Banking regulations

For all the criticism that it faces, the State Bank of Pakistan has been a remarkably successful regulator. Bank failures in Pakistan have been relatively rare. However, the banking system has had the effect of slowing down economic growth in the country, most recently in late 2008 (not directly related to the global crisis of that period, just impeccably timed).

A sharp surge in non-performing loans led to a credit crisis in the country with even the most creditworthy banks refusing to lend to each other in the interbank market. The central bank clearly had to act. It chose to do so by allowing a lenient accounting treatment of losses incurred due to non-performing loans. It also reduced the capital reserve requirements and other regulatory requirements ensuring that the bank would have more liquidity and could begin lending again.

These measures succeeded in getting the banking sector back onto its feet again without the federal government having to spend billions of rupees in bailing out the financial system (though the government of Punjab was not quite so lucky). But it appears that the central bank may have gone a bit too far. In November 2009, the bank reduced the requirement for provisioning against non-performing loans yet again which has resulted in substantially higher profits at many banks.

Given that the economy is still not out of the woods yet, it might make more sense to tighten the reins again rather than keeping on loosening them. The banks need to have adequate amounts of capital to cover their losses should the economic recovery falter. By lowering their requirements, the central bank may be setting the country up for another banking crisis. It would do well to reconsider its position.