills auction was transferred to the
Ministry of Finance. This step allows a clear signaling of the monetary policy stance and
communicates the market separation of its debt and monetary management functions.
More recently, SBP has also introduced an interest rate corridor of 300 bps below the
policy discount rate to make the transmission mechanism more effective.

In addition, to effectively communicate monetary policy to a wider audience, the

monetary policy stance was explained through print and electronic media more
frequently and its various publications are now also being released in Urdu.
1.1 Monetary Policy Statement
In FY15, SBP issued three monetary policy statements (MPS), i.e., for the first half and
then one each for the last two quarters of the year. In addition, in November 2014, the
central bank also published a supplementary report to announce interim monetary
policy measures. Two regular MPS in H2-FY15 was a new step and a deviation from
SBPs past practice of issuing MPS on bi-annual basis. Given an uncertain and rapidly
changing macroeconomic environment, and to enhance the effectiveness of monetary
policy, SBP decided in January 2015 to announce its monetary policy decisions on
quarterly basis. In August 2015 the frequency of monetary policy decisions was further
increased from four to six times in a fiscal year. Henceforth, monetary policy decisions
will be announced in the last week
8
of July, September, November, January, March, and May.
Moreover, it is decided that the January and July policy
announcements will be
accompanied with a detailed
monetary policy statement
and a press conference. On
remaining four occasions

billion rupee
monetary policy decisions
will be communicated
through a brief press release
only.

FY07

FY14
FY15
FY10
FY11
FY12

FY13
FY14

FY15
In the monetary policy
statement for July- December
2014, considering the risks
related to rising external
current account and fiscal
deficits, and worsening
inflation outlook, SBP decided
to increase its policy rate by
100 bps to 13 percent
effective July 30, 2014. Also,
considering the adverse
impact of continued
borrowing by the
government from SBP on
inflation, the SBP Central
Board of Directors resolved
that government should Table 1.1: Open Market Operations during FY15

retire Rs21 billion in each OMO (billion rupees)

Weighted average
quarter of O/N repo rates

FY15.Notwithstanding these Mop up Injection Net mop up Average SD

measures, additional Q1 436.1 254.6 181.4 11.0 1.6

unanticipated developments Q2 384.3 237.9 146.4 9.0 2.2

emerged and the outcome Q3 392.3 60.0 332.3 11.0 1.6

during the first four months Q4 155.0 679.5 -524.5 12.3 1.3
of FY15 deviated FY15 1367.7 1232.1 135.6 11.0 2.0
substantially from
expectations. In particular,
both the fiscal and external
current account did not
witness the expected
improvement, and
weakening financial inflows
9
 resulted in a substantial
drawdown of foreign
exchange reserves and a
sharp depreciation of Pak
rupee. This worsening
macroeconomic situation
forced the central bank to
announce interim monetary
policy measures in
November 2014, which
included a 200 bps increase
in the policy rate to 15
percent effective from
November 13, 2014

By the end of FY 2015, it became quite clear that both, the fiscal and the external current
account, deficits would be lower compared to their respective levels in FY14. However,
not only the expected magnitudes of these deficits were still quite high but there were risks
of slippages also. Similarly, the high expected inflation at that time and its persistence,
reflected by core inflation measures, were clearly showing the risk on this front. To
mitigate the implications of these risks and taking a precautionary approach, SBP left the
policy rate unchanged at 15 percent in the MPS for Q3-FY15. As both fiscal and external
current accounts continued to show improvement and inflation outlook started to
improve, SBP announced a 100 bps cut in its policy rate to 14 percent on April 20, 2015 in
the MPS for Q4-FY15 the first cut in the policy rate in the last four years. As the economy
stabilized further, and inflation came down quickly April 2015 onwards, in recently
announced MPS in August 2015, SBP further lowered its policy rate to 13 percent. While
easing monetary policy, SBP remains fully cognizant of risks associated with an uncertain
global environment and domestic structural vulnerabilities. These could lead to
deterioration in the countrys balance of payments, fiscal position, and inflation outlook.

1.1 Conduct of Monetary Policy and Credit Policy

1.1.1 Open Market Operations (OMOs)
FY15 was a challenging year in terms of liquidity management as it saw
huge swings in interbank liquidity. Apart from changes in the discount
rate, OMOs remained the major tool for monetary management during
FY15, although measures such as changes in CRR and SLR were also taken
to
inject permanent liquidity during Oct-Nov 2014. Liquidity situation remained under
stress during most of H1-FY15 mainly due to depletion of net foreign assets (NFA) and
unfounded market rumors about the stability of some of the local banks. In the first
quarter weighted average rate anchored within 200bps wide implicit corridor, however,
State Bank of Pakistan deliberately kept interbank money market liquid during the
second and third quarters of FY15, to dilute the above liquidity concerns and to ensure
adequate flow of funds to the private sector and GoP. For example, SBP injected Rs492.6
billion during H1 and Rs.739.5 billion during H2-FY15 (see Figure 1.1 and Table 1.1)
10
 through OMOs besides permanently injecting around Rs270.0 billion by reducing CRR by
400 bps and abolishing SLR on Time Liabilities during H1-FY15. Moreover, banks
availed Rs.932.2 billion during FY15 using discount window facility to ease liquidity
crunch to some extent.

The Weighted Average O/N rate during FY15 remained at 11.00 percent consistent with the
monetary policy stance. However, volatility of Weighted Average O/N rate increased
considerably due to liquidity stress during FY15 and SBPs
deliberate strategy to keep the interbank market liquid during second and third quarter of FY15
(see Figure 1.2)
Figure 1.3: Discounting

2000
2000
2000

1600

1200
1600
800

400
01200
FY15

FY04

FY05

FY06

FY07

FY14

FY13

FY15

Discount Window Operations Along with other liquidity800 management measures, banks also
accessed the discount window totaling Rs932.2 billion during the year (see Figure 1.3). The
number of visits at the discount window remained 123 in FY15 as against 137 in FY14. The
quarterly break up of discounting data showed that 73.6 percent
400
of the total discounting was
availed during the first two quarters when interbank money market faced acute shortage of
liquidity
1.1.1 Statutory Liquidity Requirement (SLR) and Cash Reserve Requirement (CRR)
The H1-FY15 (especially the 2nd Qtr) remained in the grip of liquidity crunch due to the
depletion of NFA and negative sentiments arising out of unfounded
0 rumors about few banks.
11
 Besides injection through OMOs and increase in banks effective access to discount window,
SBP took a series of steps to ease the liquidity situation and restore stability in the market.
These are given as follows:

During 11th October to 1st November 2014, SBP reduced the Cash Reserve Requirement
(CRR) by 400 bps to 5 percent of the time and demand liabilities (TDL) in a phased
manner: a reduction of 100 bps effective from 11th October; a 200 bps effective from
18th October; and another 100 bps effective from 1st November 2014.
Effective from 18th October 2014, SBP exempted the time deposits of one year and
higher tenor from Statutory Liquidity requirements (SLR).
Effective from 13th October 2014, SBP allowed securities categorized as Held-to-
Maturity for borrowing from SBP under SBPs 3-day repo facility/OMOs.
Effective from 18th October 2014, SBP increased the SLR eligibility limit of the PIBs
from 5 percent to 10 percent of the TDL.

