1. MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING SUPERVISION OSMAN BIN SAIF Session: One

2. Self Introduction Finance Graduate; – MSC. Accounting and Finance (University of Exeter, UK) – MBA- Finance (SZABIST, Islamabad) – Certified Financial Consultant (IFC, Canada) – Certifications in Project Management, Monitoring and Evaluation and Research Policy Development and Futures. Consultant with SDPI Senior Researcher with TP WING, MOC Visiting Faculty various universities and institutes. 2

3. Course Objective This is an introductory course With the core objective of giving an overview of the banking supervision globally and as it exists in Pakistan Explaining its functions and importance How it is regulated and Statutes providing legal guidelines for banking operations. 3

4. Course Objective (Contd.) This course covers the policies, laws and regulations which govern the banking sector as well as the role of the supervisor/ regulator i.e. the State Bank of Pakistan. The course also touches upon the banking practices globally and those specific to the Pakistan. 4

5. Key Learning Outcomes After the successful completion of this course, students will have: Knowledge and understanding of: – Importance of Banking Supervision – Banking sector in Pakistan – Role of the Supervisor/ Regulator 5

6. Key Learning Outcomes (Contd.) – Laws which govern banking sector – Prudential Regulations – Banking Companies Ordinance – Other Banking Laws 6

7. Course Contents/ Structure Section 1 Why and How Should Banks Be Regulated? – Key Objectives of Bank Regulation – Regulatory Issues Illuminated by the 2007 Banking Crisis – The 2007 Crisis – Analysis and Response of the Banking Regulatory Crises – Lessons for Regulators from the 2007 Crisis – Types of Bank Regulation 7

8. Course Contents/ Structure (Contd.) Section 2 Banking Supervision and Regulation – Key Phases in Bank Regulation (Part 1) – Regulating Bank Capital Adequacy (Part 2) – Background – The 1988 Basel Accord – The Basel II Accord 8

9. Course Contents/ Structure (Contd.) Section 3 The Institutional Structure of Financial Regulation – Approaches to Institutional Structure for Financial Regulation – Why is Regulatory Structure Important? – Regulatory Structure and the Role of the Central Bank – Guidelines of the State Bank of Pakistan 9

10. Course Contents/ Structure (Contd.) Section 4 The Prudential Supervision of Banks – The Prudential Supervision of Banks – Basel Core Principles for Effective Banking Supervision – The Effectiveness of Different Supervision Approaches 10

11. Course Contents/ Structure (Contd.) Section 5 Bank Crises – Weak Banks and Lender-of-Last-Resort Support – Introduction – Lender-of-Last-Resort Facilities (LOLR) – LOLR to Illiquid But Solvent Banks – LOLR to Illiquid, Possibly Insolvent, Banks 11

12. Course Contents/ Structure (Contd.) Section 6 Restructuring Failed Banks and Protecting Depositors – Resolving Bank Failures – Resolving ic Banking Crises – Deposit Insurance 12

13. Course Contents/ Structure (Contd.) Section 7 Overview of Banking laws and regulations – Bank Company Ordinance 1962 – Negotiable Instruments Act 1881 – State bank of Pakistan Act 1956 – Foreign Exchange Manual – Financial Institutions Ordinance 2001 – Prudential Regulations (SME/DFI, NFI) 13

14. Session Overview Section 1 Why and How Should Banks Be Regulated? – Key Objectives of Bank Regulation – Regulatory Issues Illuminated by the 2007 Banking Crisis – The 2007 Crisis – Analysis and Response of the Banking Regulatory Crises – Lessons for Regulators from the 2007 Crisis – Types of Bank Regulation 14

15. Why and How Should Banks Be Regulated? The health of the economy and the effectiveness of monetary policy depend on a sound financial system. Through supervising and regulating financial institutions, the State Bank is better able to make policy decisions. 15

16. Why and How Should Banks Be Regulated? (Contd.) Bank supervision involves monitoring and examining the condition of banks and their compliance with laws and regulations. If a bank under the State Bank’s jurisdiction is found to have problems or be noncompliant, the State Bank may use its authority to request that the bank correct the problems. 16

