SBP should be cautious about regulating banks for a smooth system. CREATIVE COMMONS
AL AIN: Maintaining and strengthening a sound financial system is one of the key goals of any central bank.
Post-crisis debates have been focusing on strengthening macro-prudential regulation, meaning to ensure stability of the financial system as a whole and not just individual institution, through a regulatory and supervisory process.
Following the global financial crisis of 2008, central banks around the world have made a sincere effort towards stabilising the financial system, one of which involves the identification and protection of systemically important financial institutions (SIFIs).
The failure of a SIFI could have a knock-on effect leading to failure of many institutions in the industry as evidenced during the current crisis. Although a standard definition of SIFI has not been decided, the Basel Committee has identified a few variables such as size, interconnectedness with other institutions and substitutability for the financial infrastructure it provides as indicators of an institution’s systemic importance.
For the purpose of this article, I would use size and interconnectedness and apply that to the Pakistan banking system.
The Pakistan banking system is highly concentrated with a few major players holding a large proportion of assets of the industry. Recent data taken from banks’ financial statements until 2012 reveals that top five players of the banking industry have a share of 55% in total assets of the banking system.
Similar is the case with deposits. Big five banks hold a share of 56% in overall bank deposits. Moreover, few accounts hold very large deposits. Less than 1% of total deposit holders have deposited an amount equivalent to 36% of total deposits of the entire banking system.
Further analysis of these ‘gigantic’ accounts reveals that they belong to the government and the private sector. Consider for a moment the catastrophe that could potentially be caused by the failure of even one of these institutions holding these accounts.
Advances and investments in government securities comprise a significant share in assets on an individual bank’s balance sheet. Top five banks in terms of advances hold a share of 54% in total advances of the banking system.
According to standards established by the Federal Reserve Bank of Cleveland (Ohio, US), if an individual entity holds more than 10% of total assets and a share of more than 15% in total advances, it is considered systemically important.
The Pakistan banking system has systemically important institutions which fulfill both these criteria.
Finally, analysing the banking system through the variable of interconnectedness, borrowings from financial institutions of the top five players comprise a whopping 49% of the total, with one bank having a share of about 20%.
Interconnectedness of these top five players is not only strong with financial institutions but also with the primary domestic sector (agriculture). The latter has many backward linkages with other sectors and is of high systemic importance. The State Bank of Pakistan needs to be extra cautious about regulating these SIFIs to ensure a smooth functioning of the financial system.
Although this area is continuously undergoing research, capital requirements to be made tougher during boom times to create buffers for crisis episodes is one way to effectively regulate the system. Regular stress tests and periodic systemic risk analyses are some of the other ways to deal with SIFIs effectively.
More research into the above mentioned indicators can be done to update the regulatory and supervisory framework to sustain and improve the resilience of the financial system.
The writer is an economist and ex-central banker
Published in The Express Tribune, September 9th, 2013.
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SIFIs concern from Pakistan's standpoint is not subject to the serious policy issue given healthy status of top banking players and absence of complex financial products as opposed to USA that caused financial panic leading to Great Recession.