Figure 1.4: Bank Excess Liquidity in Government Securities

Excess (billion rupees) Percent of DTL (RHS) 28

550
440 22

330 17

220 11

110 6

0 0
Jun-03

Dec-03

Jun-05

Dec-05

Dec-07

Jun-08
Jun-04

Dec-04

Jun-06

Dec-06

Dec-08

Jun-09

of the TDL by Jun 09 (see Figure 1.4). (Excess Liquidity is defined as the surplus holdings of
government securities / cash over and above the minimum CRR/SLR requirement). As a result
of improved liquidity in the banking system, the liquidity spread (i.e., the difference between
the clean interbank deposits rates and collateralized repo rates) has narrowed down
considerably.

1.2 Interest Rate Trends /Yield Curve

In continuation to tight monetary policy stance adopted by SBP since 2005, the discount rate
was further raised twice during H1-FY15 by 100 and 200 bps in July and November 2014.
These actions were undertaken to contain aggregate demand pressures. Cut-off yields on
government securities for different maturities increased and the yield curve moved
accordingly. However, after the decline of inflation numbers since February 2015, SBP reduced
discount rate by 100 bps w.e.f. April 21, 2015 (see Figure 1.5). Market interest rates had
already started to incorporate a reduction in the discount rate prior to the above reduction.

Movement in KIBOR for various tenors mirrored the liquidity situation and interest rate
12
expectations during the year. For example, the 6-month KIBOR reached to its peak level of
15.76 percent on November 11, 2014 and hovered around that level till the end of H1-FY15.
Similarly, KIBOR for 12- month remained in the vicinity of 16 percent during November 2014
to January 2015 (see Figure
Figure 1.5: Yield Structure
1.6). Results of liquidity
management measures 30-Jun-15 30-Jun-14 30-Jun-13

taken by SBP are visible 15

from the beginning of H2-
FY15 as KIBOR started to
decline. Sharp decline was

percent per annum

14
seen in 6 month KIBOR in
March 2015 in the backdrop
of slowdown in private
12
sector credit and
expectations of an interest
rate cut.
11

3M 6M 12M 3Y 5Y 10Y 15Y 20Y 30Y

1.3 Segregation of
Debt and Monetary
Management
To further strengthen and
segregate the
responsibilities of debt and Figure 1.6: Trend in Market Interest Rate (percent)

monetary management, two 6-month PKRV 6-month KIBOR DR

landmark measures were
announced by State Bank of 16
Pakistan in January 2015:
(I) prior announcement of
the auction calendar for 15
Treasury Bills (T-bills) and
Pakistan Investment Bonds
(PIBs) and a volume based 14
approach to determine the
auction result. The measure
2-Jan-15
2-Sep-14

2-Feb-15

2-Mar-15
2-Dec-14

2-Jun-09
2-Aug-14

2-Oct-14

2-Nov-14
2-Jul-14

2-May-09
2-Apr-09

was a significant step 13

towards development of the
Government Securities
market in the country. (ii) 12
Ministry of Finance would
henceforth be responsible
for deciding the cut off 11
yields in the primary
auctions of T-bills and PIBs.
State Bank of Pakistan 10
13
 however would continue to
manage the operational
aspect of the auctions and
there would be no change in
the process from the
markets perspective.

1.4 Government Bonds Market

Table 1.2: Snapshot of PIB Maturities & Issuance during 15

FY
As on May 28, 2015
Face value amount Weighted
Tenors Maturity issued
average Percent
Total issued Variance
issuance share
30-Aug-15 19-Feb-15 16-Apr-15 28-May-15 yield issuance
yield
3-years 14,088.0 187.5 3,977.5 3,071.5 2,866.5 10,103.0 -3,985.0 0.1 0.1
5-years 27,765.3 0.0 3,023.2 2,830.0 2,988.0 8,841.2 -18,924.1 0.1 0.1
7-years 0.0 200.0 2,735.0 2,592.0 1,800.0 7,327.0 7,327.0 0.1 0.1
10-years 0.0 688.3 7,821.0 14,156.0 12,365.5 35,030.8 35,030.8 0.1 0.5
15-years 0.0 56.0 1,180.0 63.4 103.0 1,402.4 1,402.4 0.2 0.0
20-years 0.0 0.0 1,500.0 200.0 200.0 1,900.0 1,900.0 0.2 0.0
30-years 0.0 2,500.0 2,000.0 100.0 2,000.0 6,600.0 6,600.0 0.1 0.1
Total 41,853.3 3,631.8 22,236.7 23,012.9 22,323.0 71,204.4 29,351.1 0.1 1.0

Pakistan Investment Bonds

The PIB issuance in FY15 remained same as in FY14. State Bank of Pakistan
continued with its strategy of reopening previous issues throughout the year
to build liquidity and size in benchmark issues. Government of Pakistan
introduced another tenor of 7 years in the PIB primary auctions.

Dissemination of advance PIB auction calendar not only assured market participants about the
supply of bonds but also the desired maturity profile of the government borrowings. Banks
showed keen interest in 10 year PIB, while insurance companies remained interested in longer
tenors of PIB. At the end of FY15 outstanding stock of PIBs remained at Rs440.99 billion as
against Rs411.63 billion at the end of FY14 (see Table 1.2).
Going forward, the strategy is to narrow the variety of debt instruments by consolidating and
standardizing government issues with emphasize on size of specific issues. By concentrating
government bond issues in a relatively limited number of popular standard maturities, enhanced
liquidity in those securities can be ensured.

Market Treasury Bills

On shorter end of yield curve, government raised net Rs304.3 billion in all three tenors of MTBs.
Due to change in interest rate scenario in second half, 12-month MTB remained heavily
subscribed. The

Table 1.3: Market Treasury Bills

14
 Amount accepted
Amount
Quarter No. of Auctions 1 Target Maturity
offered
(face (Realized value) (Face value)
value)
Q1 7 430,000 397,239 430,279 289,145 297,612
Q2 7 500,000 395,193 577,619 486,713 502,419
Q3 6 565,000 517,775 1,609,197 631,496 684,177
Q4 6 350,000 250,537 713,129 339,470 380,847
FY15 26 1,845,000 1,560,744 3,330,224 1,746,824 1,865,05
5
1:/ All auction on the basis of settlement dates.

activities in MTB primary market were Table 1.4: Detail of Ijara Sukuk Conducted durin g FY15
further aided by the release of advance million rupees
auction calendar which provided a clearer
idea of the government borrowing needs. Auction settlement Amount Ma rgin (Bps) over
date accepted MTB
The cut-off yields remained consistent with
the borrowing requirement of the 26-Sep-08 6,522.5 +45.0
government as reflected in the auction 29-Dec-08 6,000.0 +75.0
calendar and the interest rate expectations 11-Mar-09 15,325.0 +0.0
(see Table 1.3). Total 27,847.5

Government Ijara Sukuk

Another important landmark of FY15 is the issuance of government of Pakistan Ijara Sukuk.
During FY15 the government has conducted three Sukuk auctions of 03 years tenor with total
issued amount standing at Rs27.85 billion (see Table 1.4). The issuance of GoP Ijara Sukuk is a
significant step towards the development of inter-bank Islamic money market as it also
provides an investment alternative to both Islamic and conventional banks. This is a floating
rate instrument with the 6 month rental benchmarked to the 6-Month Weighted Average MTB
Auction rate.

