State Bank`s autonomy: legal status and the reality SBP was not at all autonomous prior to 1993

. In 1948 as the central monetary authority had relegated it to the status of an attached department of the ministry of finance. These developments included the provisions in the original State Bank Act (1956) for the dominance of the federal government (ministry of finance) in matters: Falling in the jurisdiction of a central bank, Nationalization of the banking system in 1974 and the Creation of Pakistan Banking Council, with its parallel authority similar to that of SBP,

The ministry of finance began to treat SBP as another subordinate entity.

By early 1990s, SBP was completely marginalized, monetary policy became submissive to financing requirements of the public sector, government-directed and subsidized lending accounted for a large part of private sector credit, political, bureaucratic and union interference in the banking business became rampant, supervision of banking fragmented and became very weak, loan portfolio became heavily infected, quality of services took a nosedive, the banking system was on the verge of collapse.

With the passage of time, SBP got used to acting as the most obedient servant of the ministry of finance. A movement was started in 1993 to introduce legal reforms to give independence and traditional central banking authority to SBP. This effort was completed in several phases by May 1997 with the incorporation of comprehensive reform in the SBP Act, Pakistan Banking Companies Ordinance and enactment of some additional laws.

Thus. the legislative changes made during 1993-97 gave SBP autonomy in three broad areas.Legal autonomy Broadly speaking. Accordingly. the activities of the trade unions were severely shortened. including but not limited to continuation of Pakistan Banking Council (PBC) and authority of the government to determine the borrowing from banking system. and interference of the government in supervision of the banking system was legally prohibited. the regulatory authority of SBP was strengthened. not requiring any government approval which was not the case before. the weaknesses and variances that were not addressed in the 1993 legislative reforms. autonomy of the SBP was enhanced with vast powers given to its board of directors. were removed in 1997. fixation and revision of salary structure and benefits got placed in the exclusive jurisdiction of the board. The administrative and management decisions of SBP board become final. The board was to publish an independent annual report on the state of the economy without government interference. the governor and the board once appointed could not be removed before the expiry of their tenure except for misconduct proven by the government. and in general. the limit of credit to be extended by the SBP to the federal and provincial governments and their other agencies for all purpose. it was specifically stipulated that the SBP`s Central Board was to determine and enforce. the government was banned from issuing any direct or indirect instructions to the banking system that were in conflict with SBP policies. . The government was required to consult the SBP board to determine its borrowing limits from the banking system and sanctioning and supervision of the banking system was given back to SBP. In addition. namely (i) (ii) (iii) administrative autonomy autonomy in the formulation and implementation of monetary policy autonomy in the regulation and control of the banking system. All monetary instruments were restored to SBP to be used by the board without prior approval of the government in the conduct of monetary policy. and has been fully exercised since then. Substantive administrative matters such as creation or reorganization of departments. The administrative autonomy of SBP secured in the first round of legislative changes in 1993 has not been questioned. under the legal reforms introduced in May 1997 Pakistan Banking Council was abolished. in addition to the overall expansion of liquidity. recruitment and promotion of staff. The SBP board was required to submit an independent quarterly report to the parliament. These were in themselves giant steps but not enough to separate monetary from fiscal policy and to allow SBP to conduct independent monetary and banking regulation policies.

The SBP board also developed the practice of discussing government borrowing and other policy matters in its jurisdiction in its monthly meetings and began issuing press releases on their conclusion informing the public in specific terms of its stance on the matter. However. it was recognized that the enforcement of new laws may turn out to be a more daunting task than their legislation. Autonomy in practice At the time of legislative reforms. . Thus a very healthy tradition was initiated to enforce SBP autonomy in the most critical area of government borrowing. In its quarterly reports to the parliament. inflation and balance of payment. and it is fully documented in communications with the government. the board provided an independent analysis of the state of the economy giving warning signals of any weakening trends. the safe limit of government borrowing and indicted it to the government before the formulation of the budget on whose basis the financing of the budget was finalised by the government. SBP began to follow section 9A and 9B of the State Bank Act and established an institutional procedure and an analytical framework to determine the safe limits of monetary expansion and of government borrowing from the banking system that were consistent with national economic objectives of growth.the creation of its own non-political institutional personality embodying professionalism. competence and objectivity. The federal government adhered to those limits voluntarily and when some of the provincial governments violated them their checks were bounced under instructions from SBP. during 1997-99. the SBP board determined. For example. In indicating the limit. In particular. based on SBP developed analytical framework. in fiscal year 1997-98. a promising beginning was made to make decisive moves in that direction and to assert in practice independence of SBP that had been enshrined in its charter through legislative reforms during 1993-1997. trade unions were stopped from interference in management of banks. in the matter of government borrowing from the banking system. Old order is difficult to dismantle in practice even with the changes in laws. the then governor made it clear to the government that SBP board intended to take all necessary steps to enforce those limits during the year. Commercial banks were instructed in writing to ignore any orders from any quarters that were not consistent with SBP policies conveyed to them. and new traditions and practices take time to strike roots. Strong reaction from the relevant provincial governments to this action could not deter SBP from adhering to its decisions. and loan defaulters and corrupt bankers were taken to task.

