Regulations are Restrictions, Requirements and Laws that are implemented on companies in order to preserve and maintain the financial system.These regulations may include a number of different measures and policies that are enforced on the financial institutions in order to make sure the financial system’s integrity is kept intact. Why are Regulations important?Even though financial regulations can often cause time wastage, bulked up paper work and tiresome procedures, these regulations are still necessary because are put into place in order to ensure the wellbeing of the public (consumers) as well as the economy as a whole.
Some major reasons for the need for these regulations are:Ensuring the public’s confidence in the financial system The public has to be confident in the system and must always believe that the system is stable and safe. Otherwise they would not invest or take part in the financial ecosystem. The trust and believe of the public in the financial system is vital for its strength. Regulations ensures there is no asymmetric information in the market for the customers and makes sure the customers are satisfied with the financial services provided by the institutions.
Efficiency and effectiveness. Regulations are necessary to keep operating institutions efficient and effective. These regulations often dictate certain parameters and business matters that keeps these institutions from misusing the public capital and utilize it efficiently.To keep a stable financial system The first and foremost role of these regulations is to ensure that the financial system runs smoothly and decrease chances of irregularities. Financial Regulations help fight inflation, minimize the risk of financial crises and keeps the overall economy stable.To tackle toxic influence of social and political factors
Another major objective of these regulations is to keep the financial market “Equal for all”. It helps wealth distributions in the economy and in countries like Pakistan, Regulations are essential to fight against crimes like money laundering and tax evasion.Monitoring and regulatory authoritiesSBPThe State bank of Pakistan is the main regulatory body in Pakistan for the banking sector. It acts as the central bank of Pakistan and regulates all other government and private banks. It makes sure the activities of the banks are in the best interests of its stakeholders (including its customers and shareholders) and aims to keep a stable growth in the economy while keeping inflation and other factors in check. To do so, the SBP issues various policies and regulations which are enforced on the banks and defaulters are strictly penalized.
SECPThe Securities and Exchange Commission of Pakistan is the prime regulator for all financial institutions other than those of the banking sector, which include all non-banking companies, firms as well as the capital market. Just like the State bank of Pakistan, The SECP too issues regulations and monitors compliance from the respective institutions.OthersThere are various other regulatory bodies that have their own roles to play in the financial ecosystem. They actually help the SBP and the SECP regulate the financial market. The institutions include the National Clearing Company of Pakistan Ltd (NCCPL), The Pakistan Stock Exchange (PSX), and the Central depository company (CDC).
Regulations in the Fragile Banking sectorThe banking sector is the most important financial institution in the financial system. More than 80 percent of the financial sector is comprised of Banks. The Banks keep deposits from its customers as liabilities which are highly liquid and invests in loans and bonds which are illiquid assets. Therefore one of the biggest threats to bank is a bank run in which lots and lots of depositors start taking out their money from banks, but the banks, having invested in long term investments, don’t have enough cash on hand to pay back.The customers are stakeholders of the banks and the bank needs to protect their money and minimize their risk, all while also earning for themselves. This causes a lot of conflicts of interests as well where banks become greedy and start investing in much riskier securities for higher returns.
Banks are a very integral part of the financial network and a default in banks can cause a chain effect that influences all other institutions, and intern the whole economy. It’s quite common knowledge that all businesses and companies keep their excess cash in banks and other such institutions for interest profit. A default in banks could result in great financial troubles for large companies because if a bank defaults, the depositor may default to its creditors and the creditor may then default from its creditors and so on. Hence affecting the entire economy.Therefore keeping in mind the importance of the banking sector, the State Bank of Pakistan has implemented a number of regulations and provisions that ensure banks go about their business in an efficient, effective and safe manner. Some examples of these regulations include:Lender of last resortThe State bank acts as the central bank that lend money to any and all banks that need it to survive. But it usually acts as a last resort because constant borrowing from the state gives out a very bad ineffective image.