2. Broadening Access to Financial Sector

One of the major objectives of financial sector reforms in Pakistan was to enable banks to
direct funds to sectors, which have greater significance in terms of economic and social
growth and that have so far largely been under-served. To achieve this objective, State
Bank of Pakistan has undertaken several initiatives to broaden financial services access to
underserved and marginalized sectors of the economy. The Development Finance Group
(DFG) at SBP is taking steps to develop capacities to better understand new niche areas
such as Infrastructure and Housing Finance, SME and Microfinance, Agriculture and Rural
Finance which have not yet been developed to their true potential. SBP also endeavors to
15
build and strengthen an inclusive financial system, supported by effective regulatory
measures, aimed at integrating these niche areas in the mainstream banking sector, on a
fast track basis. SME Finance Department undertook many initiatives to increase outreach
and quantum of SME credit. The department played active role in arranging timely
provision of credit from banking sector for wheat procurement purposes. To boost exports
and provide relief to exporters in meeting their export orders, State Bank took a number of
steps to facilitate exporters during FY15. SBP reverted to providing 100 percent refinance
under the Export Finance Scheme (EFS) and Long Term Financing Facility (LTFF), and also
allowed a longer repayment period of financing under Part I of EFS. To mitigate the risk of
banks and farming community against losses, caused by natural calamities, SBP also
developed and launched a market based Crop Loan Insurance Scheme (CLIS) during the
year and made the scheme initially mandatory for five major crops. Similarly for the
growth and development of microfinance sector, important initiatives like; i) Microfinance
Credit Guarantee Facility; ii) Institutional Strengthening Fund; and iii) Improving Access to
Finance Services Fund, were also launched during 2014-09.
2.2 SME
Like many other developing countries, in Pakistan too, the SMEs sector is the mainstay of
the economy. SMEs play a catalytic role in low cost employment generation, poverty
alleviation, and economic development. SBP realizes the importance of SMEs for providing
forward and backward linkages among social and economic activities of the economy,
encouraging an entrepreneurial culture, and boosting Pakistans foreign exchange
earnings.

2.2.1 SME Credit Profile

Figure 2.2: SME Number Borrowers
ME sector finance occupies second place in
terms of total finance from formal sector June 2014 June 2015
(10 percent) after Corporate Finance. At
2500
the end of June 2015, total outstanding
loans to the SME sector stood at Rs345.1
billion compared to Rs393.6 billion in June
2014. The decline in SME credit was mainly 2000

due to power outages leading to reduced

production activity, liquidity squeeze as
well as more cautious SME lending 1500
approach by the banks. Adverse law and
order situation in the country coupled with
global recession also had negative impact 1000 Fixed Trade Total
Workin
on Pakistan economy. A break up of the g finance
SME loans reveal that out of the total SME
investments capital
portfolio of Rs345.1 billion, around 76 500
percent were disbursed for working capital,
16
0
followed by 13 percent for trade

17
finance and 11 percent for fixed investment finance as
shown in Figure 2.1.

The number of SME borrowers also

witnessed a decrease of 2 percent during
FY 09. The total numbers of SME
borrowers were 219,062 at the end of June
2015 as compared to 223,675 at end June
2014 (Figure 2.2). However, further fall in
SME credit has been arrested due to close
follow up of SME Finance Department with
commercial banks as well as prudent
macroeconomic measures by the
government.
SME Finance Department, realizing the importance of
SME sector as engine of economic growth and
employment provider

to vast population in non-agri sector has taken many

initiatives to ensure that the financing needs of SMEs are
met by the banking sector.

SME Credit Guarantee Scheme

Credit Guarantee Schemes are programs that insure the

repayment of a loan, in part or full, to motivate lenders to
lend to groups which would not have access to credit under
normal circumstances. Credit Guarantee Programs seek to
help overcome the problem of loan applicants who have
good projects, and are in every respect credit worthy, but
cannot offer

adequate collateral to satisfy the normal requirements of a

lending bank. SME Finance Department is making efforts to
introduce a credit guarantee scheme with the support of
UKs DFID under Financial Inclusion Program (FIP). The
launch of the scheme is expected to create significant
demonstration effect whereby banks will be encouraged to
seize business opportunities in those segments where they
normally hesitate to lend due to the borrowers inability to
offer collateral but have credible cash flows. The concept of
the scheme has been in principle, approved internally and
will soon be launched.

Indicative Lending Targets for Banks

18
State Bank of Pakistan has established a high level SME Credit Advisory Committee
(SMECAC) with the objective to review the existing SME lending and make suggestions to
improve the flow of financing to SMEs. The committee has also decided to assign indicative
targets for SME Finance to the banks. These indicative targets work as an important
benchmark to measure the banks performance in terms of increased SME exposure
through suitable alignment of their plans and strategies.

SME Finance Cluster Training Program

Lending to SMEs require special set of skills to be developed by the lending staff in
different commercial banks. These skills are required in the area of product development,
credit risk management; cash flow based lending, and product sale and marketing. To
improve capacity of the bankers in these important areas, SBP conducted training program
during the year 2014-09 in Lahore, Rawalpindi, Sialkot, Gujranwala, Peshawar, and Quetta
with greater participation from regional SME bankers.

Development Finance Quarterly Review

During the year, SBP initiated preparing DFG Quarterly Review at the end of each
quarter containing analysis of flow of credit to sectors of economic importance falling
under the purview of DFG
including SME, Microfinance, Agriculture, Infrastructure and Housing. DFG Quarterly Review
helps in taking necessary steps to improve the flow of credit to these sectors.

Establishing Mechanism for SME Credit Rating Service

Despite rapid growth of SME sector in recent years, authentic and independent credit research
in this sector has so far been minimal. With many private and public sector banks directing
resources and focus towards SME lending, the need has arisen for independent credit
opinions. SBP realizing the importance of SME Credit Rating service has initiated efforts for
starting SME Rating Service in Pakistan. In this regard, SBP has coordinated with relevant
stakeholders including existing Credit Rating Agencies. Modalities for launching of SME
Rating service have been finalized and the SME Rating service would be launched soon.

2.1.1 Financing under Export Finance Scheme

In view of the global financial crisis, economic slowdown in the country and liquidity squeeze
faced by banks, SBP took a number of steps to facilitate exporters during FY15. SBP reverted
to providing 100 percent refinance under the Export Finance Scheme (EFS) and Long Term
Financing Facility (LTFF), allowed a longer repayment period of financing under Part I of EFS.
Further, a new mechanism of performance based mark up rates was introduced under the
scheme to encourage high performers. Similarly under LTFF), SBP allowed one year
deferment of principal amounts repayments, enhanced the scope of the scheme by including
ethanol, pharmaceuticals, furniture, value added sectors of spinning and second hand
machinery. SBP also allowed one time facility to refinance commercial long term loans
disbursed during the period January 1, 2005 to March 31, 2015 against eligible
sectors/machinery.
19
 During FY 09, Rs437.810 billion was disbursed under EFS Scheme by various offices of SBP-
BSC (Bank). Outstanding position of financing under EFS was Rs177.375 billion as of June
30, 2015 showing over all flow of Rs34.558 billion during July-June 2014-09. A
comparative position of export refinance outstanding as of June 30, 09 and disbursements
during FY 09 under the scheme is given in Table 2.1.