Instead of continuing to do its home work as required by the law. raising hopes that continuation of the enforcement effort in the subsequent years could entrench the autonomy as much in practice as it was in laws.With the initiation of enforcement of new laws on the above lines the banking system and monetary situation began to improve but at the same time. SBP practically lost control on its own balance sheet starting in 2000-2001. The State Bank was given autonomy to do independent analysis and shift the ordinary factors from the extraordinary and to give an objective assessment of the underlying macroeconomic trends. the banking system was encouraged to provide cheap credit for consumption in the private sector to promote consumption-led growth. and the government was given a free hand to inflate the economy as before the reforms of 1993-97 through printing of notes. and change of leadership in SBP. the trend of enforcement of new provisions of law with regard to government borrowing and banking supervision began to weaken. Enforcing the law With the military takeover of the government in 1999. the government was allowed in the name of ³teamwork´ to borrow from SBP even larger than the budgeted amount either to finance additional expenditure or replace more expensive commercial bank debt by cheaper borrowing from SBP . were up in arms against SBP. Together. For the first time after legislative reforms. The most painful aspect of this period was that SBP became an enthusiastic partner with the government in misleading the public about macro economic trends and creating an allusion of prosperity. provision of larger bilateral aid by the US and softening of the stance by the international financial institutions in providing loans and arranging debt relief. reflecting the impact of events of 9/11 terrorist attacks in US resulting in reverse inflow of funds into Pakistan through the banking system. and using enforcement tools at its disposal. giving the limit of borrowing to the government within which it had to arrange for financing of the budget. SBP stuck to its policy of enforcing the laws during the initial period. At the same time. with a serious setback to progress in SBP autonomy in reality. privatisation proceeds. Not only that. Previously. including some government quarters. SBP stumbled back to the old practice of accommodating whatever borrowing from the banking system was dictated by the government in its budget. However. and sale of assets to foreigners to earn foreign exchange. MUSHARRAF REGIME All effects of all these practices and policies remained hidden for several years because of inflow of foreign exchange. SBP had insisted that such proceeds should mostly be used to retire debt. Not only did . In addition. Government mandated credit requests began to be accommodated against the legal provisions of section 9A and 9B of the amended State bank Act. This resulted in a substantial dilution of institutional autonomy in practice. which are inflationary like printing of notes if used to finance current expenditure. these inflows cushioned the impact on the external sector of consumerism and high imports and helped build up reserves. vested interests. were allowed by SBP to be used as ordinary revenue by the government.

SBP should determine the limit of government borrowing both from SBP and the banking system and inform the government in order for it to prepare its budget on that basis so far as borrowing from the banking system is concerned * SBP should enforce those limits through consultation. a virtual collapse of the economy by 2007-08 could have been avoided. There were other factors also that diluted SBP autonomy. Those measures are enlisted here * State Bank should insist that the government convene regular meetings of the Monetary and Fiscal Policy Coordination Board as required by law. Failure to insist on the holding of the quarterly mandatory meetings of the Monetary and Fiscal Coordination Board set up under section 9 B of the State Bank Act increasingly isolated SBP from participation in the formulation of policies having a bearing on monetary policy. Division of SBP in two independent legal entities and distribution of authority for appointment of the governor and the board between the president and the prime minister respectively added to the confusion and weakening of SBP authority. inflation and balance of payments trends. the country would have been alerted far ahead of time about the emerging macroeconomic dangers. the legal autonomy of SBP became a causality of expediency. Restoring autonomy Several measures are necessary to restore to SBP its hard earned autonomy. inflation and reserve changes should be agreed on for all macro economic projections for a fiscal year * Based on those agreed targets and estimates of private sector credit requirements. denial of access to its resources beyond the indicated limit.SBP fail to do so. and. The doctrine of necessity began to replace the laws on the books. Like the constitutional autonomy of the superior court. The most damage to autonomy came during 2000-2006 and with the best of efforts and intentions Dr Shamshad Akhtar was unable to reverse this trend during her tenure. In the process. in which the targets of growth. * A quarterly exercise should be undertaken to review and revise those limits in line with the growth. and desires of the government began to be accepted over the rule of law. . The unlawful practices began to overshadow the laws. persuasion. it also surrendered the authority that was given to it to limit government borrowing and to ensure monetary stability. No wonder the government engaged in reckless borrowing from SBP which fueled hyper inflation and contributed to fast depletion of foreign exchange reserves and a sharp devaluation of the rupee. * It should be made clear that interest rate policy is a monetary instrument and cannot be allowed to be manipulated on fiscal considerations. and followed the practices adopted in 1997-99. and in the process by now an autonomous SBP would have become a pillar of strength for the e country`s financial and economic system. Had SBP stood its ground that was created for it through legislative reforms in 1993-97. if necessary. it became a partner in the cover up.

. appoint administrators. It is hoped that in his present position of authority he will take concrete measures on the above lines to ensure de-facto SBP autonomy. and took the banking system out of the clutches of the vested interest groups. * To enhance enforcement powers of SBP over commercial banks.* As a regulator. Criteria should be agreed upon for the qualifications and experience of the governor and the board members * Deputy governors should not be appointed by the government. SBP should make it clear to banks that their acceptance of any instructions from any quarter that conflict with SBP regulations would provoke penalty and punishment as provided by law. * No change should be made in Section 9A and 9B of SBP Act that would dilute the authority given to SBP board in the conduct of monetary policy and in determination and enforcement of government borrowing. was there on the scene as president of Habib Bank when SBP struggled to attain a measure of autonomy through hard fought legislative reforms. necessary amendments may be made in the Banking Companies Ordinance enabling SBP to change managements. it may be mentioned that Mr Shaukat Tareen. The human temptation for concentration of power in one`s individual hands at the cost of the institutions must be avoided in the larger interests of good governance. Their appointment should be made by the SBP board * Ministry of finance should exert no administrative control either on SBP or on any bank or DFI * All sections of the SBP Act that became redundant due to its nationalisation should be deleted. Adviser Finance. temporarily take over the banks and restructure them In the end. * SBP Banking Services Corporation Ordinance 2001 should be repealed to integrate the policies and operations of SBP * The appointment of the governor and the board should be for a non-renewable period of five years and both should be appointed either by the president or prime minister.

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