THE STATE BANK OF PAKISTAN

EVOLUTION, FUNCTIONS, & ORGANIZATION

The State Bank of Pakistan: Evolution, Functions, & Organization First Edition
2004
CONTENTS
Introduction
1. Primary Functions
1.1 Sole Authority to Issue Notes
1.2 Conduct of Monetary and Credit Policies
- Instruments
- Transition to Indirect Instruments
1.3 Regulation and Supervision of the Financial System
- Off-site & On-site monitoring
- Prudential regulations
1.4 Bankers' Bank
1.5 Lender of the Last Resort
1.6 Banker to Government
2. Secondary Functions
2.1 Public Debt Management
2.2 Management of Foreign Exchange
- Exchange Rate Regimes
- Development of Forex Market
2.3 Advisor to Government
- Monetary and Fiscal Policies Coordination Board
- Reports on the State of the Economy
2.4 Relationships with IFIs
3. Non-traditional Functions
3.1 Development of the Banking System
- Commercial banking
- Micro Finance
- Promotion of Islamic Banking
3.2 Training Facilities to Bankers
- Institute of Bankers Pakistan
- Training Department/Division
- NIBAF
- Training on Islamic Banking
- SEANZA Courses
- Scholarships for PhD
- Training for Rural Finance
- Library Services
3.3 Development of Specialized Financial Institutions
3.4 Credit to Priority Sectors
- Credit for Agriculture
- Export Finance Scheme
4. Islamisation of the Banking System
4.1 Secretariat of Council of Islamic Ideology
4.2 Commission for Transformation of Financial System
4.3 Measures for Transformation of Financial System
5. Autonomy of the State Bank
6. Organization of the State Bank
6.1 Board of Directors
6.2 Management
6.3 Departments
6.4 Information Technology
6.5 Subsidiaries
Tables
Table 1: Issue of Currency Notes By SBP
Table 2.1: Changes in Liquidity Ratio
Table 2.2: Changes Cash Reserve Requirement
Table 3.1: Export Refinance: Outstanding Position
Table 3.2: Export Refinance: Gross Disbursement
Annexure
Annex 1: List of Currencies declared Approved Foreign
Exchange in terms of section 19 of SBP Act
Annex 2: List of Scheduled Banks/DFIs
Annex 3: Governors of the State Bank of Pakistan
Annex 4: Regular and Periodic Publications available to the
public
THE STATE BANK OF PAKISTAN
Evolution, Functions, & Organization
Introduction
The State Bank of Pakistan is the central bank of the country. Usually the starting
point for a central bank is a banking system that is already in place - the banking
system necessitates the presence of a central bank. But the State Bank of Pakistan
(SBP) is unique in the sense that it started its function in a newly born country,
where it also had to shoulder responsibilities of developing and rehabilitating a
banking system and the economy, in addition to the traditional central banking
functions. Performance of the Bank since its inception in 1948, as reviewed in
subsequent pages, shows that it has faced all the challenges with a great zeal and
commitment. The founders of the Bank set a multi-dimensional target before it
that included not only regulation of the monetary and credit system but also the
growth of this system. The vision of its founders was a stable monetary system in
Pakistan with fuller utilization of the country’s productive resources (SBP Act,
1956).
In order to achieve the goals set before it, the State Bank of Pakistan performed all
the traditional and non-traditional functions. The traditional functions, which are
generally performed by central banks all over the world, are classified into two
groups;
the primary functions1 including issue of notes, regulation of the financial
system, lender of the last resort, and conduct of monetary policy,
the secondary functions including management of public debt,
management of foreign exchange, advising the Government on policy
matters, anchoring payments system, and maintaining close relationships
with international financial institutions.
1 There has been a considerable controversy among the economists over the
question as to
which function is the primary function of a central bank. According to Hawtrey
(1932) the
lender of last resort is the essential characteristic of a central bank, while Vera
Smith (1936)
regarded the monopoly in note issue as the peculiarity of a central bank. Kisch and
Elkin
(1932) considered that ‘the essential function of a central bank is the maintenance
of the
stability of the monetary standard’. In the Statute of the Bank for International
Settlement, on
the other hand, a central bank was defined as ‘the bank in any country to which has
been
entrusted the duty of regulating the volume of currency and credit in that country
(Article 56
a).
The central bank operations can also be categorized into macroeconomic function
and microeconomic function. The macroeconomic function is to preserve the
value of the currency, that is, maintain price stability and the microeconomic
function is to maintain stability in the banking system. However, in this document,
we have discussed these functions in commonly used classification of primary and
secondary functions.
The non-traditional or promotional functions performed by the State Bank include
development of financial framework, provision of training facilities to bankers,
and provision of credit to priority sectors. The State Bank has also been playing an
active part in the process of Islamization of the banking system. All these
functions are shown in a flow chart (Chart 1). In the subsequent pages, we have
given a brief but comprehensive description of these functions and examined how
the SBP has been performing them since its inception in 1948.
