Needed: single regulator for the financial sector

The Advisor on Finance to the Prime Minister, Shaukat Tarin, is holding an in-house meeting on the need of a single regulator for the oversight of companies in the financial sector today. At present, commercial banks are regulated by the State Bank of Pakistan (SBP) while non-bank financial institutions (NBFIs) operate under the umbrella of the Securities and Exchange Commission of Pakistan (SECP).
Until 2001-02, the SECP was the licensing authority for the NBFIs and the SBP was entrusted with the task of supervision and inspection. The SBP had to approach SECP for latters intervention for action against the erring NBFIs. The SBP felt handicapped without full authority over the NBFIs while NBFIs felt that the SBP could not differentiate between the business model of a commercial bank and an investment bank. As a result of which the growth of investment banking was badly stunted. Therefore, the then Governor SBP, Dr Ishrat Husain, decided with the consent of Chairman SECP Khalid Mirza to hand over the oversight of the NBFIs to the SECP.
Commercial banking in Pakistan was nationalised when the private sector was given permission to operate investment banks. A few years later, the private sector was allowed to enter commercial banking as well. Every investment bank then wanted to convert itself into a commercial bank. The muddle created amounted to hockey players being allowed to play cricket. And, like cricket offers players more glamour and money, we are in a situation in which commercial bankers are now running development financial institutions (DFIs).
There is a dearth of investment bankers and the DFIs have failed in meeting the needs for long term financing in the country. In a high interest rate/tight liquidity environment, the business model of an investment bank at this juncture is non-functional. Allowing brokerage firms to freely grow and graduate to become an NBFI made a greater sense. But, subsequently, allowing them to become commercial banks is not without controversial consequences and grave implications as some of them have really run into deep trouble. In addition, industrial groups were given banking licences in the 1990s and also allowed to purchase privatised banks. Now both the SBP and the SECP want to regulate conglomerates who have become major players in both financial and industrial sectors over a period of time.
Advisor Tarin is holding the meeting against the above backdrop. He needs to keep in mind the capabilities of the two existing regulators. The SBP has sixty years of experience of oversight of commercial banks. Pakistan has experience of failed banks on SBPs watch. And, on most occasions NBP has been used as a convenient and handy vehicle to bail out the depositors. As a consequence, the taxpayer - directly through SBP or indirectly through NBP - has footed the bill. Instead of building in-house capacity and mechanisms for inspection, the SECP has taken the route of hiring auditing firms for this task. Auditing firms can undertake inspection provided they have a clear objective of what they have been sent to detect and investigate. They cannot make a judgement call. That is the job of the regulator.
Although, Parliament makes laws, legislation for financial sector requires expertise of a much higher level and competence. Therefore, Parliament is normally guided by regulators for the passage and enactment of laws and regulations governing the financial sector. Even the Cabinet of ministers prefers to leave it to the finance officials to collaborate with regulators when rules in relation to this vital sector are conceived, planned and finally framed.
NBFIs are restricted from deposit taking. They can raise money through issuance of Certificate of Investments (COIs) to savvy and knowledgeable high-net worth individuals. These instruments cannot be encashed prior to their tenor date and are meant to be tradable - in case the COI holder needs money before maturing of the instrument. This does not happen, because we have miserably failed in creating a debt market for trading of such term-paper/bonds. The reason for the failure is the profound short-sightedness of the last government.
Instead of issuing bonds to finance the fiscal deficit, with regularity, budgetary gaps have been bridged by borrowing from the SBP or the banking system or through the National Saving Schemes (NSS). In essence, both banks and NBFIs and mutual funds are now a deposit takers. All kinds of deposit taking needs to be under the lender of the last resort - SBP.
Do we need a single regulator? Yes, we do. Should we follow the UK model and create a third regulatory agency or else entrust it either to the SBP or the SECP? The answer has to be a categorical yes to house it under the SBP - as it is the lender of the last resort. Why? Because (A) making a third independent supervisor body will be difficult in a country which is already suffering from acute capacity building. Failure of Northern Rock in UK has raised questions and given birth to serious doubts about the effectiveness of FSA model. Despite a very close liaison between Bank of England the red flags raised on Northern Rock fell in between cracks. The SECP instead of growing into an effective regulator has already been on a downslide. It has lost 90 key officials during the last two years.
The SBP has a wholly-owned subsidiary "Banking Services Corporation" - SBP BSC (Bank). The deposit of banks, currency and cash, securities, forex reserves and government accounts are held by the SBP BSC (Bank). Supervisory and inspection, function for all financial sector entities, can easily be transferred to this subsidiary. The reporting line has to be kept, leading to the Governor SBP. NBFIs, especially investment banks, mutual funds and leasing companies are wary of the central bank. SBP has a fiduciary responsibility. The risk parameters for banks and NBFIs have to be different. As such, the supervisory approach and inspection methodology has to vary for different types of financial businesses.
One stick for all will not work. Regulatory capability enhancement even at SBP BSC (Bank) would be needed on ongoing basis and specialist groups created for different types of financial segments. Monitoring of conglomerates avoids contagion impact under one umbrella. Joint monitoring by the SBP and the SECP will not work. Let us change this instead of waiting for meeting with a fatal accident.