Prudential Regulations for Banks

If the banks in Pakistan violate these Prudential Regulations they are liable to face heavy financial penalties and the bank officers can face disciplinary action by the State Bank of Pakistan and the bank can lose their banking licence besides heavy financial penalties.)

Nature of Prudential Regulations:
Prudential Regulations are both preventive and protective techniques. Preventive regulations forestall crises by reducing the risks facing banks such as controlling and monitoring the management of banks’ capital, solvency (CHECK THE MEANINGS OF SOLVENCY IN THE COMPUTER) and liquidity standards and large exposure limits. Protective techniques provide support to banks once a crisis threatens; lender-of-the-last-resort facilities are of immediate benefits.

In case of Pakistani banks branches functioning overseas the Prudential Regulations or legal requirements of host country shall prevail. The Prudential Regulations do not supersede other directives issued by SBP from time to time.

Definitions of important terms:

1. Account Holder means a person who has opened any account with a bank or is a holder of deposit / deposit certificate or any instrument representing deposit / placing of money with a bank or has borrowed money from the bank/DFI. A DFI means a Development Finance Institution.
2. Borrower means a person on whom a bank has taken any exposure during the course of business.
3. Contingent liability means: (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
   (b) a present obligation that arises from past events but is not recognized because: 
   1. it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or 
   2. the amount of the obligation cannot be measured with sufficient reliability; and includes letters of credit, letters of guarantee, bid bonds / performance bonds, advance payment guarantees and underwriting commitments. (Bid Bond= A guarantee that the firm will enter into a contract if it is awarded to the firm)
4. Documents include vouchers, cheques, bills, pay-orders, and promissory notes, securities for leases / advances and claims by or against the bank/DFI or other papers supporting entries in the books of a bank/DFI.
5. Equity of the borrower includes paid-up capital, general reserves, balance in share premium account, reserve for issue of bonus shares and retained earnings / accumulated losses, revaluation reserves on account of fixed assets and subordinated loans.
6. Exposure means financing facilities whether fund based and / or non-fund based and include any form of financing facility extended or bills purchased / discounted except ones drawn against the L/Cs of banks rated at least ‘A’ by credit rating agency on the approved panel of State Bank of Pakistan. 
7. Forced Sale Value (FSV) means the value which fully reflects the possibility of price fluctuations and can currently be obtained by selling the mortgaged / pledged assets in forced / distressed-sale conditions.
8. Government Securities shall include such types of Pak. Rupee obligations of the Federal Government or a Provincial Government or of a Corporation wholly owned or controlled, directly or indirectly, by the Federal Government or a Provincial Government and guaranteed by the Federal Government.
9. Group means persons, whether natural or juridical, if one of them or his dependent family members or its subsidiary, have control or hold substantial ownership interest over the other.
10. Liquid Assets are the assets which are readily convertible into cash without recourse to a court of law and mean--- encashment / realizable value of government securities, bank deposits, certificates of deposit, shares of listed companies which are actively traded on the stock exchange, National Investment Trust (NIT) Units, certificates of mutual funds, Certificates of Investment issued by entities rated at least ‘A’ by a credit rating agency on the approved panel of State Bank of Pakistan. These assets with appropriate margins should be in possession of the bank with perfected lien.
11. Guarantees issued by domestic banks when received as collateral by banks will be treated at par with liquid assets whereas, for guarantees issued by foreign banks, with rating of ‘A’ and above.
12. Medium and Long Term Facilities mean facilities with maturities of more than one year and Short Term Facilities mean those facilities with maturities up to one year
13. NBFC means Non-Banking Finance Company and includes a Modaraba, Leasing Company, Housing Finance Company, Investment Bank, Discount House, Asset Management Company and a Venture Capital Company.
14. Other Form of Security means hypothecation of stock (inventory), assignment of receivables, lease rentals, contract receivables, etc.
15. Readily Realizable Assets mean and include liquid assets and stocks pledged to the banks in possession, with ‘perfected lien’ duly supported with complete documentation.
16. Secured means exposure backed by tangible security and any other form of security with appropriate margins. Exposure without any security or collateral is defined as clean.
17. Equity of the Bank/DFI means Tier-I Capital or Core Capital and includes paid-up capital, general reserves, balance in share premium account, reserve for issue of bonus shares and retained earnings/accumulated losses as disclosed in latest annual audited financial statements. In case of branches of foreign banks operating in Pakistan, equity will mean capital maintained, free of losses and provisions, under Section 13 of the Banking Companies Ordinance, 1962.
18. Nominee Director means a person nominated on the board of a bank/DFI by sponsor(s), persons, company, institution etc. by virtue of his/their shareholding in a bank/DFI.
19. PBA means Pakistan Banks Association.
20. Subordinated Loan means an unsecured loan, extended to the borrower for a minimum original maturity period of 5 years, subordinate to the claim of the bank/DFI taking exposure on the borrower, and documented by a formal sub-ordination agreement between provider of the loan and the bank/DFI. The loan shall be disclosed in the annual audited financial statements of the borrower as subordinated loan.
21. Tangible Security means readily realizable assets (as defined in these Prudential Regulations), mortgage of land, plant, building, machinery and any other fixed assets.
22. Underwriting Commitments mean commitments given by commercial banks/DFIs to the limited companies at the time of new issue of equity/debt instrument, that in case the proposed issue of equity/debt instrument is not fully subscribed, the un-subscribed portion is taken up (purchased) by the underwriting entity.