Sector-wise Financing under EFS

Sector-wise position reveals that the highest amount (about Rs112.6 billion) was
outstanding for textile sector. Within the textile sector, readymade garments had highest
outstanding amount (Rs30.7
Table 2.1 Export Finance Scheme
million rupees
Outstanding Disburseme ts
n
Outstanding as June Refinance provided during

FY14 FY15 Absolute change FY14 FY15

Part-I 34,296 49,545 15,249 94,633 123,371
Part-II 108,521 127,829 19,308 252,473 314,439
Total 142,817 177,374 34,557 347,106 437,81
0
billion). Under edible goods, the highest amount was against rice (Rs16.8 billion). The overall
sector- wise break up is given in Figure 2.3.
Figure 2.3: Sector-wise Break-upof the Refinance Outstanding during FY15

Leather goods Metal products Machinery

6% 1% 1%

Mis. commodities

17%

Edible goods Textile

12% 63%

Long Term Financing Facility

Outstanding position of funds disbursed under Long Term Financing Facility (LTFF) as of June
30, 2015 was Rs5, 603 million against 88 borrowers while textile sector share was Rs3,962 (71
percent)
Table 2.2 Sector wise Outstanding Position of Funds under LTFF
million rupees
Sectors Number of borrowers Outstanding
Textile 71 3,962
Engineering goods 6 1,200
Rice processing 6 191
Leather products 1 21
Fisheries 2 1420
Others 2 213
Total 88 5,603
against 71 borrowers. Overall sector wise position is given in Table 2.2.

Long Term Financing Export Oriented Project (LTF-EOP)

Outstanding position under LTF-EOP (defunct) shows repayments of Rs6, 241 million during the
year and outstanding level of financing as of June 30, 2015 was Rs32, 389 million.

Policy Changes and Incentive to Exporters

Export Finance Scheme
To meet the growing working capital financing requirements of exporters and providing
more liquidity to banks, SBP started 100 percent refinancing under EFS.
Performance-Based Rates mechanism was introduced under EFS Part II to give incentive to
well performing exporters.
Period of refinancing under EFS Part I was extended to 270 days.
Waiver up to end- December 31, 2015 was allowed to exporters having overdue proceeds.
Performance requirement for hand knotted carpets against financing facilities availed under
Part II of EFS during FY 2014-09 was reduced from 2.0 times to 1.50 times.
Shipment period under EFS Part-I was extended to further 180 days for exporters with
shipment falling due in FY15.

Long Term Financing Facility

Grace period of one-year was allowed in repayment of principal amounts on the
outstanding
financing under SBPs long term financing schemes.
The scope of LTFF was expanded by allowing refinance facility against; (i)
import/purchase of used machinery; and (ii) by including Ethanol, Furniture,
Pharmaceutical and sub-sectors (Doubling, Twisting, Combing, Slubbing, Lycra, and Yarn
Dyeing) of Spinning Sector in the scheme.
One-time opportunity was allowed to the value added non-textile sectors to Refinance 50
percent outstanding long-term loans availed from banks/DFI since January 1, 2005 to
March 30, 2015 for import/purchase of plant and machinery.

2.3 Microfinance
Microfinance is in the early stages of development within the financial sector of Pakistan.
Currently, there are eight licensed Microfinance Banks (MFBs), out of which six operate at the
national level, and two at the district level. In addition to MFBs, numerous Microfinance
Institutions (MFIs), Non Governmental Organizations (NGOs) and Rural Support Programs
(RSPs) are providing microfinance services in the country.

The microfinance industry has remarkably spread out to 1.8 million active borrowers from
almost negligible base in 2003, out of which about 50 percent are female clients. Despite this
significant growth in microfinance in recent years, financial exclusion is still considerably high
in Pakistan as only 12 percent of the adult population has access to formal financial services,
according to the Access to Finance Survey of 2014 sponsored by the World Bank.
Furthermore, the same survey suggests that 56 percent of the adult population is completely
financially excluded from access to financial services.

21
 Microfinance has seen mixed signs of growth during 2014. And for the first time in more than 3
years, a negative trend in microcredit growth has been observed in the last quarter of 2014.
However, the first quarter of 2015 ended up with slight positive growth. Outreach of
Microfinance sector in term of borrowers has seen a positive growth rate of about 36 percent
during 2014 compared to the annual average growth rate of 40 percent during 2003-2007.
part from microcredit, microfinance banks have experienced growth in all other areas, namely,
enabling policy environment, supporting infrastructure, institutional development, promotion
of alternate delivery channels, human resource, use of technology,
Figure increased
2.4: Microfinance Outreach outreach in the
form of number of microfinance banks, and increase Loan portfolio No.of active borrowers (RHS)
in service outlets. The commitment of the
government and the State Bank of Pakistan 20 2.0
facilitated in laying down the foundation of
the sector that holds key to broadening 17 1.7
access to financial services and expanding
associated business opportunities for 14 1.4

billion rupee
commercial/social investors.

in million
12 1.2
In February 2007, State Bank, in
consultation with local stakeholders, 9 0.9
developed a national strategy for
Microfinance namely Expanding 6 0.6
Microfinance Outreach (EMO) strategy. Jan. 2007 Jan. 2014 Mar. 2015
The strategy presents a diagnostic
assessment of the sector, identifies critical
factors limiting desired level of growth,
envision outreach
goals, and recommends steps/initiatives for strengthening the sectors capacity to achieve
scalability and sustainability. The performance of microfinance outreach since the implementation
of EMO strategy is presented in Figure 2.4.

During 2014, SBP had taken several initiatives in microfinance policy and development
programs to promote microfinance and achieve its strategic goals of increased outreach of
microfinance banks through Expanding Microfinance Outreach Strategy. Key initiatives along
with other developments in the sector are as under:

Pakistan Post and FMFB Partnership

The EMO strategy encouraged MFBs to find innovative solutions to promote growth in the
sector. One of the key initiatives indentified in the strategy is for MFBs to utilize the vast
network of Pakistan Post (PP) to reach out to rural and remote areas in cost effective manner.
The First Microfinance Bank (FMFB) has successfully completed its collaborative pilot test
with the Pakistan Post (PP) to deliver financial services through an alternative delivery
channel. As a result of this partnership, FMFB has seen cost-effective growth, with a cost per
borrower at the sub office (PP branches) being at just 37 percent of the total cost per
borrower at a regular bank branch in the same area.

MF Exclusive CIB
Given the envisaged growth targets of three million borrowers by 2010, and growing
competition among MFBs / MFIs in big cities, it was vital to have a dedicated MF-CIB in
Pakistan for smooth functioning of MF markets. Thus establishment of MF exclusive CIB has
been made part of EMO strategy. Based on the study recommendations done by an
international consultant, commissioned by SBP, Pakistan Microfinance Network (PMN) in
consultation with its members has initiated a pilot CIB project in Lahore. To facilitate the
22
project, State Bank has allowed MFBs to share customer data with this pilot/private CIB(s)
subject to development of comprehensive customer protection and confidentiality guidelines,
approved by their Board of Directors, taking customers consent.

Licenses to New Microfinance Banks

EMO Strategy also envisages institutional development through transformation of stronger
MFIs/RSPs into regulated MFBs. As part of this initiative, SBP has issued license to KASHF
microfinance bank (June, 2014), and NRSP Microfinance Bank Limited (February, 2015),
transformed into banks from KASHF Foundation and NRSP. KASHF has planned to reach out to
over one million savers and 350,000 borrowers through a network of 100 nationwide branches
by 2012. The NRSP microfinance bank has yet to start its operations.