There are six sections of this document. The first and second sections give reviews
of primary and secondary functions of the State Bank of Pakistan. Section 3 is on
non-traditional functions. Islamization of the banking system in Pakistan is also an
important function entrusted to SBP which is discussed in section 4. Section 5
outlines measures taken during 1990s and thereafter to grant autonomy to SBP in
performing its functions. Finally the last section presents an account of the
institutional evolution of the Bank and sketches its current structure.
Chart 1: Functions of State Bank of Pakistan
1 Primary Functions
1.1 Sole Authority to Issue Notes
One of the primary responsibilities of the State Bank is the regulation of currency
in accordance with the requirements of business and the general public. For this
purpose the Bank has been granted the sole right of issuing notes in the country
under Section 24 of the State Bank of Pakistan Act, 1956. The overall affairs with
respect to the issuing of notes are conducted through two notionally separate
departments of SBP, viz., Issue Department which deals with the issue of notes,
and the Banking Department which undertakes general banking business2.
There are four issue departments one each in four provincial capitals viz., Karachi,
Lahore, Peshawar and Quetta. Under section 30 of the State Bank Act, 1956 the
assets of the Issue Department should at no time fall short of its liabilities, i.e.,
total notes issued.
Of the total amount of the assets of the Issue Department, a stipulated amount,
which Government can vary from time to time, is to be kept in the form of gold
coins, gold bullion, silver bullion, special drawing rights held with IMF, or
approved foreign exchange. Since 1965, the Bank has been required to keep a
minimum amount of Rs.1.2 billion in the shape of gold coins, gold bullion, and
silver bullion or approved foreign exchange as the backing for note issue. The
remainder of the assets of Issue Department should consist of rupee coins, rupee
securities and the internal bills of exchange and other commercial papers as are
eligible for purchase by the Bank under Section 17 (2a, 2b, & 2d) of the SBP Act,
1956. Approved Foreign Exchange includes major currencies of the world which
are detailed in Annex 1.
The notes issued by the Bank constitute by far the largest portion of the currency
in circulation in the country (See Table 1 for volume of notes issued since 1948),
the other components being one-rupee coins, two-rupee coins, and subsidiary
coins3. The issue of one rupee and subsidiary coins is the prerogative of the
Federal Government. The Bank merely looks after the management of their issue
on behalf of the Government. The State Bank also issues "Commemorative
(Yadgari)" notes and coins of different denominations at occasions of national
importance.
2 Both these departments are now part of State Bank of Pakistan Banking Services
Corporation
(SBPBSC), a subsidiary of the Bank.
3 One and two rupee notes also remained in circulation till 31st December 2001.
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1.2 Conduct of Monetary and Credit Policies
The State Bank of Pakistan is responsible to regulate the monetary and credit
system of the country in such a manner that ensures monetary stability in the
economy. Section 9A of SBP Act, 1956 entrusts the Central Board of the Bank to
formulate and monitor monetary and credit policy by taking into account the
Federal Government's targets for growth and inflation, in accordance with the
recommendation of the Monetary and Fiscal Policies Co-ordination Board
(MFPCB). The State Bank has a number of instruments at its disposal to regulate
the volume of credit and to ensure its flow to the priority sectors.
-Instruments
The Bank has been equipped with both indirect (marketoriented) and direct
instruments of credit control. Indirect and market-oriented instruments include
changes in discount rate (3-day repo rate), T-bill auction rate,
Open Market Operations in government securities and other eligible assets,
Statutory Reserve Requirement, and Statutory Liquidity Ratio (See Box 1). Under
the direct instruments, the Bank can prescribe credit ceilings, set credit/deposit
ratio, fix margin requirements, and control the rate of return. It can also direct the
banks to restrict credit for certain purposes as well as to direct the flow of credit to
priority sectors. Before 1990, State Bank of Pakistan used to conduct monetary and
credit policies by applying mostly direct instruments. Since the last decade, with
the introduction of financial sector reforms the Bank has been using indirect
measures of monetary policy.
Transition to Indirect Instruments
A number of policy changes have been made since 1990-91 to move towards
indirect and market-based monetary management. As a major step in this direction,
the prescription of credit ceilings, as an instrument of credit control, was abolished
in August, 1992 and was replaced by a system which required the commercial
banks to extend credit to the private sector within limits worked out on quarterly
basis in relation to a Credit/Deposit Ratio5. Thereafter the Credit/Deposit Ratio
(CDR) was liberalized gradually. It was abolished
completely w.e.f. October, 1995. Now the monetary management is carried out
through changes in discount rate, T-bill auction rate, open market operations, and
reserve requirement (See Table 2.1 & Table 2.2 for changes in CRR & SLR).