The Need for Prudential Regulations
The Basel Accord of 1988 and desirability to avail the benefits of laissez- faire prompted the introduction of Prudential Regulations by State Bank of Pakistan with effect from 1 January, 1992, to counter any adverse impact of a deregulated banking sector in Pakistan. The key objectives of these regulations are outlined below:

1. To protect the safety of public’s savings deposited in Banks.
2. To control the supply of money and credit in order to achieve a nation’s broad economic goals (such as high employment and low inflation).
3. To ensure equal opportunity and fairness in the public’s access to credit and other vital financial services.
4. To promote public confidence in the financial system, so that savings flow smoothly into productive investment.
5. To avoid concentrations of financial power in the hands of a few individuals and institutions.
6. To provide the government with credit, tax revenues and other services.
7. To help those sectors of the economy that have special credit needs (such as housing, small business, and agriculture).

Categories of Prudential Regulations:

1. The Prudential Regulations are divided in four categories:
   
   1. Risk Management (R), (Prefix R)
   (There are different sets of Risk Regulations for Corporate and Commercial Banking, SME, Consumer, Agriculture and Micro Finance Loans.)
2. Corporate Governance (G),
3. KYC and Anti Money Laundering (M), and
4. Operations (0).

Risk Management
1) Corporate/Commercial Banking
Regulation R-1
Limit on Exposure to a Single Person/Group

1. The total outstanding exposure (fund based and non-fund based) by a bank/DFI to any single person shall not at any point in time exceed 30% of the bank's/DFI's equity as disclosed in the latest audited financial statements, subject to the condition that the maximum outstanding against fund based exposure does not exceed 20% of the bank's/DFI's equity.
2. The total outstanding exposure (fund based and non-fund based) by a bank/DFI to any group shall not exceed 50% of the bank's/DFI's equity as disclosed in the latest audited financial statements, subject to the condition that the maximum outstanding against fund based exposure does not exceed 35% of the bank's/DFI's equity.
   The rationale of this regulation is to diversify the bank’s exposure to a large number of clients. If a bank gives loans only to a small number of clients giving large chunks to each customer the bank’s credit risk will be high. If loans are given to a large number of clients and each customer is given a smaller amount the overall RISK will be lower.
3. Limit on exposure to a single person/Group effective from 31-12-2009 and onward would be as under:
   Effective date Exposure limit as a % of bank’s/DFI’s equity (as disclosed in the latest audited financial statements)
   For single person For group
   Total outstanding(fund and non-fund based) exposure limit Fund based outstanding limit Total outstanding (fund and non-fund based) exposure limit Fund based outstanding limit
   31-12-2009 30 20 45 35
   31-12-2010 30 20 40 35
   31-12-2011 30 20 35 30
   31-12-2012 30 20 30 25
   31-12-2013 25 25 25 25

Regulation R-2
Limit on Exposure Against Contingent Liabilities
1. Contingent liabilities of a bank/DFI shall not exceed at any point in time 10 times of its equity. Contingent Liabilities are the total of the following commitments undertaken by a bank:-

1. Letters of Guarantee issued by a bank.
2. Letters of Credit issued by a bank.
3. Letters Underwriting the issue of shares or TFC’s to the Public.