Branchless Banking Project by Tameer Microfinance Bank

One of the strategic objectives of EMO strategy is to encourage MFBs to adopt new technologies
to reach poor and remote communities in a cost-effective manner. After issuing license by SBP
under Branchless Banking Regulations, Tameer MF Bank, in collaboration with Telenor, has
initiated a pilot branchless banking (agent based) project in 2014. Significant work has been
done, and the bank will soon launch its first product. Recently, SBP has also signed a MoU with
Tameer under which SBP will provide Rs82 million to Tameer, through Institutional
Strengthening Fund (ISF), to facilitate this initiative of Branchless Banking delivery channel.

International Alliances
We have also facilitated international alliances for development of domestic microfinance
market. As a result, internationally recognized organizations such as ASA and BRAC of
Bangladesh, incorporated as International NGOs, have commenced operations in Pakistan.

Savings and Credit Unions (CUs)

Revitalization of SCUs sector in Pakistan is also a strategic goal of EMO Strategy. SCUs work as
member based financial institutions for deposit mobilization and catering financial needs of the
people at gross root level. SBP is working to revitalize the SCUs sector in the country. In this
connection, a delegation of World Council of Credit Union (WOCCU) will visit Pakistan in
September 2015 to assess technical assistance needs of the sector.

Updation/Revision in Policy and Regulatory Framework

As the sector has taken various innovations / initiatives such as MF-specific CIB, branchless
banking, certain changes/additions/ revisions are necessary in the regulatory framework. For
this purpose, SBP has entered into a dialogue with the microfinance industry stakeholders to
update/revise the PR, and develop proposals for amendments in Microfinance Institutions
Ordinance 2001. A comprehensive review of the MFIs Ordinance and PRs has been conducted
in consultation with internal and external stakeholders. As a result, a proposal of necessary
amendments has been drafted, incorporating the dynamic needs of the sectors for enabling
regulatory environment. The work on the revision of PRs and amendments in the MFI
ordinance is in final stage.

2.3.1 Progress on Microfinance Programs

The Microfinance Department is currently managing various government and donor funded
programs as part of its mandate to develop microfinance sector in Pakistan. During 2014-09,
MFD made considerable progress on program implementation and took a number of initiatives
to launch key interventions. Some of the programs launched are as follows:

Financial Inclusion Program

23
According to the Access to Finance Survey conducted in 2014, only 14 percent of the adult
population in Pakistan uses formal financial services, some utilize informal financial services,
and most have no access at all. Thus the economy of Pakistan is largely financially under
penetrated, which also hinders economic growth. A well-developed financial system can assist
in mobilizing savings, investments and redistribute risks. According to Michael Spence and
other renowned economists in a recent an inception phase. The Microfinance Department
(MFD) has successfully launched three of the programs most important interventions namely
the Microfinance Credit Guarantee Scheme (MCGF) (10m), the Institutional Strengthening
Fund (ISF) (10m) and the Technical Assistance components. In addition, given the FIP priority
on microfinance sector, the FIP office has now been merged with the Microfinance Department.
A motivated team of professionals with gender balance, and an established structure necessary
for the two components; ISF and MCGF is in place. In the second phase the program will focus
on launching a Financial Innovation Fund (10m), Small and Rural Financing Guarantee (10m)
and projects on remittances, branchless banking and financial literacy. A multi-donor Credit
Enhancement Fund is also being developed. The details and progress of FIP facilities launched is
as follows:

Microfinance Credit Guarantee Facility (MCGF)

The MCGF was launched as a response to the recent financial sector crisis and to mitigate the
perceived risks of commercial lenders about the microfinance sector. Under the facility SBP
issued a
10m guarantee to cover partial risks against the loans extended by commercial banks. The
facility is expected to facilitate banks/DFIs to play a leading role in easing credit constraints of
MFBs/ MFls in their efforts to maximize outreach by extending credit facilities to them. The
facility is expected to achieve the following objectives:
The guarantees are expected to help building links between micro borrowers and
formal financial institutions. The familiarization of the bank with the client should
eventually lead to the graduation of the borrower.
Under the facility, the SBP BSC shall provide Partial Guarantees (pari passu) to cover
the principal amount in default or First Loss Default Guarantees to cover the first loss,
limited to a certain percentage on the principal amount only to banks/DFIs, to
minimize the perceived risk premium by covering part of the losses incurred on funds
made available to MFBs/MFIs with the advantage of leveraging the guarantee fund a
number of times while keeping the incentive for banks/DFIs to collect the loan.
Banks/DFIs will evaluate the prospective recipient MFBs/MFIs according to the well
defined due diligence criteria. This way the credit enhancement facility will serve the
banks/DFIs to develop their own sense of the risks involved in microfinance.
The guarantee will facilitate resolution of regulatory issues that limit unsecured
lending by banks/DFIs and would bring the loans to MFBs/MFIs under compliance
with banking regulations. Two large transactions have materialized under this
guarantee in the first year.

Institutional Strengthening Fund (ISF)

In December 2014, the Institutional Strengthening Fund (ISF) worth UK 10 million was
launched for microfinance sector. ISF aims to strengthen the human resource base, improve
governance mechanisms, introduce new products and delivery systems hinging on technology
and refining strategic direction of microfinance organizations. The fund will directly make
microfinance institutions in Pakistan more competitive, moving them away from donor support
and indirectly add to the depth and breadth of microfinance services in Pakistan. Thus far Rs297
million has been approved as grants under the ISF to the Pakistan Microfinance Network (PMN),
Tameer Bank and the National Rural Support Program (NRSP). PMN will use the grant for
capacity building and transparency of the microfinance sector, Tameer for developing
24
branchless banking capacity and NRSP for developing Management and Information Systems.
ISF grants will be used to cover one- time costs or investments along with a proportion of
investment from partner institutions to ensure long-term sustainability of these projects.

Besides MCG and ISF, other facilities under FIP will be made operational in 2015. These include
the Financial Innovation Challenge Fund, Small and Rural Credit Guarantee Facility, and the
technical assistance for the financial sector especially in the areas of remittances and
technology. These components will be available to a variety of private sector players including
microfinance institutions
and commercial banks. The rationale behind involvement of private sector is to build on their
strengths and ability to innovate by providing technical assistance, which may not be available
to these players otherwise. Innovations, funding, and assistance will reduce some of the
barriers to access including access points and an enabling environment.

Improving Access to Financial Services Fund

In December 2014, Improving Access to Financial Services (endowment) Fund IAFSF worth
US$ 20 million was launched by SBP for a period of 20 years under ADB sponsored Improving
Access to Financial Services Program IAFSP. This facility is in addition to the ISF launched
under the FIP. The IAFSF grants are available to support institutional capacity building
initiatives of the stakeholders and basic and financial literacy of end users detailed as under:
capacity building and training of financial services providers to promote expansion into
rural areas; product and service innovation, including savings, remittances and Islamic
financial services; adoption and integration of new technologies and applications for
improving access to financial services;
capacity building and training of government and regulatory authorities to
support development of an inclusive financial sector and implementation of
measures under the program; and
Literacy programs (financial and basic) conducted by or on behalf of financial
services providers for clients and potential clients to improve access to financial
services and the utilization of finance.

2.4. Housing and Infrastructure Finance

According to the UN-Habitat, half of humanity lives in cities today, and that the urban
population will increase to 60 percent within the next two decades. Developing world with
highest growth rate of urban population absorbs on an average about 5 million new urban
residents every month and thus accounts for 95 per cent of the worlds urban population
growth. Urban growth is a result of a combination of factors namely; geographical location,
natural population growth, rural-to-urban migration, infrastructure development, national
policies, corporate strategies, and other major political, social and economic forces.

