Prudential Regulations Banks – Part III

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Prudential Regulations Banks – Part III

Prudential Regulations Part III
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Prudential Regulations play a crucial role in regulating and ensuring the stability of commercial banks in Pakistan. These regulations, set forth by the State Bank of Pakistan, establish guidelines and standards for various aspects of banking operations, including risk management, exposure limits, financial analysis, and security requirements. Adhering to these regulations is vital for banks to maintain a sound and secure financial system.

In this article, we will explore the key provisions of the Prudential Regulations imposed by the State Bank of Pakistan on commercial banks, highlighting Monitoring of collaterals , joint inspection of pledge stock and exposure in shares / TFCs . Stay tuned to gain valuable insights into the regulatory framework governing the operations of commercial banks in Pakistan.

Regulation – R-5 Monitoring

Collateral Management

a) Banks and Development Financial Institutions (DFIs) must have a Collateral Management Policy in place, which should be approved by the Board of Directors or the Country Head (for branches of foreign banks).

This policy can be integrated into the bank’s overall credit policy or kept separate, based on the bank’s discretion.

The policy should address various aspects related to collateral, including acceptable forms, quality, valuation at the time of acceptance and throughout the loan tenure, haircuts, price volatility, diversification, limits for margin calls, the substitution of collateral, and managing collateral in the event of a counterparty default.

b) The policy should clearly define the responsibilities in different scenarios, including the safekeeping and inspection of collateral.

This applies when the bank or DFI is the sole lender or one of the multiple lenders. In the latter case, the policy should cover coordination with other financial institutions, especially when financing is provided against the hypothecation of stock and/or receivables on a pari-passu or ranking charge basis, as well as the pledge of stock.

c) Banks and DFIs should establish an appropriate mechanism to ensure that the financing they provide is used for its intended purpose.

Additionally, they must ensure that the financing is not misused for non-productive purposes such as hoarding or speculation.

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It typically involves holding onto large quantities of items, such as essential commodities, in order to create artificial scarcity and drive up prices. Hoarding can disrupt a market’s supply and demand dynamics, leading to higher prices and scarcity for consumers.


It refers to engaging in financial transactions or investments with the expectation of making a profit from price fluctuations. Speculators typically buy or sell assets, such as stocks, bonds, or commodities, based on their predictions of future price movements. They seek to profit from short-term price changes rather than investing for the long term.

Joint Inspection of Pledged Stocks:

a) Banks and Development Financial Institutions (DFIs) that provide financing to customers based on the pledge of stocks of specific commodities must conduct joint inspections of the pledged stocks at least once every quarter if the aggregate exposure against such stocks reaches or exceeds the specified limits for each commodity. The specified limits are as follows:

  • Cotton (bales), excluding phutti and Sugar: Rs. 500 million
  • Wheat: Rs. 250 million
  • Rice/Paddy: Rs. 150 million
  • Edible Oil: Rs. 250 million

However, banks and DFIs have the option to voluntarily conduct joint inspections for smaller exposures and for commodities not mentioned above.

b) The bank or DFI with the highest committed exposure limit for a particular commodity shall act as the lead institution responsible for coordinating the quarterly joint inspection.

If multiple banks or DFIs have the same highest exposure level, they must mutually agree on which institution will assume the coordination responsibility. Once selected, the lead institution will coordinate the inspections for one year and then transfer the responsibility if another bank or DFI commits a higher exposure during that period.

In the case of syndicate financing involving the pledge of stocks, the agent bank or DFI will act as the lead institution for coordinating the quarterly joint inspection.


Syndicate Financing

It refers to a situation where multiple banks or financial institutions come together to jointly provide financing to a borrower. It is typically used for large-scale projects or transactions that require a substantial amount of funding that a single bank may not be able to provide alone. In syndicate financing, the participating banks or financial institutions share the risk and the financial commitment associated with the financing.

Agent Bank:

It plays a crucial role in syndicate financing. It acts as the lead institution responsible for coordinating and managing the syndicate on behalf of the lenders.

c) The Borrower’s Basic Fact Sheet (BBFS) will serve as the primary source of information for obtaining details about the exposures committed by banks and DFIs against pledged stocks for a specific customer.

Any bank or DFI that extends credit to a customer based on the pledge of stocks must, with the prior written consent of the obligor as required by law, inform all the banks and DFIs that are already providing financing to the same customer about the new exposure within five working days of the credit approval.

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Regulation – R-6 Exposure in shares and TFCs / Sukuk

Exposure in Shares and TFCs / Sukuk

Acquisition of Shares/Mutual Funds:

Single Company Investment Limit:

(i) The investment of Banks/DFIs in shares of a single company will be subject to the lower of the two following limits:

(a) 5% of the Tier-I Capital reported in the bank/DFI’s preceding half-yearly reviewed/annual audited financial statements, or

(b) 10% of the paid-up shares of the Investee Company.

These limits also apply to investments in units of all types of mutual funds.

(ii) Banks/DFIs’ investment in shares/units of any single startup (including Fintech Startups) or any single Real Estate Investment Trust (REIT) shall be limited to the lower of the following limits:

(a) Startups: 5% of the Tier-I Capital reported in the bank/DFI’s preceding half-yearly reviewed/annual audited financial statements or Rs. 500 million.