Following shall not constitute contingent liabilities for the purpose of this regulation:

1. Bills for collection.
2. Obligations under Letters of Credit and Letters of Guarantee to the extent of cash margin retained by the bank/DFI.
3. Letters of credit/guarantee where the payment is guaranteed by the State Bank of Pakistan/Federal Government or banks/DFIs rated at least 'A' by a credit rating agency on the approved panel of State Bank of Pakistan or Standard & Poors, Moody's, Fitch- Ibca or Japan Credit Rating Agency (JCRA).
4. Non-fund based exposure to the extent covered by liquid assets.
5. Claims other than those related to provision of facilities (fund based or non-fund based) to the banks'/DFIs’ constituents, where the probability of conversion of these claims into liabilities are remote.

Regulation R-3
Minimum Conditions for Taking Exposure

1. While considering proposals for any exposure (including renewal, enhancement and rescheduling/restructuring) exceeding such limit as may be prescribed by State Bank of Pakistan from time to time (presently at Rs 500,000), banks/DFIs should give due weightage to the credit report relating to the borrower and his group obtained from Credit Information Bureau (CIB) of State Bank of Pakistan. However, banks/DFIs may take exposure on defaulters keeping in view their risk management policies and criteria, provided they properly record reasons and justifications in the approval form. The condition of obtaining CIB report will apply to exposure exceeding Rs 500,000/- after netting-off the liquid assets held as security.
2. Banks/DFIs shall, as a matter of rule, obtain a copy of financial statements duly audited by a practicing Chartered Accountant, relating to the business of every borrower who is a limited company or where the exposure of a bank/DFI exceeds Rs 10 million, for analysis and record. The banks/DFIs may also accept a copy of financial statements duly audited by a practicing Cost and Management Accountant in case of a borrower other than a public company or a private company which is a subsidiary of a public company. However effective from December 31, 2009, if the borrower is a public limited company and exposure exceeds Rs. 500 million, banks/DFIs should obtain the financial statements duly audited by a firm of Chartered Accountants which has received satisfactory rating under the Quality Control Review (QCR) Program of the Institute of Chartered Accountants of Pakistan. Subsequently, if the firm's rating is downgraded in QCR program, then the financial statements of such borrowers are audited in the subsequent year by a firm having satisfactory rating under QCR.l Banks/DFIs may waive the requirement of obtaining copy of financial statements when the exposure net of liquid assets does not exceed the limit of Rs 10 million. Further, financial statements signed by the borrower will suffice where the exposure is fully secured by liquid assets.
3. Banks/DFIs shall not approve and/or provide any exposure (including renewal, enhancement and rescheduling/restructuring) until and unless the Loan Application Form (LAF) prescribed by the banks/DFIs is accompanied by a 'Borrower's Basic Fact Sheet' under the seal and signature of the borrower as per approved format of the State Bank of Pakistan (Annexure II-A for corporate borrowers and Annexure II-B for individual borrowers).

Regulation R-4
Limit on Exposure Against Unsecured Financing Facilities

1. Banks/DFIs shall not provide unsecured/clean financing facility in any form of a sum exceeding Rs 500,000/- (Rupees five hundred thousand only) to any one person. Financing facilities granted without securities including those granted against personal guarantees shall be deemed as 'clean' for the purpose of this regulation. Further, at the time of granting a clean facility, banks/DFIs shall obtain a written declaration to the effect that the borrower in his own name or in the name of his family members, has not availed of such facilities from other banks/DFIs so as to exceed the prescribed limit of Rs 500,000/- in aggregate.
2. For the purpose of this regulation, following shall be excluded/exempted from the per party limit of Rs 500,000/- on the clean facilities:
   a) Facilities provided to finance the export of commodities eligible under Export Finance Scheme.
   b) Financing covered by the guarantee of Pakistan Export Finance Guarantee Agency.
   c) Loans/advances given to the employees of the banks/DFIs in accordance with their entitlement/staff loan policy.
   d) Investment in COIs/inter bank placements with NBFCs, provided the investee NBFC is rated 'A+', 'A' or 'A-' for long-term rating and at least 'A2' for short-term rating or equivalent by a credit rating agency on the approved panel of the State Bank of Pakistan or Standard & Poors, Moody's, Fitch-Ibca or Japan Credit Rating Agency (JCRA).n instructions, will be exempted from the aggregate exposure limit.
3. Banks/DFIs shall ensure that the aggregate exposure against all their clean facilities shall not, at any point in time, exceed the amount of their equity. However, investment of banks/DFIs in subordinated and unsecured TFCs, issued by other banks/DFIs to raise Tier-II Capital as per State Bank of Pakistan's instructions, will be exempted from the aggregate exposure limit.