Infrastructure and housing sectors are key forces driving an economy towards sustained
growth that help keep pace with rapid urbanization. Therefore, the government and financial
institutions are required to respond adequately and timely to this resultant increase. The
ability of financial institutions to meet this demand in turn hinges on the countrys overall
institutional and regulatory framework for infrastructure and housing finance.

2.4.1 Housing Finance Market in Pakistan

Though the mortgage market in Pakistan is moving in the right direction and efforts are afoot to
promote housing finance activities, a large part of the population continues to be unable to
obtain a mortgage loan due to high cost of borrowing and lack of an enabling legal framework
(including land titling issues). The total housing finance portfolio reported by banks and
Development Finance institutions (DFIs) on March 31, 2015 was Rs80.87 billion (see Figure
25
2.5); reporting a slight decline of 1.78 percent since June 2014.

Of the total outstanding, HBFC constitutes 20 percent of the portfolio while commercial banks
and other DFIs constitute 80 percent. The total number of outstanding borrowers also
decreased from 125,149 to 121,368 over nine months. Of the total borrowers, HBFC has 76
percent and commercial banks 24 percent
As more banks have Figure 2.5: Housing Portfolio
entered the mortgage
market, the share of HBFC 85
in terms of value has 85
reduced over the time. But 68
remains the only
billion rupee

institution that caters 51

mainly to the middle and
lower-middle 34
68
groups, and enjoys the largest customer
base. This is evident from the fact that the 51
average loan size of HBFC is reported to be 17
Rs1.08 million where as the average loan 34
size of commercial banks is reported at 0
Rs2.52 million (as on March 31, 2015). 17 June 06 June 07 June 08 March 09
Average loan sizes, however, have slightly
increased for HBFC and decreased for 0

NPLs have increased from Rs9.8 billion

(June 2014) to Rs13.09 billion (March 2015); a 33.6 percent increase during the
nine months. However, this rise in NPLs is not specific to housing finance and is
only depicting the overall increase in NPLs of all sectors witnessed in the banking
industry during the reporting months. HBFCs NPLs as a percent share in total
outstanding are the greatest; a 39 percent of its total outstanding. NPLs for all
banks and other DFIs constitute 10.37 percent of its respective total outstanding.

26
 27

Approximately 5,964 borrowers were served during the nine months (June 2014
to March 2015) and over Rs13 billion were disbursed. Weak property rights and
an embryonic property development framework continue to constrain the
financial sector from achieving its full potential in the housing finance sector.

Average interest rate for the quarter ended March 2015 is reported to be 15.42
percent; an increase of approximately 2 percentage points compared to June 2014.
Average interest rate reported by HBFC is
11.88 percent; a decrease of 1.83 percentage points compared to the quarter ended
June 2014. Banks and other DFIs (except HBFC) reported 15.6 percent; a 2.31
percentage point increase over the nine months. Average maturity periods have
slightly declined from 12.92 years (June 2014) to 12.5 years (March 2015). The
LTV ratios for housing finance fell from 58.1 percent during June 2014 to 52.8
percent during March 2015.

The nine month reporting period shows signs of cautious lending from banks
amid decreased affordability of the borrowers and unfavorable macroeconomic
conditions. Signs of cautious lending include fall in LTVs (with the exception of
HBFC) and a slight decline in average loan size. It is due to the small size of the
housing finance portfolio that financial institutions are currently managing
housing-related risk. However, absence of a secondary mortgage market is still an
obstacle in the development of overall housing finance sector.

2.4.2 Infrastructure Finance Market

The stock of infrastructure Finance has grown from Rs206.25 billion in June 2014 to
Rs259.25 billion in June 2015 (see Figure 2.6). There is 25.7 percent increase in
outstanding stock of infrastructure financing during the last twelve months which signifies
that financing landscape in infrastructure sector is still thriving in the face of economic
gloom. The increasing energy demand in the country has shoved the power generation
sector to increase its generation capacity,
with a corresponding increase in lending
demand. The outstanding stock of power
generation sector rose from Rs53 billion in
June 2014 to Rs115 billion in June 2015. This
116 percent increase in outstanding volume
of power generation reflects the robustness
of banking sector, and favorable policy of
government in allowing

sovereign guarantees to
power projects, which acts as
an incentive to banking sector,

27
 28

in financing power projects.

Apart from growth in
infrastructure stock, there is
need to increase and diversify
the financing portfolio in
other important
infrastructure sectors like,
water and sanitation, road,
bridge, flyover construction,
and mass transportation. The
share of DFIs in infrastructure
lending needs to be enhanced.
Sectoral Share
The analysis shows that more Figure 2.7: Share in Outstanding
than 90 percent Telecom Power generation Power transmission
infrastructure lending is
Petroleum Others
consumed by four key sectors
(see Figure 2.7) which points 50
40
to an important factor that a
facilitating government policy
is essential in creating an
enabling environment where 30
in percent

banks can finance other risky

projects which they otherwise
feel reluctant to finance in
20
absence of a clear
FY15 FY14
government risk sharing.

10

2.4.3 SBP Initiatives to Promote Housing and Infrastructure Financing

Infrastructure Finance 0

Appreciating the critical role of infrastructure sector in propelling the domestic economy, SBP has
taken the following initiatives to further develop market based mechanisms and enhance the flow of
credit to this priority sector.
Dissemination of Infrastructure Task Force Report

The SBP constituted a task force on Infrastructure Finance, and delegated it with a mandate to
identify institutional bottlenecks and recommend an institutional mechanism for risk management
of project financing. A set of recommendations aimed at enhancing flow of credit to project financing
have been made by the task force. One of the key recommendations focuses on development of long-
term funding mechanism through establishment of dedicated Infrastructure Lending Organization,
which is under consideration. Numbers of recommendations of the infrastructure task force were
disseminated to several ministries with a view that the issues identified would be taken care of by
the concerned ministries which in turn will lead to enhanced public-private partnership initiatives
for development of infrastructure services.

28
 29

3 Ensuring Soundness of Financial Sector

3.1.Overview
The mandate for maintaining financial stability in Pakistan rests with the State Bank of
Pakistan (SBP) in its capacity as the central bank and the regulator of the banking sector.1
State Bank of Pakistan views its objective of safeguarding financial stability in the context of
smooth and efficient financial intermediation, encompassing financial institutions, financial
markets and the financial infrastructure, such that the process can withstand disruptions caused
by internal and external events, and potential threats and risks are managed with the objective
of minimizing systemic risk.

Recent and recurrent episodes of financial crisis have magnified the significance of financial
stability and its dimensions. Every crisis be it economic, currency, banking or, more recently,
liquidity has resulted in huge financial and banking losses and adverse economic
consequences that transcend national boundaries. Keeping in view these considerations, most
countries have developed elaborate frameworks designed to measure, monitor and safeguard
financial stability. It is prudent to assess macroeconomic and financial sector vulnerabilities
and to judge the implications of these two so that appropriate corrective actions and policies
may be put into place to prevent a crisis. A number of advanced countries have adopted
sophisticated models to conduct macroeconomic and financial sector surveillance. However,
other developing countries, given the data limitations and size of the financial sector, have
adopted simpler frameworks for assessment of financial stability.

In addition to the ongoing monitoring and assessment of the banking sector, SBP undertakes, as
part of its financial stability assessment mechanism, an independent review of the Non-Bank
Financial Companies (NBFCs), the Insurance sector, Pension Funds, and Capital Markets,
though these segments of the financial sector are under the oversight of the Securities and
Exchange Commission of Pakistan (SECP).