17. Why and How Should Banks Be Regulated? (Contd.) Bank regulation includes issuing specific regulations and guidelines to govern the operations, activities and acquisitions of banking organizations. 17

18. The State Bank The State Bank supervises and regulates a wide range of financial institutions and activities. The State Bank works in conjunction with other federal and state authorities to ensure that financial institutions safely manage their operations and provide fair and equitable services to consumers. 18

19. The State Bank (Contd.) Bank examiners also gather information on trends in the financial industry, which helps the State Bank meet its other responsibilities, including determining monetary policy. 19

20. How a Bank earns Profit? Just like any other business, a bank earns money so that it can run its operations and provide services. First, customers deposit their money in a bank account. The bank provides safe storage and pays interest on customers’ deposits. The bank is required to keep a percentage of deposits in reserve as cash in its vault or in an account at The State Bank. 20

21. How a Bank earns Profit? (Contd.) The bank can lend the rest to qualified borrowers. Potential borrowers may wish to buy a house or a new car; However, they may not have enough money to pay the full price at one time. Instead of waiting to save the money to pay for a new house, which could take years, they take out a loan from a bank. Borrowers are charged interest on the loan – a bank’s primary source of income. Banks also make money from charging fees for other financial services, such as debit cards, automated teller machine (ATM) usage and overdrafts on checking accounts. 21

22. Safety and Soundness Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection laws. To measure the safety and soundness of a bank, an examiner performs an on-site examination review of the bank's performance based on its management and financial condition, and its compliance with regulations. 22

23. CAMELS The Banking Supervisor/examiner uses the CAMELS rating system to help measure the safety and soundness of a bank. Each letter stands for one of the six components of a bank’s condition: – capital adequacy, – asset quality, – management, – earnings, – liquidity – and sensitivity to market risk. 23

24. CAMELS (Contd.) When performing an examination to determine a bank’s CAMELS rating, instead of reviewing every detail, the examiner evaluates the overall health of the bank and the ability of the bank to manage risk. 24

25. RISK A simple definition of risk is the bank’s ability to collect from borrowers and meet the claims of its depositors. A bank that successfully manages risk has clear and concise written policies. It also has internal controls, such as separation of duties. For example, a bank’s management will assign one person to make loans and another person to collect loan payments. 25

26. CONSUMER PROTECTION Remember that customers deposit money in a bank, and then the bank makes loans with these deposits to qualified borrowers. Whether a customer deposits money in a bank or applies for a loan, there is a lot of information to consider. Suppose you deposit money into a savings account at a local bank. What minimum balances are you required to keep? Are you charged a penalty if your account falls below the minimum amount? 26

27. CONSUMER PROTECTION (Contd.) When you apply for a loan for a used car, do you know if the interest rate is allowed to vary, or is it fixed for the life of the loan? If it is allowed to vary and interest rates go up, the total amount of interest you owe will increase. Banks are required to provide customers clear and accurate information about services, such as savings accounts, loans and credit cards. 27

28. CONSUMER PROTECTION (Contd.) For example, a bank’s brochure for a savings account should include information on any minimum balance required, monthly service fee and the average percentage yield. In addition, the Truth in Lending Act requires banks to disclose the finance charge and the annual percentage rate so that a consumer can compare the prices of credit from different sources. It also limits liability on lost or stolen credit cards. 28

29. CONSUMER PROTECTION (Contd.) These laws ensure that consumers and banks make decisions based on the same information. If consumers have a complaint about a financial institution they can contact The State Bank. 29

30. What are Banking Regulations? Bank Regulations are a form of government regulations which subject banks to certain requirements, restrictions and guidelines. 30

31. Key Objectives of Bank Regulation The objectives of bank regulations, and the emphasis, varies between jurisdiction. The most common objectives are: – Prudential—to reduce the level of risk bank creditors are exposed to (that is, to protect depositors); – Risk Reduction—to reduce the risk of disruption resulting from adverse trading conditions for banks causing multiple or major bank failures; – Avoid Misuse of Banks—to reduce the risk of banks being used for criminal purposes, e.g. laundering the proceeds of crime; – To Protect Banking Confidentiality; – Credit Allocation—to direct credit to favored sectors. 31

32. THANK YOU 32