Regulation R-5
Linkage betwween Financial Indicators of the Borrower and Total Exposure from Financial Institutions

1. While taking any exposure, banks/DFIs shall ensure that the total exposure (fund-based and/or non-fund based) availed by any borrower from financial institutions does not exceed 10 times of borrower's equity as disclosed in its financial statements (obtained in accordance with Para 2 of Regulation R-3), subject to the condition that the fund based exposure does not exceed 4 times of its equity as disclosed in its financial statements. However, where the equity of a borrower is negative and the borrower has injected fresh equity during its current accounting year, it will be eligible to obtain finance up to 4 times of the fresh injected equity (instead of the existing 3 times) provided the borrower shall plough back at least 80% of the net profit each year until such time that it is able to borrow without this relaxation. After 30th June 2009, the borrower will be eligible only up to 3 times of his fresh injected equity.
   In exceptional cases, banks/DFIs may allow seasonal financing to borrowers, for a maximum period of six months, not meeting the criteria of 4 times of fund based exposure and 10 times total exposure, subject to the condition that fund based exposure does not exceed 8 times and total exposure does not exceed 12 times of borrower's equity. 
2. At the time of allowing fresh exposure/enhancement/renewal, the banks/DFIs should ensure that the current assets to current liabilities ratio of the borrower is not lower than such ratio as may be required under the Credit Policy of the bank/DFI. Banks/DFIs shall prescribe the minimum current ratio under their Credit Policy keeping in view the quality of the current assets, nature of the current liabilities, nature of industry to which borrower belongs to, average size of current ratio of that industry, appropriateness of risk mitigants available to the bank/DFI etc. It is expected that bank/DFI's Credit Policy, duly approved by the Board of Directors, shall emphasize higher credit standards and provide full guidance to the management about the current ratio requirement for various categories of clients and corresponding risk mitigants etc. acceptable to the bank/DFI. 
3. For the purpose of this regulation, subordinated loans shall be counted as equity of the borrower. Banks/DFIs should specifically include the condition of subordinated loan in their Offer Letter. The subordination agreement to be signed by the provider of the subordinated loan, should confirm that the subordinated loan will be repaid after that bank's/DFI's prior approval.
4. This regulation shall not apply in case of exposure fully secured against liquid assets held as collateral, as well as in cases where the exposure is taken on Units/Projects revived as a consequence of settlement under Committee for Revival of Sick Industrial Units (CRSIU), Corporate & Industrial Restructuring Corporation (CIRC) and the State Bank of Pakistan BPD Circular No. 29 dated October 15,2002, for a period of five years from the date of such settlement. Export finance and finance provided to ginning and rice husking factories shall also be excluded from the borrowings (exposure) for the purpose of this regulation.
5. Where the banks/DFIs have taken exposure on exceptional basis as provided in para 1 above, they shall record in writing the reasons and justifications for doing so in the approval form and maintain a file in their central credit office containing all such approvals. The Exceptions Approval file shall be made available to the inspection team of State Bank during the inspection.

Regulation R-6
Exposure Against Shares/TFCs and Acquisition of Shares
1. A) Exposure Against Shares/TFCs:
Banks/DFIs shall not:

1. Take exposure against the security of shares/TFCs issued by them. XYZ bank cannot grant loans against shares issued by XYZ bank.
2. Provide unsecured credit to finance subscription towards floatation of share capital and issue of TFCs.
3. Take exposure against the non-listed TFCs or the shares of companies not listed on the Stock Exchange(s). However, banks/DFIs may make direct investment in non-listed TFCs.
4. Take exposure on any person against the shares/TFCs issued by that person or its subsidiary companies. It means Packages Ltd cannot obtain loan against shares issued by Packages Ltd.
5. Take exposure against 'sponsor director's shares' (issued in their own name or in the name of their family members) of banks/DFIs.
6. Take exposure on any one person (whether singly or together with other family members or companies owned and controlled by him or his family members) against shares of any commercial bank/DFI in excess of 5% of paid-up capital of the share issuing bank/DFI.
7. Take exposure against the shares/TFCs of listed companies that are not members of the Central Depository System. Check on internet the purpose of Central Depository Company.
8. Take exposure against unsecured TFCs or non-rated TFCs or TFCs rated below 'BBB' or equivalent. Exposure may, however, be taken against unsecured/subordinated TFCs, which are issued by the banks/DFIs for meeting their minimum capital requirements, as per terms and conditions stipulated in BSD Circular No. 12 of August 25, 2004.
9. Take exposure against shares unless the beneficiary of the facility is absolute owner of the shares so pledged or has the necessary mandate to pledge the shares of third party as security for availing financing facility from the bank/ DFI.