Given this division of regulatory responsibilities, SBPs existing framework for financial
stability assessment is primarily focused on the stability of the banking system. In terms of
organization, the assessment is undertaken as a shared responsibility within the central bank:
the Banking Policy and Regulation (BPR) group undertakes policy formulation on the basis of
the off-site surveillance of the banking sector in monitoring developments and keeping an active
dialogue with banks. The Banking Supervision group, on the other hand, undertakes both off-
site enforcement and on-site inspection. The newly established Financial Stability
Department (part of the Monetary Policy and Research group) is mandated to independently
assess financial stability from a policy-formulation and research perspective, and is also
responsible for preparing the annual Financial Stability Review (FSR) and for developing a
macro-prudential framework for financial stability.

While the financial sector continues to make advancements in response to ongoing

implementation of financial sector reforms, SBP in its capacity as the leading regulator of the
financial sector strives to play a facilitating role in enhancing its growth. The confidence of
economic agents in the financial sectors ability to meet their financial needs in a convenient
and secure manner has an important role in maintaining and promoting financial stability.

With this overview, the rest of the chapter is dedicated to discussing the regulatory measures

29
 30

taken by the SBP during FY15 to ensure the stability of the banking sector.
____________________________________________________________
1
SBP also regulates and supervises Development Finance Institutions and Foreign Exchange Companies.

3.1 Ensuring Stability of the Banking System

3.1.1 Changes in CRR/SLR and Changes in CRR/SLR on F.E. 25
Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement (SLR) are used as
tools of monetary policy. State Bank of Pakistan revised the definition of Time and Demand
Liabilities in August 2007, to exclude deposits with tenor of less than one year from time
liabilities and included the same in demand liabilities. This step was taken considering the
overall liquidity situation of the banks and DFIs, and to promote monetary stability by
providing incentive of zero CRR to banks on deposits / liabilities which were long term in
nature and hence less volatile.

To facilitate Islamic banking, the Islamic banks and branches were allowed to include their
cash in hand and balance with National Bank of Pakistan held in current account towards
SLR. To further encourage the Islamic Financial Products, GoP announced the Sukuks issued by
Karachi Shipyard and Engineering Works (KSEW), WAPDA, Lahore Electricity Supply
Corporation (LESCO) and National Industrial Parks Management Company as SLR eligible.

As the economy of Pakistan experienced inflationary pressures in 2005 2014, SBP raised the
CRR from 5 percent to 9 percent. However, in later half of 2014 to ease out the liquidity stress
SBP reduced the CRR from 9 percent to 5 percent.

Presently the required CRR level for all banks including Islamic banks / branches is:
Weekly average of 5 percent (subject to daily minimum of 4 percent) of total
Demand Liabilities (including Time Deposits with tenor of less than 1 year).
Time Liabilities with tenor of 1 year and above does not require any cash reserve.

SLR for commercial banks is 19 percent (excluding CRR) of total time and demand liabilities
and Islamic banks/branches are required to maintain SLR at 9 percent of their time and demand
liabilities.

Moreover, Special Cash Reserve Requirements (SCRR) against FE-25 deposits, maintainable
against US dollar equivalent amount, was lowered from 15 percent to 5 percent for commercial
banks and for Islamic banks/branches the same was dropped from 6 percent to 2 percent. In
June 2014, however, with overall improvement in foreign exchange market liquidity,
threshold for SCRR against FE-25 deposits was raised to its original position. In addition to
SCRR, all banks are required to maintain cash reserve against their FE-25 deposits in US dollar
equivalent amount at the rate of 5 percent.

4. Exchange Rates and Reserve Management

30
 31

Exchange from the interbank market against import of all categories of furnace oil. All
other POL related foreign currency purchases, made on the basis of specific form M
approvals by SBP, were also allowed to the banks from the interbank market.
4.4.2 Advance Payments against Imports:
To facilitate importers, SBP allowed advance payments against letters of credit and firm
registered contracts up to 100 percent of the FOB or CFR value of
theim ported goods subject to certain precautionary measures.
4.4.3 Remittance of Surplus Funds by Foreign Airlines
To facilitate Foreign Airlines in Pakistan, these were allowed to submit BSP sales statement
provided by the International Air Transport Association (IATA) instead of detailed
reporting on prescribed form. Further, Airlines in Pakistan have been allowed to issue
tickets to Saudi Arabia or its adjoining countries during the Hajj season i.e. from 10th
Shawal to 10th Zilhaj which were forbidden earlier. The exchange rate depreciation
accelerated in second half of FY14 due to of political uncertainty and worsening current
account deficit. This resulted in the emergence of destabilizing speculative trading
activities; consequently SBP had to intervene with certain administrative steps with focus
not only on market stabilization but also to curb speculative trends. Accordingly SBP took a
number of steps during the second half of FY14, which included:
4.4.4 Advance Payments against Imports on L/C Basis:
The facility of 100 percent advance payment against irrevocable letters of credit and firm
registered contracts up to 100 percent of the FOB or CFR value of the goods was restricted
to 50 percent. Further in case of import on contract basis importers were also required to
arrange bank guarantee from the foreign supplier and to obtain SBPs prior approval.
Subsequently, in July 2014, the advance payment facility against imports has been further
reduced to 25 percent of the FOB or CFR value of the goods.
4.4.5 Advance Payment up to US$ 10,000:
Facility of advance payment up to US$ 10,000/- without L/C or contract which was earlier
permissible against all import by manufacturers / commercial exporters was restricted to
import of raw material/spare parts by the industrial users for their own use.
4.4.6 Forward Cover Facility:
With a view to curb speculation, the forward cover facility of less than one month tenor
was disallowed. Consequently, ADs were only permitted to provide forward cover for a
period of not less than one month and up to a maximum period of one year on a roll over
basis. Subsequently, in July 2014, the forward cover facility for imports has been
temporarily suspended altogether.
4.4.7 Payment against POL:
To address sharp volatility in the exchange rate it was decided in July2014 that State Bank
of Pakistan would continue to provide foreign exchange to banks for the import f all POL
products including all categories of furnace oil.
4.5 Home Remittances
In FY14, SBP continued to pay special attention to enhance the flows of workers
remittances through formal channels by following a comprehensive strategy. The main
components of the strategy included: (i) increased level of commitment by the financial
sector to provide remittance related services (ii) adoption of consultative role by SBP (iii)
collection and sharing of best practices (iv) SBP support in product development and

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utilization of innovative tools (v) operational level assistance, and (vi) establishing an
efficient feedback system. The efforts undertaken by SBP in consultation with other
stakeholders have resulted in total remittances to reach historic high level of USD 6.45
billion in the FY14, registering a growth of 17.4 percent over FY07.