MCRThe minimum capital requirement is enforced on banks to make sure that the bank has some portion of the deposits in liquid form. This is to make sure that the banks can pay back to their depositors on short term notices.Investment restrictionsA very important restriction applied by the state bank is the limitation on investment options. The SBP prohibits the banks to invest in high risk securities or trading in the stock exchange. This is primarily to protect the capital of the depositors because all the money invested by the banks actually just borrowed from the depositors and must be returned. The depositors are usually not well aware of the banks investments hence the SBP monitors them on their behalf and ensures that the public depositors maintain trust and confidence in the system, and minimize the chances for a bank run that could crumble the financial system.“Facing the ‘too-big-to-fail’ problem, regulators are needed to monitor and restrict banking activities that may lead to such scale of banking failure.” (Xuan)
Pakistan’s history of macro-economic Financial Deficits Deficit increase in the Musharraf eraIMF and china loansBanking regulations during the 2008 financial crisisFinancial Reforms in the 90’sUntil the early 1990’s the banks followed a quite extensive monetary policies and credit policies, but this had caused the financial system, as a whole, to become repressed and slow. The growth and efficiency of the financial sector declined. (SBP)In the 1990’s however, a number of reforms took place including the privatization of different banks such as UBL and ABL, Opening of many new banks, and most importantly, the strengthening of the State Bank’s autonomy in 1994 and the creation of the SECP by the end of 1997.The opening of new banks was put a halt to after 1995 and branching policies were eased to let the existing new banks grow. M=Meanwhile nationalized banks weren’t allowed to open new branches and were ordered to close non profitable ones. Other than this banks were allowed by the SBP to offer many fund management and investment advisory services.
Along with these a number of other step were taken to improve the level of efficiency and the competition level in the financial sector.Because of the Rigid and strict policies of SBP placed on the banks and other financial institutions in Pakistan, the 2008 financial crisis’ Shock did not affect Pakistan as much as it did in the US or other Countries.Weaknesses“Because Pakistan’s economy – particularly the private sector and the banks – are not that well-connected with the global economy, the Lehman crisis did not hit us that much”, Shaukat Tarin (Finance Minister 2008) (Tirmizi). However during the Musharraf era, the oil prices had been artificially lowered in Pakistan while the continued to rise throughout the world, this caused the government to spend its foreign exchange reserves which in turn caused a large fiscal deficit.Moreover the banks up till then were allowed to invest in stocks and they had been investing the depositor’s cash into the stock market which was already falling. Hence they faced heavy losses.
RepairsThe banks were then allowed to break up their loss into quarters and record it in that manner. This gave the banks and the markets more time to recover.The issue of the foreign currency deficit could not be solved through investments as the whole world was dealing with the financial crisis, so all that was lest as an option was remittances and a deal with the IMF.ResultsThe banking regulations in Pakistan have become much more strict and regulated. Banks are far more restricted in their investments in risky assets like stocks and giving out risky consumer loans. But the other issue of the macroeconomic deficit still exists due to a number of reasons including undue political influence etc. Terror financing Terror Financing has been a major issue in the whole world since the last decade and Pakistan has often been pointed out as one of the major countries affected by it and being unable to contain or eliminate the issue. Militant groups raise money for their activities through this path. “Foreign funding, drug trafficking, extortion from business and kidnapping for ransoms are other means of income for terrorists in Pakistan. They also largely use Hawala system, an alternative or parallel banking system to launder money” (Anwar)
The FATF (Financial Action Task Force) is a global financial monitor that keeps an eye out for such activities and it has recently placed Pakistan into its “Grey List”, because of Pakistan’s presumed inability to eradicate Terror financing from its system. This action has been taken to put more pressure on Pakistan to work harder against this threat. Even last year Washington suspended a 2 billion dollar aid to Pakistan accusing it to have been harboring terrorists. Seeing such reactions, it is clear that regulations and restrictions are quite necessary for Pakistan to fight against this issue. SECP’s Steps against Terror FinancingThe SECP has taken notice of this issue and has already issued “Anti-Money Laundering and Countering Financing of Terrorism Regulations, 2018”. This is a regulatory framework made while keeping in mind the requirements of the FATF. Moreover the SECP also banned individuals placed on “terror lists” from collecting funds in the name of charity or welfare.
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