B) Acquisition of Shares: 

1. Banks/DFIs shall not own shares of any company/scrips in excess of 5% of their own equity. Further, the total investments of banks in shares should not exceed 20% of their own equity.
   The shares acquired in excess of 5% limit due to the underwriting commitments will be sold off/off loaded within a period of three months.
2. Banks/DFIs may also take exposure in future contracts to the extent of 10% of their equity on aggregate basis. In this connection, the 10% exposure limit for future contracts will include both positions taken in futures buying and selling.
3. Banks/DFIs may combine the limits for ready market and future contracts and have the aggregate exposure in shares to the extent of 30% of their equity provided that investment in future contracts shall not exceed 10% of their equity. 
4. Banks/DFIs will obtain prior approval from the State Bank while purchasing shares of a company in excess of 5% of their paid-up capital or 10% of the capital of investee company, whichever is lower. These limits will be calculated as under:
5. Regarding strategic investment, the banks/DFIs will exercise proper diligence, as their decision to make strategic investment carries great significance, keeping in view the implications of such investment in terms of liquidity management and long term outlook of the investee companies. In this regard, the banks/DFIs should take into account all relevant factors. Accordingly, the following should be ensured:
   • A committee, clearly designated/empowered by the bank, should take the decision for strategic investment.
   • All Record of transactions/decisions, taken by the committee, regarding strategic investment should be properly maintained and kept in a separate file, for provision of the same to the SBP Inspection Team during their visit to the bank.
   • The banks/DFIs will report their investment in strategic portfolio to the Banking Policy Department, within 2 working days from the date of such investment.

2. Banks/DFIs shall not hold shares in any company whether as pledge, mortgagee, or absolute owner, of an amount exceeding 30% of the paid-up share capital of that company or 30% of their own paid-up share capital and reserves, whichever is less.
3. Security Margin : Exposure against the shares of listed companies shall be subject to minimum margin of 30% of their current market value, though the banks/DFIs may, if they wish, set higher margin requirements keeping in view other factors. However, banks/DFIs should not give a margin call until the margin reaches to the level of 25%. Banks/DFIs will monitor the margin on at least weekly basis and will take appropriate action for top-up and sell-out on the basis of their Board of Directors' approved credit policy and pre-fact written authorization from the borrower enabling the bank/DFI to do this. 4. SECURITY MARGIN : Exposure against TFCs rated 'A' (or equivalent) and above by a credit rating agency on the approved panel of State Bank of Pakistan shall be subject to a minimum margin of 10% while the exposure against TFCs rated 'A-' and 'BBB' shall be subject to a minimum margin of 20%.

Regulation R-7 Guarantees

1. All guarantees issued by the banks/DFIs shall be fully secured. Further the banks/DFIs to hold at least 20% of the guaranteed amount in the form of liquid assets as security.
2. The requirement of security can also be waived by the banks/DFIs in cases of guarantees issued to Pakistani firms and companies functioning in Pakistan against the back to back/counter guarantees of branches of guarantee issuing bank/DFI or banks/DFIs rated at least 'A' or equivalent by a credit rating agency on the approved panel of State Bank of Pakistan or Standard & Poors, Moody's, Fitch-Ibca or Japan Credit Rating Agency (JCRA). Besides, in cases where the counter-guarantee issuing bank is situated in a foreign country, the rating of at least 'A' or equivalent by a local credit rating agency of the respective country shall also be acceptable, provided the guarantee issuing bank in Pakistan is comfortable with and accepts the counter-guarantee of such foreign bank.
   However, the prescribed rating requirement for banks situated in foreign countries may be relaxed for transaction amounts up to US$250,000, subject to internal credit controls and approval of the relevant bank/DFI in Pakistan. For transaction amounts greater than US$250,000, banks/ DFIs may approach the State Bank of Pakistan for specific approvals/exemption, on a case-by-case basis, where the prescribed minimum rating requirement cannot be complied with. Banks/DFIs are encouraged to set limits for acceptance of guarantees issued by other banks/DFIs.
3. In case of back-to-back letters of credit issued by the banks/DFIs for export-oriented goods and services, banks/DFIs are free to decide the security arrangements at their own discretion subject to the condition that the original L/C has been established by branches of the guarantee issuing bank or a bank rated at least 'A' by Standard & Poors, Moody's, Fitch-Ibca or Japan Credit Rating Agency (JCRA).
4. The guarantees shall be for a specific amount and expiry date and shall contain a claim lodgement date. However, banks/DFIs are allowed to issue open-ended guarantees without clearance from State Bank of Pakistan provided banks/DFIs have secured their interest by adequate collateral or other arrangements acceptable to the bank/DFI for issuance of such guarantees in favour of Government departments, corporations/autonomous bodies owned/controlled by the Government and guarantees required by the courts.