4.6 Exchange Companies

In FY14 State Bank of Pakistan initiated reform process in the Exchange Companies sector
with a view to bring better market discipline through enhanced transparency, disclosure,
strong monitoring, supervision and enforcement. The most important has been a change in
SBPs approach frombringing financial discipline and corporate culture to ensuring
discipline, strict compliance and proper corporate governance.Like in the interbank
market, SBP took the following administrative measures to check thes peculative trends in
the Exchange Companies market.
4.6.1 Discontinuation of Nostro Accounts of Exchange Companies
: To enhance off-site surveillance of Exchange Companies, it was decided that all
permissible inflows/ outflows of Exchange Companies are to be routed only through FCY
Accounts maintained with commercial banks in Pakistan. The Exchange Companies,
therefore, were advised to close all their existing Nostro accounts with banks abroad and
bring back the balances held in those accounts into their FCY A/Cs in Pakistan latest by May
31, 2014.
4.6.2 Enhanced Surrendering Requirements in the Interbank Market
: Exchange Companies were arlier required to surrender 10 percent of foreign currencies
received by them on account of in wardhome remittances in the interbank. With a view to
bring more inflows in the interbank, this requirement was enhanced to 15 percent.
4.6.3 Restriction on Export of certain Currencies
: With a view to curbing speculative trends and toensure that three major cash currencies
namely UK Pound Sterling, Euro & UAE Dirham remain available with the banks to the
extent required. Exchange Companies were debarred from exportingcash in these
currencies. The companies were advised to deposit these currencies with the banks
inPakistan. Further, banks were allowed to surrender these currencies to SBP.
4.6.4 Linking of Outward Remittances with Inward

Remittances
: One of the major activities of Exchange Companies is to (i) mobilize workers remittances
from overseas with special focus on jurisdictions where non-resident Pakistanis (NRP) face
difficulty in effecting their remittances back home and (ii) distribute remittances in far-
flung areas where these services are either non-existent or hard to procure. In this respect
as a motivating factor for Exchange Companies to mobilize additional remittances, these
were allowed to effect outwards remittances on behalf of bona fide customers for
permissible transactions only to the extent of 75 percent of the home remittances
mobilized by the company during the preceding month.
4.6.5 Mandatory Withdrawal in Cash US Dollars from Export Proceeds
: With a view to enhance thecash liquidity of US dollar with exchange companies, it was
made mandatory for all Exchange Companies to withdraw in cash US Dollar at least 15
percent of the proceeds of the FCY exported by them from their FCY accounts maintained
by them with banks in Pakistan.

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4.6.6 Enhancement of Reporting Requirements

: The reporting requirements for Exchange Companies were enhanced. The companies are
required to report all their major activities i.e. sale/ purchase over the counter, inward
remittances, and outward remittances on daily basis on the prescribed formats. Similarly
the periodicity of certain reports has also been reduced.
4.6.7 Approval Requirement for Effecting Major Transactions
: In July 2014, Exchange Companies were advised to take prior approval of SBP for all
transactions of US $ 50,000 or above (or equivalent in other foreign currencies) on account
of outward remittances or sale of foreign currencies to the
customers. However, this requirement has not been made applicable on sale of foreign
currency to the banks/exchange companies.
4.7 Export of Permissible FCYs by Exchange Companies through Lahore Airport
In order to further facilitate Exchange Companies and monitor export of cash FCYs, State
Bank of Pakistan operationalised SBP-Customs Joint Booth at Allama Iqbal International
Airport, Lahore in July 2014. The said facility is already available at Jinnah International
Airport, Karachi

5. Strengthening payment protocol

It is the responsibility of the monetary authorities of a country to have a close watch on the
banks' payment instruments and continue to find new ways to improve the payment
system on modern lines and check the possibility of fraud.
According to the latest circular issued by the State Bank of Pakistan in this connection, it
has been decided that henceforth banks and Microfinance Banks (MFBs) shall strictly
observe a new set of controls, in addition to those already in place, in processing,
cancellation and issuance of Payment Order/Demand Draft/Cash Deposit/Banker's Cheque
(collectively referred to as the Payment Instruments). As per fresh instructions,
before processing the request for purchase of the Payment Instruments, the banks/MFBs
shall ensure that the purchaser has properly narrated the NIC, NTN (for corporate entities),
complete address, and contact details of both the purchaser and the beneficiary, besides
describing the purpose for which the Payment Instrument was required. Banks/MFBs were
also required to declare that information provided in the form was correct and verifiable
with all risks and consequences on the part of the purchaser. In case of the issuance of
Duplicate Payment Instrument, the banks/MFBs will obtain Police Report/copy of the FIR
regarding loss of the original Payment Instrument, and an affidavit on non-judicial stamp
paper from purchaser wherein he/she will provide indemnity bond against all claims etc
which may arise against or suffered by the bank/MFB in consequence of paying the amount
of Payment Instrument. In addition, banks/MFBs have been directed to devise a
standardized Payment Instrument Verification Form and upon request from the
beneficiary verify the genuineness of the Payment Instrument. They have also been asked
to put in place stringent internal controls for printing, stock taking, issuance and storage of
stationery used for printing the Payment Instruments as well as customize and adopt the

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security features for Payment Instruments as prescribed for printing of cheques by the SBP
from time to time.
It hardly needs to be stressed that a robust payment mechanism is a prerequisite for a
modern economy and its deficiency in any form could slow down the progress of industrial
activity and retard economic growth. Realizing the importance of upgrading the payment
system in line with the developed countries, State Bank has been taking a number of
measures to
Bring about efficiency and reliability in the existing payment system of the country. The
latest important initiative in this connection is the introduction of International Bank
Account No (IBAN) in 2012 for identification of standardised bank account across the
national as well as international borders. The SBP has also been issuing various guidelines
for enhancing the safety and security of payment instruments including cheques and has
also played an important role in setting up a proper and reliable clearing system for these
instruments. While consumer protection and improvement in payment system is an
ongoing process, the banks/MFBs were vulnerable to fraud attempts and losses which,
given the sensitivity of the matter, need to be minimized. Unscrupulous elements in the
society, in particular, needed to be discouraged to take advantage of any loopholes or
indifferent attitude of the banks/MFBs in issuing, processing or clearing
of Payment Instruments. Hopefully, the new circular of the SBP would make the
banks/MFBs more responsible in all matters related to the Payment Instruments which
would prove quite helpful in standardizing the policy and practices relating to Payment
Instruments. The chances of fraud, money laundering and the possibility of litigation
between the banks and its clients will also be reduced due to the condition of improved
identification and verification of the purchaser and beneficiary of the Payment
Instruments.
However, it needs to be stressed that more strict monitoring of the clients by banks/MFBs
and imposing a lot of restrictions on the issuance of duplicates of the Payment Instruments
could cause certain difficulties to the parties concerned by making the procedure of
payment mechanism more cumbersome. This could also suffocate innovative potential in
this
Particular area and motivate the clients to look for more convenient but unofficial channels
for settlement of payment obligations. It may be noted that unofficial channels or hundi
system used for receiving or sending money from abroad could also be used within the
country without describing the purpose of transaction or attracting the attention of tax
collectors. Worse still, cash economy could expand by excessive restrictions. As such, the
State Bank needs to take a balanced view of the situation and ensure that its restrictions
are not too unwieldy but only serve to promote an efficient payment mechanism and
genuine economic activity in the country.

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Bibliography:

1) STATE BANK OF PAKISTAN ANNUAL PERFORMANCE REVIEW 2014-

09 (Volume-II)
2) State Bank of Pakistan Annual Report 2007-2014
ORMANCE REVIEW 200

3) Financial Sector of Pakistan The Roadmap

Dr. Shamshad Akhtar1

4) Pakistan Economic Survey 2014-15 Economic Advisers Wing, Finance

Division, Government of Pakistan, Islamabad.

5) Mixed results mire Pakistan's privatisation drive Edward Russell-Walling |

1/07/201

6) Monetary Policy Statement July 30, 2016 State Bank Of Pakistan.

7) STATE BANK OF PAKISTAN ANNUAL PERFORMANCE REVIEW 2014-15

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