Another important step towards market-based monetary management was effective
March 26, 1995 when the State Bank removed the cap on lending rates of Banks
and NBFIs other than that applicable to special financing schemes. Subsequently
the floor on the lending rates was also removed. Similarly,
restrictions on deposit rates have also been removed effective from 1998.
Accordingly, banks and other financial institutions are now free to set their lending
and deposit rates keeping in view the demand and supply conditions in the market.
Directed and mandatory credits have been phased out. SBP is conducting regular
Open Market Operations (OMOs) since January 1995. The State Bank of Pakistan
is using Market Treasury Bills (MTBs) both on an outright basis as well as under
Repo contracts (generally for the short term maturities) to control liquidity through
Open Market Operations.
Box 1: Main Instruments
SBP 3-day Repo Rate
SBP provides a lending facility to the scheduled banks for up to 3 days through
Reverse Repo transactions. The interest rate charged on this facility serves as the
main tool to give interest rate signals to the money market. Increase in this rate
gives a signal of monetary tightening.
T-Bill Auctions
SBP 3-day repo rate influences the yield of T-bills sold through auctions The cut
off yield is determined by the Auction Committee, keeping in view monetary
targets, current economic and financial conditions and expected market response.
The Six month T-bill is considered the most important benchmark by the money
market.
Open Market Operation
SBP is conducting regular Open Market Operations (OMOs) since January 1995.
Up till October 1997, OMOs were unidirectional, i.e. the SBP used to mop up
liquidity from the market in case of excess but it refrained to inject funds in case of
liquidity crunch. However, in October, 1997, it started bi-directional intervention;
now Repo transactions are used to mop up liquidity and Reverse Repo to inject it.
Decisions upon the direction and extent of OMO are taken by the OMO
Committee.
Statutory Liquidity Ratio
Commercial banks are required to keep some fraction of their assets in the form of
cash, Treasury Bills (T-Bills) or other approved securities. This fraction is called
Statutory Liquidity Ratio. Its main objective is to ensure that banks have sufficient
funds in the form of liquid assets. Currently this ratio (excluding Cash Reserve
Requirement) is 15% of time and demand liabilities.
Statutory Cash Reserve Requirement (CRR)
Under this requirement, banks are required to keep a weekly average balance of
5% of their total time and demand liabilities with the SBP, subject to daily
minimum balance of 4%. Recently State Bank has also issued a Master Circular of
regulations on CRR.

1.3 Regulation and Supervision of the Financial System

Another principal task of the Bank is to safeguard the soundness of the financial
system. To perform this crucial role effectively and efficiently, State Bank of
Pakistan has been given vast powers under the State Bank of Pakistan Act, 1956,
Banking Companies Ordinance, 1962, Banks Nationalization (Amendment) Act,
1974 and Microfinance Institutions Ordinance 2001 to regulate and supervise the
activities of Banks, Development Finance Institutions and Microfinance Banks.
These laws have been subject to amendments over time to meet changing
circumstances. During the year 1997 some major amendments were made in the
banking laws, which gave autonomy to the State Bank in the area of banking
supervision. Under Section 40-A of the said ordinance it is the responsibility of
State Bank to systematically monitor the performance of every banking company
to ensure its compliance with the statutory criteria, and banking rules &
regulations (See Section 5 on Autonomy of the SBP).
The financial sector in Pakistan comprises of Commercial Banks, Specialized
banks, Development Finance Institutions, Microfinance Banks, Non-banking
Finance Companies (NBFCs) (leasing companies, investment Banks, discount
Houses, housing finance companies, venture capital companies, mutual funds,
etc.), Modarabas, Stock Exchange and Insurance Companies. Under the prevalent
legislative structure the supervisory responsibilities in case of Banks,
Development Finance Institutions (DFIs), and Microfinance Banks (MFBs) fall
within legal ambit of the State Bank of Pakistan while the rest of the financial
institutions are monitored by Securities and Exchange Commission of Pakistan.
As of December 31, 2003 there are 40 scheduled banks, 2 MFBs, and 6 DFIs,
operating in Pakistan whose activities are regulated and supervised by State Bank
of Pakistan. The commercial banks comprise of 4 public sector banks, 19 private
sector banks (including 1 Islamic Bank), and 14 foreign banks. In addition there
are 3 specialized banks. (See Annex 2 for the detailed list).
