Lecture Legal and regulatory aspects of banking supervision – Chapter 1

The following will be discussed in this chapter: Course objectives, key learning outcomes course contents/ structure why we need regulations? Who are the supervisors / regulators of banking industry? How bank earns Profit? What is safety and soundness of a bank? How is safety and soundness of a bank measured? CAMELS.

MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING

SUPERVISION

OSMAN BIN SAIF

Session: One

Self Introduction

• Finance Graduate;

– MSC Accounting and Finance (University of Exeter, UK)

– MBA- Finance (SZABIST, Islamabad)

– Certified Financial Consultant (IFC , Canada)

– Certifications in Project Management,

Monitoring and Evaluation and Research

Policy Development and Futures.

• Consultant with SDPI

2

Course Objective

• This is an introductory course

• With the core objective of giving an

overview of the banking supervision

globally and as it exists in Pakistan

• Explaining its functions and importance

• How it is regulated and Statutes providing legal guidelines for banking operations

Course Objective (Contd.)

• This course covers the policies, laws and regulations which govern the banking

sector as well as the role of the

supervisor/ regulator i.e the State Bank of Pakistan

• The course also touches upon the banking practices globally and those specific to the

Key Learning Outcomes

After the successful completion of this course, students will have:

• Knowledge and understanding of:

– Importance of Banking Supervision

– Banking sector in Pakistan

– Role of the Supervisor/ Regulator

Key Learning Outcomes

(Contd.)

– Laws which govern banking sector

– Prudential Regulations

– Banking Companies Ordinance

– Other Banking Laws

Course Contents/ Structure

Be Regulated?

– Key Objectives of Bank Regulation

– Regulatory Issues Illuminated by the 2007 Banking Crisis

– The 2007 Crisis – Analysis and Response of the Banking Regulatory Crises

– Lessons for Regulators from the 2007 Crisis

Course Contents/ Structure

(Contd.)

• Section 2 Banking Supervision and Regulation

– Key Phases in Bank Regulation (Part 1)

– Regulating Bank Capital Adequacy (Part 2) – Background – The 1988 Basel Accord

– The Basel II Accord

Course Contents/ Structure

– Why is Regulatory Structure Important?

– Regulatory Structure and the Role of the

Central Bank

– Guidelines of the State Bank of Pakistan

Course Contents/ Structure

(Contd.)

• Section 4 The Prudential Supervision of Banks

– The Prudential Supervision of Banks

– Basel Core Principles for Effective Banking

Supervision

– The Effectiveness of Different Supervision

Approaches

Course Contents/ Structure

(Contd.)

• Section 5 Bank Crises – Weak Banks and Lender-of-Last-Resort Support

– Introduction

– Lender-of-Last-Resort Facilities (LOLR)

– LOLR to Illiquid But Solvent Banks

– LOLR to Illiquid, Possibly Insolvent, Banks

Course Contents/ Structure

(Contd.)

• Section 6 Restructuring Failed Banks and Protecting Depositors

– Resolving Bank Failures

– Resolving ic Banking Crises

– Deposit Insurance

Course Contents/ Structure

(Contd.)

• Section 7 Overview of Banking laws and regulations

– Bank Company Ordinance 1962

– Negotiable Instruments Act 1881

– State bank of Pakistan Act 1956

– Foreign Exchange Manual

– Financial Institutions Ordinance 2001

– Prudential Regulations (SME/DFI, NFI)

Session Overview

Be Regulated?

– Key Objectives of Bank Regulation

– Regulatory Issues Illuminated by the 2007 Banking Crisis

– The 2007 Crisis – Analysis and Response of the Banking Regulatory Crises

Why and How Should Banks

Be Regulated?

• The health of the economy and the

effectiveness of monetary policy depend

on a sound financial system

• Through supervising and regulating

financial institutions, the State Bank is

better able to make policy decisions

Why and How Should Banks

Be Regulated? (Contd.)