Regulation R-8
Classification and Provisioning for Assets Loans / Advances
Classification and Provisioning
Classification here means classifying the lending portfolio of a bank into different categories based on the fact whether the loan and / or interest is being repaid to the bank in accordance with the loan contract and whether the other terms and conditions are being met or not. For example whether security as required is present, whether business is running and whether the turnover in the business account with the bank is satisfactory or not. We can classify the students of a college by gender, age or qualifications.

Provisioning is the name given to the process whereby the bank deducts an amount from the profit it has made and places the amount in a separate account called ‘Provision for bad and doubtful debts’ when the bank has come to the conclusion that there are evidences which indicate that either the borrower is willingly avoiding to repay as required or there is an erosion in the ability of the borrower to repay and there is a reduction in the available security and there is a strong apprehension that the customer will fail to repay and the bank will have to suffer a financial loss. The amount that is transferred to provision account does not available to distribute to the shareholders as dividend and can only be used to cover the possible loss in the financing and is used to write off the loan.

Regulation R-11 Payment of Dividend
Banks/DFIs shall not pay any dividend on their shares unless and until:

1. they meet the minimum capital requirements as laid down by the State Bank of Pakistan from time to time;
2. all their classified assets have been fully and duly provided for in accordance with the Prudential Regulations and to the satisfaction of the State Bank of Pakistan; and
3. all the requirements laid down in Banking Companies Ordinance, 1962 relating to payment of dividend are fully complied.

Regulation R-12 Monitoring
While extending fund-based facilities to borrowers against hypothecation of stock and/or receivables on pari-passu basis, banks/DFIs shall obtain monthly statements from borrowers that contain a bank-wise break-up of outstanding amounts with the total value of stocks and receivables there-against.


Small and Medium Enterprises
General RISK Prudential Regulations Check-list for SME s

General Regulations covering both 1) SMALL and 2) MEDIUM Enterprises

Criteria
SME Specific Credit Policy to be formulated by Bank management
Procedures on loan administration, disbursement, and monitoring and recovery mechanism are clearly documented.
Specifications of main functions, role & responsibilities of key positions, as well as delegation matrix for approvals/sanctioning of financing limits.
Borrowers Basic Fact Sheet and e-CIB Report
Duly signed/stamped 'Borrower’s Basic Fact Sheet' (BBFS) obtained.
Duly signed/stamped 'Loan Application Form' (LAF) obtained.
e-CIB report on borrower and on his group is obtained and in case of default proper justification and reasons of default are recorded.
Personal Guarantees
All facilities, except for those secured against liquid assets are backed by PG of the owners of SME's.
PGs of all directors other than nominee directors shall be obtained, in case of limited companies
Limit on Clean facilities
Clean Exposure (facilities secured against personal guarantees only other than consumer financing limits i.e credit card, personal loans) does not exceed Rs 5 M in aggregate from all banks.
Written declaration that clean facilities does not exceed prescribed limit (s) is available
Proper Utilization of Loan
Appropriate system for monitoring utilization of loan is in-place.
In case of Fixed Assets/Project Financing: Appropriate system for monitoring utilization of loan is in-place.
In case of Working Capital/revolving credits: Declaration for utilization of loan for the purpose indended obtained.
Restriction on Facilities to Related Parties
Any of financing bank’s director, its chief executive or major share holding 5% or more of share capital of the Bank or an employee or any dependent family member of these persons is not interested in SME.
An undertaking from SE stating that there is no existence of any interest between the borrower and the above-mentioned related parties is obtained.
Translation of Loan Documents into Urdu Language
Arrangements are in-place for provision of LAF, BBFS and other related documents (except charge documents) on specific request of the customer.
Securities and margin Requirements
All facilities except the ones extended under clean financing are secured appropriately.
General Measures
Pricing policy, processing & documentation fee, prepayement/late-payment penalities etc explicitly mentioned in loan agreement
A transparent, customer focused complaints resolution system is available
An efficient Management Information System (MIS) for SME Finance to effectively cater to needs of the borrower is implemented