Off-site & On-site monitoring
The Bank monitors the banking activities through a combination of off-site
monitoring and on-site inspection. Off-site surveillance is conducted by the State
Bank through various periodical returns received from banks and DFIs. On the
other hand, on-site inspection is undertaken on the premises of the concerned
banks. The purpose of inspection is to check the assets and liabilities as they
appear on the books, to evaluate the quality of the assets, to determine compliance
with laws, regulations, directives and policy guidelines provided by the State
Bank, to judge the soundness of operations and the prudence of lending and
investment policies, to appraise the quality of the management and to attempt an
10
estimate of the overall position of the bank. The State Bank can give directions to
commercial banks pertaining to any matter concerning their business, and can call
for any information in respect of their transactions.
During the decade of 1990s, the Bank undertook a number of measures to
strengthen its supervisory and regulatory capabilities. In 1997, services of an
international consultant were acquired by the Bank6 to undertake an in-depth
review of the banking supervisory system and monitoring techniques. The
consultants recommended risk-based inspection of financial institutions and
CAMELS (Capital, Asset quality, Management soundness, Earnings, Liquidity &
Sensitivity to other risks) system of off-site surveillance. The training of Bank
officials (both in the country and abroad) and up-gradation of information
technology system is a continuing process for effective implementation of the
consultant's recommendations.
To ensure a cohesive and proactive monitoring of the risks the banks/DFIs are
exposed to and to further strengthen the existing supervisory mechanism, State
Bank of Pakistan has introduced in 2004 a framework, called Institutional Risk
Assessment Framework (IRAF), on which the banks/DFIs will henceforth be
monitored. The new framework envisages a collaborative and seamless
supervisory focus amongst the various supervisory departments within the SBP.
The framework, being technology driven, would ensure swift flow of information
leading to more efficient and effective banking supervision and continuous
monitoring, integrating on-site inspection, off-site surveillance and current market
information.
Prudential Regulations
In order to safeguard the interest of depositors and to ensure the safety and
soundness of the banks/DFIs, the State Bank has issued Prudential Regulations.
These Prudential Regulations present a prudent operating framework for the
banks/DFIs. The regulations incorporate the spirit and essence of Bank of
International Settlement (BIS) regulations and are constantly watched for possible
improvement so that their enforcement yields the best possible results to promote
the overall objectives of financial sector supervision.
The State Bank has devised separate Prudential Regulations for different areas viz.
Corporate and Commercial Banking, Small and Medium Enterprise Financing,
Consumer Financing and Micro Financing while those for Agriculture Financing
6 Such services were financed by the World Bank under Financial Sector
Deepening and
Intermediation Project (FSDIP).
11
are being framed. This way each set of regulations serves the relevant area in the
best possible way. A brief introduction to these is given below:
Prudential Regulations for Corporate and Commercial Banking
The Prudential Regulations for Corporate and Commercial Banking govern
operations of the financial institutions in respect of their dealing with the corporate
entities. The regulations focus on Credit Risk Management, Corporate
Governance, Anti Money Laundering and Operations.
The regulations on Credit Risk cover per party exposure limits of the bank/DFIs
for fund-based and non-fund based facilities, Limit for clean advances, investment
in shares/Term Finance Certificates (TFCs), provisioning requirements for stuckup
assets, exposure to NBFC and Margin requirements etc. The regulations on
Corporate Governance put in place exhaustive criteria for management and the
Board of Directors (BOD) to ensure Good Governance in all respective areas.
Similarly, the regulations on Anti Money Laundering and Operations cover
eliminating criminal use of banking channels for the purpose of money laundering,
and restricting window dressing & wrong use of suspense account respectively.
Prudential Regulations for Consumer Financing
Regulations for Consumer Financing have been devised to encourage the banks to
diversify their loan portfolio through creation of new products and to ensure that
banks undertake Consumer Financing in a prudent manner. Consumer Financing
cover any financing allowed to individuals for meeting their personal, family or
household needs and include credit cards, Auto Loans, Housing Finance and other
consumer financing.
The Regulations require strengthening of risk-management processes of the
banks/DFIs through establishing comprehensive credit risk management systems
appropriate to their type, scope, sophistication and scale of operations. The BOD
of the banks/DFIs has been required to establish policies, procedures and practices
to define risks, stipulate responsibilities, specify security requirements, design
internal controls and then ensure strict compliance with them. They also cover
different consumer products through separate rules so that each product is dealt
with while keeping in view their specific nature.
Prudential Regulations for SME Financing
The Prudential Regulations for Small and Medium Enterprises (SMEs) facilitate
and encourage the flow of bank credit to the SME sector, keeping in view their
important role in the economic development. Its features are;
_ Shift from collateral based lending to cash flow based lending
12
_ Maximum limit of clean financing against personal guarantees increased
to Rs. 3 million for SMEs. This is greater than that for consumer as well
as the corporate clean financing.
_ The requirement for banks/DFIs to obtain copy of accounts has been
relaxed for exposures of up to Rs.10 million.
Through the Prudential Regulations for SMEs, the State Bank of Pakistan has
provided guidelines to the banks/DFIs for effective reach out to the SME sector.