• Bank supervision involves monitoring and examining the condition of banks and their compliance with laws and regulations

• If a bank under the State Bank’s

jurisdiction is found to have problems or

be noncompliant, the State Bank may use its authority to request that the bank

Why and How Should Banks

Be Regulated? (Contd.)

• Bank regulation includes issuing specific regulations and guidelines to govern the operations, activities and acquisitions of banking organizations

The State Bank

• The State Bank supervises and regulates

a wide range of financial institutions and activities

• The State Bank works in conjunction with other federal and state authorities to

ensure that financial institutions safely

manage their operations and provide fair

The State Bank (Contd.)

• Bank examiners also gather information

on trends in the financial industry, which helps the State Bank meet its other

responsibilities, including determining

monetary policy

How a Bank earns Profit?

• Just like any other business, a bank earns money so that it can run its operations and provide services

• First, customers deposit their money in a bank account The bank provides safe

storage and pays interest on customers’

deposits

How a Bank earns Profit?

(Contd.)

• The bank can lend the rest to qualified

borrowers Potential borrowers may wish

to buy a house or a new car;

• However, they may not have enough

money to pay the full price at one time

Instead of waiting to save the money to

pay for a new house, which could take

years, they take out a loan from a bank

• Borrowers are charged interest on the

loan – a bank’s primary source of income Banks also make money from charging

fees for other financial services, such as debit cards, automated teller machine

(ATM) usage and overdrafts on checking

21

Safety and Soundness

• Two major focuses of banking supervision and regulation are the safety and

soundness of financial institutions and

compliance with consumer protection

• Each letter stands for one of the six

components of a bank’s condition:

CAMELS (Contd.)

• When performing an examination to

determine a bank’s CAMELS rating,

instead of reviewing every detail, the

examiner evaluates the overall health of the bank and the ability of the bank to

manage risk

• A simple definition of risk is the bank’s

ability to collect from borrowers and meet the claims of its depositors

• A bank that successfully manages risk has clear and concise written policies

• It also has internal controls, such as

separation of duties For example, a

bank’s management will assign one

person to make loans and another person

CONSUMER PROTECTION

• Remember that customers deposit money

in a bank, and then the bank makes loans with these deposits to qualified borrowers

• Whether a customer deposits money in a bank or applies for a loan, there is a lot of information to consider

• Suppose you deposit money into a

savings account at a local bank What

CONSUMER PROTECTION

(Contd.)

• When you apply for a loan for a used car,

do you know if the interest rate is allowed

to vary, or is it fixed for the life of the loan?

If it is allowed to vary and interest rates go

up, the total amount of interest you owe

will increase Banks are required to

provide customers clear and accurate

information about services, such as

savings accounts, loans and credit cards

CONSUMER PROTECTION

(Contd.)

• For example, a bank’s brochure for a

savings account should include

information on any minimum balance

required, monthly service fee and the

average percentage yield

• In addition, the Truth in Lending Act

requires banks to disclose the finance

charge and the annual percentage rate so that a consumer can compare the prices

of credit from different sources

CONSUMER PROTECTION

(Contd.)

• These laws ensure that consumers and

banks make decisions based on the same information

• If consumers have a complaint about a

financial institution they can contact The State Bank

What are Banking Regulations?

• Bank Regulations are a form of

government regulations which subject banks to certain requirements,

restrictions and guidelines

Key Objectives of Bank

Regulation

• The objectives of bank regulations, and the emphasis, varies between jurisdiction The most common

objectives are:

– Prudential—to reduce the level of risk bank creditors are

exposed to (that is, to protect depositors);

– Risk Reduction—to reduce the risk of disruption resulting

from adverse trading conditions for banks causing multiple

or major bank failures;

– Avoid Misuse of Banks—to reduce the risk of banks

being used for criminal purposes, e.g laundering the

proceeds of crime;

– To Protect Banking Confidentiality;

THANK YOU