Small Enterprises (SE) Specific Prudential Regulations Check- list

Name of the Customer

Criteria
Definition of Small Enterprise
A Small Enterprise (SE) is a business entity which meets both the following parameters
No: of employees (inclusive of contract employees): upto 20
Annual Sales Turnover : Upto Rs 75 M
Per Party Exposure Limit
The maximum exposure on a counterparty does not exceed Rs 15 M from a Single Bank/ All Banks
Requirement of Audited Accounts
Financials duly signed by the borrower obtained
Repayment Capacity of the Borrower and Cash Flow Based Lending
Cashflows of the borrower properly assessed by applying appropriate techniques
Collateral Valuation
Valuation conducted by Pakistan Banks Associatin (PBA) approved evaluator or Bank's/ DFI own evaluating staff (for exposures upto Rs 5.0M)
Recovery of Outstanding Dues
Incase, cash collection/recovery is done at a place other than authorised place of the business, appropriate secuirty and risk management measures are adopted (including necessary steps such as intimation to the borrower)
General Reserve against Small Enterprise Finance
General reserve atleast equivalent upto 1% of the secured SE portfolio and 2% of the unsecured SE portfolio, is maintained
Classification and Provisioning for Loan /Advances
Classification and Provision guidelines are meticulously observed as required.
Restructuring/Rescheduling of Loan
Guidelines for Restructuring/Rescheduling of Loan are met
Minimum Turnaround Time
TAT for approval process (from the date of receipt of complete information) is within 30 days


Medium Enterprises (ME) Specific Prudential Regulations Check- list

Name of the Customer

Criteria
Definition of Medium Enterprise
A Medium Enterprise (ME) is a business entity (Ideally not a public limited Company), which meets both the following parameters:
No: of employees (inclusive of contract staff): 21-250 (Manufacturer & Services) OR 21-50 (Traders)
Annual Sales Turnover : Above Rs 75 M and upto Rs 400 M
Repayment Capacity and Cashflow Based Lending
Repayment capacity of the borrower on the basis of asset conversion cycle & expected future cash flow is assessed
Key drivers & risks of borrower’s business and risk mitigants are identified
Rationale & parameters used to project the future cash flows are documented and annexed with cash flow analysis undertaken
Per Party Expsoure Limit
The maximum exposure on a counterparty does not exceed Rs 100 M from a Single Bank.
Total exposure (including leased assets) on a counterparty does not exceed Rs 200 M from All Bank.
Requirement of Audited Accounts
Copy of financial statements duly audited by a practicing chartered accountant to be obtained where the borrower is a limited company and/or the exposure net of liquid assets exceeds Rs 10M.
Classification and Provisioning for Assets
Classification and Provision guidelines are meticulously observed as required.

We are not discussing the remaining categories of Risk Prudential Regulations.
The serious students may visit sbp website for the Regulations.
The regulations appearing in the book by Dr Israr may or may not be uptodate.
Corporate Governance:
In order to ensure that the management of bank should not fall in the hands that might damage both the institution and the banking industry as a whole, the appointment of proposed President/Chief Executive and Directors on the Board require prior clearance from State Bank of Pakistan. A similar type of approach will be observed by the Banks while appointing the key executives of the Bank which will serve as intimation to State Bank of Pakistan.

A. Fit And Proper Test
The "Fit and Proper Test" (FPT) is applicable to the sponsors (both individual and companies) who apply for a commercial banking license, the investors acquiring strategic/controlling stake in the banks/DFIs, major shareholders of the banking companies and to the appointment of Directors, CEO, and Key Executives of the banks/DFIs. The fitness and propriety will be assessed on the following broad elements (Annexure VII-B)

1. Integrity, Honesty and Reputation
2. Track Record
3. Solvency and Integrity
4. Qualifications and Experience
5. Conflict of Interest
6. Others