Presently most of the SMEs in Pakistan lack sophistication to have reliable and
sufficient data and financial information, thus the banks/DFIs have been advised
to come up with the minimum information requirements and standardized formats
to facilitate SMEs. Close coordination of officials of the banks/DFIs and SMEs
has been stressed in these regulations. The regulations are aimed at encouraging
banks/DFIs to develop new financing techniques and innovative products to meet
the requirements of SMEs and develop effective risk and resource management
systems.
Prudential Regulations for Micro Finance Banks
The Bank has issued Prudential Regulations for Microfinance Banks and
institutions, which are licensed by it. Some of the main points of these regulations
are given below;
_ No Microfinance Bank/Institutions (MFBs/MFIs) shall commence
business unless it has a minimum paid-up capital as prescribed in MFIs
Ordinance 2001. It shall also maintain equity equivalent to at least 15% of
its risk-weighted assets.
_ The MFB/MFI shall maintain a cash reserve equivalent to not less than
5% of its time and demand liabilities in a current account opened with the
State Bank or its agent. In addition to cash reserve it shall also maintain
liquidity equivalent to at least 10% of its time and demand liabilities in the
form of liquid assets i.e. cash, gold and unencumbered approved
securities.
_ The MFB/MFI shall not extend loans exceeding Rs.100,000/- to a single
borrower.
_ The outstanding principal of the loans and advances, payments against
which are overdue for 30 days or more shall be classified as Non-
Performing Loans (NPLs).
13
1.4 Bankers' Bank
The Bank also functions as the bankers’ bank. Banks are classified as scheduled
and non-scheduled. The Bank maintains an updated list of all scheduled banks at
its various offices. These banks are entitled to certain facilities from the State
Bank and in return they have some obligations to it. State Bank provides the
following three important services to the scheduled banks;
a. It keeps the deposits of commercial banks, which primarily constitute the
statutory reserves of scheduled banks. Scheduled banks are required to keep
with the State Bank certain percentage of their demand and time liabilities
under Section 36 of SBP Act, 1956. Normally, the statutory reserves are kept
with the Bank free of any return. However, the Bank can offer some interest
on certain fraction of these reserves. Scheduled banks also keep a certain
amount of excess reserves with the Bank, which not only facilitate inter-bank
payments but also provide buffer for statutory reserves in case of fluctuations
in banks demand and time liabilities.
b. The State Bank also provides extensive remittances facilities to banks at a
concessional rate under the Remittance Facilities Scheme introduced since
1948. This facility helps the flow of funds smoothly and efficiently between
various centres in the country. The Bank provides this facility through the
media of its own offices, the branches of National Bank of Pakistan acting as
its agents, and treasuries and sub-treasuries holding permanent currency chests
at places where the State Bank has no office. Telegraphic Transfers (T.T.),
Mail Transfers (M.T.), Demand Draft (D.D.) and Government Draft (G.D.)
are the principal instruments used for remittances.
c. In order to streamline payments through the financial system, the Bank also
manages the operations of clearing houses. In the five major cities, the
functions of SBP clearing house has been handed over to a private agency
namely National Institutional Facilitation Technologies Private Limited
(NIFT) to the extent of sorting of payments instruments and preparing clearing
schedules. Presently NIFT covers 80 percent of clearing services. However,
the settlement of accounts is still undertaken at SBP. In other financial centres
of the country, the Bank performs all the functions of the clearing house which
are now managed by SBPBSC.
14
1.5 Lender of the Last Resort
One of the important characteristics of a central bank is its being the lender of the
last resort. The State Bank provides loan and re-discount facilities to scheduled
banks in times of dire need when they find no other source of funds. These
facilities are ordinarily provided by the Bank against government securities, trade
bills, agriculture bill, etc. These loans are essentially short-term in nature and are
advanced to enable the banks to meet their temporary requirements of funds
arising out of seasonal expansion in trade, commerce, agricultural operations, and
other economic activities. These operations are carried out in accordance with the
provisions of Section 17 of the State Bank of Pakistan Act, 1956. Notwithstanding
any limitations contained in different sub-clauses of the Section 17, the Section 18
of the act gives the Bank the power of direct discount for undertaking this
function.
In order to bring flexibility in accommodating short term liquidity requirements of
financial institutions and to implement market oriented monetary policy, a 3-Day
Repo facility was introduced by the State Bank of Pakistan with effect from 1st
February, 1992, and the earlier arrangement of re-discount was discontinued
effective from February 15, 1992. Against the 3-day repo facility, funds are
allowed by accepting Market Treasury Bills/ Federal Investment Bonds/ Pakistan
Investment Bonds.
