State Bank of Pakistan - The Central Bank (2024)

State Bank of Pakistan is the Central Bank of the country. Whileits constitution, as originally laid down in the State Bankof Pakistan Order 1948, remained basically unchanged until 1stJanuary 1974 when the Bank was nationalised, the scope of itsfunctions was considerably enlarged. The State Bank of PakistanAct 1956, with subsequent amendments, forms the basis of itsoperations today.

Underthe State Bank of Pakistan Order 1948, the Bank was chargedwith the duty to "regulate the issue of Bank notes andkeeping of reserves with a view to securing monetary stabilityin Pakistan and generally to operate the currency and creditsystem of the country to its advantage". The scope of theBank’s operations was considerably widened in the StateBank of Pakistan Act 1956, which required the Bank to "regulatethe monetary and credit system of Pakistan and to foster itsgrowth in the best national interest with a view to securingmonetary stability and fuller utilisation of the country’sproductive resources". Under financial sector reforms,the State Bank of Pakistan was granted autonomy in February1994. On 21st January, 1997, this autonomy was further strengthenedby issuing three Amendment Ordinances (which were approved bythe Parliament in May, 1997) namely, State Bank of PakistanAct, 1956, Banking Companies Ordinance, 1962 and Banks NationalisationAct, 1974. The changes in the State Bank Act gave full and exclusiveauthority to the State Bank to regulate the banking sector,to conduct an independent monetary policy and to set limit ongovernment borrowings from the State Bank of Pakistan. The amendmentsin Banks Nationalisation Act abolished the Pakistan BankingCouncil (an institution established to look after the affairsof NCBs) and institutionalised the process of appointment ofthe Chief Executives and Boards of the nationalised commercialbanks (NCBs) and development finance institutions (DFIs), withthe Sate Bank having a role in their appointment and removal.The amendments also increased the autonomy and accountabilityof the Chief Executives and the Boards of Directors of banksand DFIs.

Likea Central Bank in any developing country, State Bank of Pakistanperforms both the traditional and developmental functions toachieve macro-economic goals. The traditional functions, whichare generally performed by central banks almost all over theworld, may be classified into two groups: (a) the primary functionsincluding issue of notes, regulation and supervision of thefinancial system, bankers’ bank, lender of the last resort,banker to Government, and conduct of monetary policy, and (b)the secondary functions including the agency functions likemanagement of public debt, management of foreign exchange, etc.,and other functions like advising the government on policy mattersand maintaining close relationships with international financialinstitutions. The non-traditional or promotional functions,performed by the State Bank include development of financialframework, institutionalisation of savings and investment, provisionof training facilities to bankers, and provision of credit topriority sectors. The State Bank also has been playing an activepart in the process of islamization of the banking system. Themain functions and responsibilities of the State Bank can bebroadly categorised as under.

Being the Central Bank of the country, State Bank of Pakistanhas been entrusted with the responsibility to formulate andconduct monetary and credit policy in a manner consistent withthe Government’s targets for growth and inflation andthe recommendations of the Monetary and Fiscal Policies Co-ordinationBoard with respect to macro-economic policy objectives. Thebasic objective underlying its functions is two-fold i.e. themaintenance of monetary stability, thereby leading towards thestability in the domestic prices, as well as the promotion ofeconomic growth.

Toregulate the volume and the direction of flow of credit to differentuses and sectors, the Bank makes use of both direct and indirectinstruments of monetary management. Until recently, the monetaryand credit scenario was characterised by acute segmentationof credit markets with all the attendant distortions. Pakistanembarked upon a program of financial sector reforms in the late1980s. A number of fundamental changes have since been madein the conduct of monetary management which essentially markeda departure from administrative controls and quantitative restrictionsto market-based monetary management. A reserve money managementprogramme has been developed. In terms of the programme, theintermediate target of M2 would be achieved by observing thedesired path of reserve money - the operating target. Whileuse in now being made of such indirect instruments of controlas cash reserve ratio and liquidity ratio, the program’sreliance is mainly on open market operations.

One of the fundamental responsibilities of the State Bank isregulation and supervision of the financial system to ensureits soundness and stability as well as to protect the interestsof depositors. The rapid advancement in information technology,together with growing complexities of modern banking operations,has made the supervisory role more difficult and challenging.The institutional complexity is increasing, technical sophisticationis improving and technical base of banking activities is expanding.All this requires the State Bank for endeavoring hard to keeppace with the fast-changing financial landscape of the country.Accordingly, the out dated inspection techniques have been replacedwith the new ones to have better inspection and supervisionof the financial institutions. The banking activities are nowbeing monitored through a system of ‘off-site’ surveillanceand ‘on-site’ inspection and supervision. Off-sitesurveillance is conducted by the State Bank through regularchecking of various returns regularly received from the differentbanks. On other hand, on-site inspection is undertaken by theState Bank in the premises of the concerned banks when required.

Todeepen and broaden financial markets as also to diversify thesources of credit, a number of non-bank financial institutions(NBFIs) were allowed to increase substantially. The State Bankhas also been charged with the responsibilities of regulatingand supervising of such institutions. To regulate and supervisethe activities of these institutions, a new Department namely,NBFIs Regulation and Supervision Department was set up. Moreover,in order to safeguard the interest of ultimate users of thefinancial services, and to ensure the viability of institutionsproviding these services, the State Bank has issued a comprehensiveset of Prudential Regulations (for commercial banks) and Rulesof Business (for NBFIs).