(b) REITs: 5% of the Tier-I Capital reported in the bank/DFI’s preceding half-yearly reviewed/annual audited financial statements or 15% of the paid-up shares of the Investee Company.

(iii) Banks/DFIs must have an approved policy that includes an internal evaluation process for analyzing and assessing equity investment decisions.

The evaluation process should consider factors such as the bank/DFI’s financial standing, aggregate investment portfolio, risk appetite, expected return, level of expertise, business strategy (including exit strategy), and more. (BPRD Circular Letter No. 04 of 2022 dated March 8, 2022).

Aggregate Investment Limits:

i) Banks and DFIs that mobilize funds as deposits/COIs (certificate of investment) from the general public/individuals have an aggregate equity investment limit of 30% of their equity.

ii) Islamic banks and DFIs without public deposits/COIs have a maximum aggregate investment limit of 35% of their equity.

iii) Within these limits, banks/DFIs can have a maximum exposure of up to 10% of their equity in future contracts, including both buying and selling positions in futures.

iv) Strategic investments and investments in units of different types of mutual funds (excluding NIT units until privatization) are included in the above limits.

v) The aggregate investment limit in units of REITs (Real Estate Investment Trust) is 15% (as per BPRD circular letter no. 07 of 2021 dated March 22, 2021) of the bank/DFI’s equity, separate from the above aggregate limits.

vi) Investments in subsidiary companies (listed and non-listed) of the bank/DFI are not included in these limits.

2. The above limits do not apply to shares acquired due to underwriting commitments, debt satisfaction, or debt-equity conversion schemes.

However, these shares must be sold or offloaded within 18 months; otherwise, they will be counted towards the above limits after that period. Banks/DFIs are responsible for planning their disposal to ensure compliance within the specified timeframe.

3. Investment in preference shares that meet the criteria of equity instruments, as outlined in Annexure-III, is considered part of the equity investment.

Investments in preference shares that do not meet these conditions are not included in the limits set by this regulation.

However, such investment portfolios are considered part of the maximum exposure limit prescribed under R-1 of these regulations.


Annexure – III Criteria for Preference Shares for inclusion in Investment in Equities

a) The issuer has the choice to redeem the preference shares.

b) If the issuer has the option to redeem the preference shares, it will be done through a sinking fund funded by the company’s profits, according to the agreed terms and conditions.

c) The terms and conditions of these shares do not create a contractual obligation for the issuer to provide another financial asset or exchange another financial instrument under potentially unfavorable conditions. However, the preference shares may include an option to convert them into common shares.

d) The terms and conditions of the preference shares do not force the issuer to redeem the shares due to economic, financial, or other reasons.

e) The payment and distribution of dividends to shareholders of preference shares, whether cumulative or non-cumulative, is at the discretion of the issuer.

4. Valuation of Investments:

Unless stated otherwise, the bank’s/DFI’s investments will be valued at the cost of acquisition for the purpose of calculating exposure.

When calculating the maximum investment limit in shares, the amount of provisions created against permanent impairment, as instructed in BSD Circular No.10 dated July 13, 2004, may be deducted from the cost of acquisition and the maximum limit.

5. Financing against Shares/TFCs/Sukuk: Banks/DFIs are prohibited from:

a) Taking exposure against their own issued shares/TFCs/Sukuk as security.

b) Providing unsecured credit for financing subscriptions to share capital floatation and TFCs/Sukuk issuance.

c) Taking exposure against non-listed TFCs/Sukuk or shares of companies not listed on the Stock Exchange(s), except for direct investments in non-listed TFCs.

d) Taking exposure on any company against shares/TFCs/Sukuk issued by that person (BPRD circular letter no. 07 of 2021 dated March 22, 2021).

e) Taking exposure against shares known as ‘sponsor director’s shares’ (issued either in their own name or in the name of their family members) of banks/DFIs.

f) Taking exposure on any individual, along with their family members or companies under their control or their family members’ control, exceeding 5% of shares in any commercial bank/DFI

g) Taking exposure against shares/TFCs of listed companies that are not members of the Central Depository System.

h) Taking exposure against TFCs that are unsecured or have a non-rated status, or TFCs with a rating below ‘BBB’ or its equivalent.

However, exposure may be taken against unsecured/subordinated TFCs issued by banks/DFIs to meet their minimum capital requirements, subject to the terms and conditions stipulated in BSD Circular No. 8 of June 27, 2006.

i) Taking exposure against shares unless the beneficiary of the facility is the absolute owner of the pledged shares or has the necessary mandate to pledge the shares of a third party as security for availing financing from the bank/DFI.

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Exposure refers to various types of financing facilities provided by a bank/DFI.

This includes fund-based or non-fund-based financing facilities such as;

  • bills purchased/discounted;
  • credit facilities through corporate cards;
  • financing obligations under letters of credit;
  • loan repayment financial guarantees;
  • and other types of guarantees;
  • subscriptions or investments in shares;
  • certificates, or commercial papers issued or guaranteed by the person;
  • net open positions on derivative transactions allowed under Financial Derivatives Business Regulations

SBP Prudential Regulations Link

Please Also Read:

Prudential Regulations Banks– Part I

Prudential Regulations Banks – Part II

PR – Consumer 1

PR – Microfinance Banks

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