1.6 Banker to Government
The State Bank conducts the banking business of Federal and Provincial
Government and some government agencies. These functions performed by the
Bank are akin to those ordinarily performed by commercial banks for their
customers. The Bank provides the following services to the governments:
a. It accepts the deposits of cash, cheques and drafts by the Government and
undertakes the collection of cheques and drafts drawn on other banks. The
Bank transfers government funds from one account to another or from one
centre to another as advised by them. The statutory provisions for this function
were made first in the State Bank of Pakistan Order, 1948 and then in the SBP
Act, 1956. Federal and Provincial governments keep their deposits with the
Bank free of interest. In turn, the Bank does not charge any commission to the
governments for the banking services rendered to them.
b. The Federal and Provincial governments can obtain advances from the Bank
subject to mutual agreements in respect of the terms and conditions for such
advances. The Bank makes ways and means advances to the Federal as well as
to the Provincial governments without any collateral security. However, some
15
times loans are also granted to the Provincial governments against the
collateral of Federal Government securities.
c. On behalf of Federal, Provincial or Local governments the Bank also
undertakes sale/purchase of gold, silver, approved foreign exchange, securities
or shares in any company, collection of return on these shares/securities,
transaction of SDR, etc. (Section 17(13) of the act).

2 Secondary Functions
2.1 Public Debt Management
The Bank is responsible for the management of government debt under subsection
13(e) of section 17, and section 21 of the SBP Act, 1956. The Public Debt
Act 1944 also defines the responsibilities of SBP for public debt management. The
following actions are involved in this regard:
_ Subscribing Federal and Provincial governments’ securities at the time of
their issue
_ Sale/purchase of such securities in the Money Market (through auction,
OMO or discount window)
_ Payments of interest to holders of public debt instruments
In order to efficiently manage the public debt, a department namely, Securities
Department was set up in December, 1990 for the business of government
securities7. This department was subsequently merged with foreign exchange
dealing room and a new department Exchange & Debt Management Department
(EDMD) was created in February, 2000.
For the auction of Treasury Bills and government bonds, a primary dealer system
is developed. The securities are offered for sale on fortnightly basis in case of
Market Treasury Bills (MTBs) and on quarterly basis in case of Pakistan
Investment Bonds (PIBs) to primary dealers8. Primary dealers are then allowed to
undertake the business of government securities in secondary market9.
The State Bank undertakes draws of prize bonds along with their sale/purchase. It
also carries out the sale, purchase and interest payments on some of the saving
schemes, however the overall management of prize bonds and saving schemes lies
7 Before 1991 government securities were offered on Tap. Tap remained open for
subscription
throughout the year on weekly basis. In March 1991 this system was discontinued
with the
introduction of an auctioning system.
8 For the year 2003-04, the primary dealers were American Express Bank HBL,
Standard Chartered
Bank, UBL, ABN Amro Bank, NBP, Citibank, Union Bank, Pak Oman Investment
Company
Limited, Bank Alfalah Limited, Jahangir Siddiqui & Co Limited (EDMD Circular
No. 11 August 07,
2003)
9 Secondary market consists of SBP, primary dealers, banks other than primary
dealers, non-bank
financial institutions, financial brokerage houses, different financial funds,
individuals, etc.
17
with the Central Directorate of National Savings. The State Bank is entitled to
receive commission on the transactions of government savings certificates. The
State Bank also has an advisory role with regard to government loans, terms and
timings for their floatation.
2.2 Management of Foreign Exchange
Being responsible for maintaining the external value of the currency, the State
Bank of Pakistan assumed the charge of management and administration of the
exchange system of the country in line with the Foreign Exchange Regulation Act,
1947 which was originally enacted by the British Government and subsequently
adopted by Pakistan. As an agent to the Government, the Bank has been
authorized to purchase and sell gold, silver or foreign exchange and transactions of
special drawing rights with the International Monetary Fund under sub-sections
3(a) and 13(a,f) of section 17, and section 23 of the SBP Act, 1956.
Exchange Rate Regimes
The Bank is responsible to keep the exchange rate of the rupee at an appropriate
level and prevent it from wide fluctuations in order to maintain competitiveness of
our exports and maintain stability in the foreign exchange market. Various
exchange policies have been adopted at different times for this purpose keeping in
view the circumstances. With the collapse of Bretton-Woods arrangements in
early 1970s and adoption of floating exchange rate regime by major trading
countries of the world, Pakistan did not float the rupee but linked it to US Dollar
to avoid the adverse impact of appreciating Pound Sterling to which rupee
remained linked up to September, 1971. This link continued till January 7, 1982.
However, with a view to reducing the ill effects of an appreciating US Dollar, in
terms of major currencies of the world during early 1980s on our export
competitiveness in the international markets, it was decided to adopt the managed
floating exchange rate system with effect from January 8, 1982. Under this system
the value of the rupee was determined on daily basis, with reference to a basket of
currencies of Pakistan’s major trading partners and competitors. Adjustments were
made in the value of rupee as and when the circumstances so warranted.