The"Prudential Regulations" for banks, besides providingfor credit and risk exposure limits, prescribe guide lines relatingto classification of short-term and long-term loan facilities,set criteria for management, prohibit criminal use of bankingchannels for the purpose of money laundering and other unlawfulactivities, lay down rules for the payment of dividends, directbanks to refrain from window dressing and prohibit them to extendfresh laon to defaulters of old loans. The existing format ofbalance sheet and profit-and-loss account has been changed toconform to international standards, ensuring adequate transparencyof operations. Revised capital requirements, envisaging minimumpaid up capital of Rs.500 million have been enforced. EffectiveDecember,1997, every bank was required to maintain capital andunencumbered general reserves equivalent to 8 per cent of itsrisk weighted assets.

The"Rules of Business" for NBFIs became effective sincethe day NBFIs came under State Bank’s jurisdiction. Asfrom January, 1997, modarbas and leasing companies, which arealso specialized type of NBFIs, are being regulated/supervisedby the Securities and Exchange Commission (SECP), rather thanthe State Bank of Pakistan.

EXCHANGERATE MANAGEMENT AND BALANCE OF PAYMENTS

One of the major responsibilities of the State Bank is the maintenanceof external value of the currency. In this regard, the Bankis required, among other measures taken by it, to regulate foreignexchange reserves of the country in line with the stipulationsof the Foreign Exchange Act 1947. As an agent to the Government,the Bank has been authorised to purchase and sale gold, silveror approved foreign exchange and transactions of Special DrawingRights with the International Monetary Fund under sub-sections13(a) and 13(f) of Section 17 of the State Bank of PakistanAct, 1956.

TheBank is responsible to keep the exchange rate of the rupee atan appropriate level and prevent it from wide fluctuations inorder to maintain competitiveness of our exports and maintainstability in the foreign exchange market. To achieve the objective,various exchange policies have been adopted from time to timekeeping in view the prevailing circ*mstances. Pak-rupee remainedlinked to Pound Sterling till September, 1971 and subsequentlyto U.S. Dollar. However, it was decided to adopt the managedfloating exchange rate system w.e.f. January 8, 1982 under whichthe value of the rupee was determined on daily basis, with referenceto a basket of currencies of Pakistan’s major tradingpartners and competitors. Adjustments were made in its valueas and when the circ*mstances so warranted. During the courseof time, an important development took place when Pakistan acceptedobligations of Article-VIII, Section 2, 3 and 4 of the IMF Articlesof Agreement, thereby making the Pak-rupee convertible for currentinternational transactions with effect from July 1, 1994.

Afternuclear detonation by Pakistan in 1998, a two-tier exchangerate system was introduced w.e.f. 22nd July 1998, with a viewto reduce the pressure on official reserves and prevent theeconomy to some extent from adverse implications of sanctionsimposed on Pakistan. However, effective 19th May 1999, the exchangerate has been unified, with the introduction of market-basedfloating exchange rate system, under which the exchange rateis determined by the demand and supply positions in the foreignexchange market. The surrender requirement of foreign exchangereceipts on account of exports and services, previously requiredto be made to State Bank through authorized dealers, has nowbeen done away with and the commercial banks and other authoriseddealers have been made free to hold and undertake transactionin foreign currencies.

Asthe custodian of country’s external reserves, the StateBank is also responsible for the management of the foreign exchangereserves. The task is being performed by an Investment Committeewhich, after taking into consideration the overall level ofreserves, maturities and payment obligations, takes decisionto make investment of surplus funds in such a manner that ensuresliquidity of funds as well as maximises the earnings. Thesereserves are also being used for intervention in the foreignexchange market. For this purpose, a Foreign Exchange DealingRoom has been set up at the Central Directorate of State Bankof Pakistan and services of a ‘Forex Expert’ havebeen acquired.

The responsibility of a Central Bank in a developing countrygoes well beyond the regulatory duties of managing the monetarypolicy in order to achieve the macro-economic goals. This rolecovers not only the development of important components of monetaryand capital markets but also to assist the process of economicgrowth and promote the fuller utilisation of a country’sresources.

Eversince its establishment, the State Bank of Pakistan, besidesdischarging its traditional functions of regulating money andcredit, has played an active developmental role to promote therealisation of macro-economic goals. The explicit recognitionof the promotional role of the Central Bank evidently stemsfrom a desire to re-orientate all policies towards the goalof rapid economic growth. Accordingly, the orthodox centralbanking functions have been combined by the State Bank witha well-recognised developmental role.

Thescope of Bank’s operations has been widened considerablyby including the economic growth objective in its statute underthe State Bank of Pakistan Act 1956. The Bank’s participationin the development process has been in the form of rehabilitationof banking system in Pakistan, development of new financialinstitutions and debt instruments in order to promote financialintermediation, establishment of Development Financial Institutions(DFIs), directing the use of credit according to selected developmentpriorities, providing subsidised credit, and development ofthe capital market.