In order to improve the quality of directives originated from the Board, it has been particularly highlighted that their role will be only policy making and general directions, oversight and supervision of the affairs and business of the bank and shall not indulge in day-to-day operations of the business of the bank.
B. Head of Compliance / Compliance Officer:
Banks/DFIs shall put in place a Compliance Program to ensure that all relevant laws are complied with, in letter and spirit, and, thus, minimize legal and regulatory risks. For this purpose, the Board of Directors, or Country Manager in case of foreign banks, shall appoint/designate a suitably qualified and experienced person as Compliance Officer on a countrywide basis, who may be assisted by other Compliance Officers down the line. The Head of Compliance will report directly to the President/Chief Executive Officer of the bank/DFI. The Compliance Officers will primarily be responsible for bank's/DFI's effective compliance relating to:

1. SBP Prudential Regulations.
2. Relevant provisions of existing laws and regulations.
3. Guidelines for KYC.
4. Anti money laundering laws and regulations.
5. Timely submission of accurate data/returns to regulator and other agencies.
6. Monitor and report suspicious transactions to President/Chief Executive Officer of the bank/DFI and
   
   The Board of Directors of a Bank shall also ensure that it receives Management Letter from the external auditors without delay and appropriate action is taken thereon in consultation with the Audit Committee to deal with control or other weaknesses identified therein. A copy of Management Letter should also be submitted to the State Bank of Pakistan for further follow up at their level

With a view to safeguard the interest of prospective investors, depositors and creditors, it shall be mandatory for all banks to have themselves credit rated by a Credit Rating Agency on the approved panel of the State Bank of Pakistan. Further, the banks will disclose their credit rating prominently in their published annual and quarterly financial statements
Know Your Customer (KYC) and Money Laundering:
The Prudential Regulation impresses upon the banks to remain fully conversant about their customers to prevent the possible use of the banking sector for money laundering, terrorist financing, and transfer of illegal / ill-gotten monies. Further, it is not a one time exercise but an on going process and will commence with the start of banker customer relationship and will remain in operation during the currency of each account.

Regulation M-1 Customer Due Diligence (Cdd)1
1. With a view to preserving the integrity and safety of the financial system, it is expedient to prevent the possible use of the banking sector for money laundering and terrorist financing. To this end, Customer Due Diligence/Know Your Customer (CDD/KYC) procedures require special attention and concrete implementation. Accordingly, the following minimum guidelines are required to be followed by banks/DFIs to avert the risks posed by money laundering and terrorist financing activities. However, banks/DFIs are free to take additional measures in line with Financial Action Task Force Recommendations.


The Prudential Regulations have listed different documents that must be obtained from different types of customers while opening each account for the ease and guidance of the banks. During the course of inspection of the banks, the efficacy of KYC system will be checked to ensure effective observance of SBP directives

The banks are required to preserve their record for a minimum period of five years. The records relating to the suspicious transactions reported by the bank shall be retained even after the lapse of this period, till such time the State Bank of Pakistan permits to destroy the same.
Regulation M-4 Correspondent Banking
1. Banks/DFIs shall gather sufficient information about their correspondent banks to understand fully the nature of their business. Factors to consider include:
x Know your customer policy (KYC)
x Information about the correspondent bank's management and ownership
x Major business activities x Their location
x Money laundering prevention and detection measures x The purpose of the account
x The identity of any third party that will use the correspondent banking services (i.e. in case of payable through accounts) x Condition of the bank regulation and supervision in the correspondent's country


Suspicious Transactions
The Banks are also required to report all suspicious transactions through Compliance Officer of the bank to Banking Policy Department of State Bank of Pakistan. The employees of the banks are strictly prohibited to disclose the fact to the customer or any irrelevant quarter that a suspicious transaction or related information is being reported for investigation


Operations:
Banks have been restrained from window dressing i.e. artificially or temporarily showing an ostensibly different position of bank’s accounts as reflected in their financial statements. Particular care shall be taken in showing the position of deposits, non-performing loans/assets, provision, profit, inter-branch and inter-bank accounts etc.

All entries outstanding in the Inter-Branch Accounts and/or Suspense account must be reconciled /cleared and taken to the proper head of account within a maximum period of 30 days from the date of entry made in the said account

Every Bank shall maintain in Pakistan not less than 80% of the assets created by it against time and demand liabilities. Accordingly assets held abroad shall not, at any point in time, exceed 20% of its time and demand liabilities. All other assets financed from sources other than time and demand liabilities shall be held within Pakistan

In case of FE 25 deposits, these shall not be invested in fund management schemes of other banks, whether in Pakistan or abroad. At the same time amount invested in a single institution should not exceed 25% of total investable funds, available with the investing bank

The prescribed ratio of Cash Reserve /Special Cash Reserve against FE-25 deposit shall be maintained in USD Dollars.