After nuclear detonation by Pakistan in 1998, a two tier exchange rate system was
introduced temporarily, under which official exchange rate was fixed at Rs. 46 per
US dollar and only certain percentage of exchange requirements of the economic
agents were available at official rate, the rest of the requirements were to be met
from inter-bank market at market rate. This policy significantly reduced the
pressure on official reserves and prevented the economy to some extent from
adverse implications of sanctions imposed on Pakistan due to nuclear explosion.
The exchange rate was unified w.e.f. May 19, 1999 with the introduction of
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market based floating exchange rate system. However, there still remained an
unofficial ceiling on the Rupee/Dollar parity until June 2000. During FY01, as a
part of stabilization program, the Rupee band was dismantled in July 2000, and
the monetary policy was used to quell market pressures and smooth out volatility.
As the custodian of country’s external reserves, State Bank is also responsible for
the management of the foreign exchange reserves. The task relating to the
management of foreign exchange reserves is being performed by an investment
committee. The committee after taking into consideration the overall level of
reserves, maturities and payment obligations, make investment of surplus funds in
such a manner that ensures liquidity of funds and maximizes earnings. These
reserves are also being used for intervention in the foreign exchange market. For
this purpose a Foreign Exchange Dealing Room was set up at the Central
Directorate and services of a forex expert had been acquired10.
While the foreign exchange reserves continue to grow substantially, SBP has
adopted a new investment strategy for its foreign exchange reserves management.
SBP has hired the services of Investment Consultant Firm M/s Mercer to advice
and build capacity in this respect. In an attempt to diversify the composition of
reserves, SBP for the first time, invested reserves in the commercial market,
choosing five-year Islamic Bond worth of US$ 25 million.
The overall objective of this management strategy, in order of priority, is to ensure
safety (preservation of capital), liquidity and maximum return on these reserves
within the above constraints. The management strategy entails both, the
development of in-house capacity and the partial outsourcing of reserve
management to reputable foreign investment companies. The following are the
salient features of the reserve management strategy:
Since the overall objectives are by definition conflicting, the optimal strategy is to
strike a balance among them through dividing the overall portfolio into three
subportfolio
buckets including cash portfolio, liquidity portfolio and long-term
portfolio. Given the level of reserves at the time of finalizing the strategy, the
three portfolios had the fund allocation of US$ 3 billion, US$ 4 billion and US$ 2
billion respectively. The SBP has decided to award $3.2 billion out of the total
US$ 6 billion allocated currently for the liquidity portfolio and the long-term
10 The dealing room was subsequently merged with Securities Department and
new
department Exchange & Debt Management Department was established.
19
investment portfolio, to nine international fund managers. Any increment to the
reserves, thereafter, would be allocated to the cash portfolio.
_ Apart from short-term placements, the portion of reserves will also be
invested in fixed income instruments.
_ Their would be a maximum duration limit of long-term portfolio.
_ The overall portfolio rating would be at least ‘AA’ while rating of any
single instrument would not be below investment grade. The investment in
equities is not permitted.
_ The bank will appoint fund managers and the funds will be distributed
among the external fund mangers according to their areas of expertise.
_ Similarly, custodian banks may be appointed out of top highest-rated
banks offering custodial services.
_ All the matters pertaining to foreign exchange reserve position would be
monitored and reviewed regularly.
Development of Forex Market
As a part of market based economic policies stance, the process of liberalization of
exchange and payments regime has been started since 1991. A number of reforms
have been undertaken since then including (a) permission to residents for opening
foreign currency deposits, (b) granting license to Pakistani nationals and resident
companies/firms to work as authorized money changers on payment of prescribed
fee, (c) permission for opening of a ‘Special Convertible Rupee Account’ by
nonresidents
for purchase of shares quoted on the Stock Exchange, (d) permission to
investment banks to raise foreign currency funds from abroad through issue of
certificate of investment, (e) liberalization of rules relating to investment in
government securities, including NIT Units, by non-resident Pakistanis on
repatriable basis, (f) permission to authorized Dealers for import and export of
foreign currency notes and coins, (g) establishment of exchange companies, (h)
relaxation in respect of trade-related remittances, and (i) adoption of measures to
deepen forex markets/treasury operation etc.
Before 1990s - when the process of liberalization started - all transactions in
foreign exchange were to be conducted at specified rates through authorized
dealers. All foreign exchange receipts on account of exports and services were
required to be declared and surrendered to the authorized dealers who, in turn,
passed them on to the State Bank. However, now the Bank has done away with the
surrender requirement; and the commercial banks and other authorized dealers
have been made free to hold and undertake transaction in foreign currencies.
20
A new foreign currency accounts scheme has been introduced under which banks
keep the funds with them and pay return keeping in view their earnings and cost of
funds. The funds under this scheme have been allowed to be used for financing of
trade-related activities. The traders, particularly the exporters, can now avail
foreign currency loans at cheaper rates.
Exchange companies have been established to carry out sale/purchase,
export/import and remittances of foreign currencies. They have been allowed to
make remittances on account of dividend, royalty and franchise fee etc., subject to
an NOC from the designated authorised dealer. Formulation of exchange
companies would help in unification of exchange rates. Presently, it has given a
corporate culture to money changing/remittances business in the country. Home
remittances are also being routed through these companies, which have been
brought in the reporting ambit.
2.3 Advisor to Government
The State Bank of Pakistan, also acts as an advisor to the Government on financial
and economic matters particularly with reference to their monetary aspects. The
Bank counsels the Government on loan operations and advises it with regard to
the timings, terms and conditions and rate of return on these loans. The advice is
also tendered on matters like agricultural credit, cooperative credit, industrial
finance, exchange regulations, banking and credit control, mobilization of savings,
financial aspects of planning and development and similar other economic issues.
State Bank of Pakistan also tenders advice to the Government on debt
management issues. The advisory role of the Bank has been made mandatory in
accordance with the Section 9A(d,e) of the SBP Act 1956.
Monetary and Fiscal Policies Coordination Board (MFPCB)
The State Bank also participates in economic policy making as a member of
various government agencies and committees. In order to coordinate fiscal,
monetary, foreign trade and exchange rate policies, a “Monetary and Fiscal
Coordination Board” has been set up under Section 9B of the SBP Act 1956 with
the Finance Minister as its Chairman and Federal Minister or secretary for
Commerce, Deputy Chairman Planning Commission, Governor State Bank of
Pakistan and Secretary of Finance, as its members. The Board is responsible for
ensuring consistency among macro targets and to determine, in consultation with
the Federal Government, the limits of credit to be extended to the Federal and
Provincial governments and review, on a quarterly basis, Government’s
borrowings in relation to pre-determined or revised targets. The Bank is required
to place before the Board its assessment regarding the impact of economic policies
21
on monetary aggregates and recommendations for fixing the safe limits of
monetary expansion and Government borrowings.
In carrying out its assigned functions of coordinating fiscal, monetary and
exchange rate policies and for ensuring consistency among macroeconomic targets
of growth, inflation, fiscal, monetary and external accounts, the Coordination
Board shall not take any measure that would adversely affect the autonomy of the
State Bank of Pakistan as provided in the SBP Act.
Reports on the State of the Economy
The Bank submits its review of the economy to the Parliament through its annual
and quarterly reports. The advisory function of the State Bank has been assigned
to it by sub-sections (d), (e) and (f) of Section 9A of the SBP Act, 1956 which
enjoins the Central Board of the State Bank to (i) tender advice to the Federal
Government on the interaction of monetary policy with fiscal and exchange rate
policy; (ii) analyse and advice the Federal Government on the impact of various
policies on the state of the economy; and (iii) submit a quarterly report to the
Majlis-e-Shoora (Parliament) on the state of the economy with special reference to
economic growth, money supply, credit, balance of payments and price
developments.
2.4 Relationships with International Financial Institutions
Pakistan is the member of International Monetary Fund. The State Bank of
Pakistan deals with the IMF on behalf of the Government of Pakistan (subsections
13(f) and 15 of Section 17 of the act). As a member of the Fund, the
Government accepted the obligations of Article-VIII, Sections 2, 3 and 4 of the
IMF Articles of Agreement w.e.f. July 1, 1994. As a result of which Pak-rupee
was made convertible on current international transactions. The Governor State
Bank accompanies the Minister of Finance in annual general meeting of the IMF
and World Bank. The Bank officials also participate in negotiations with IMF
missions in Pakistan and at IMF Head Office.
The State Bank of Pakistan also deals with other international financial
organizations including Bank for International Settlement, the World Bank,
Central Banks of foreign countries, etc. Almost all the agreements of Provincial
and Federal Government with International Financial Institutions (IFIs) are
executed through the State Bank of Pakistan.

3 Non-traditional Functions
Responsibilities of the State Bank of Pakistan go well beyond the conventional
functions that have been discussed above. The scope of Bank’s operations has
been widened considerably by including the economic growth objective in its
statute under the State Bank of Pakistan Act, 1956. In fact, the Bank has been
involved in developmental and promotional activities even before the enactment
of SBP Act, 1956. The Bank’s participation in the development process has been
in the form of rehabilitation of banking system in Pakistan, development of new
financial institutions and debt instruments to promote financial intermediation,
establishment of Development Finance Institutions (DFIs), directing the use of
credit according to development priorities, providing subsidized credit, and
development of capital market.