Prudential Regulations Banks – Part II

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Prudential Regulations Banks – Part II

Prudential Regulations Commercial Banks – Part II
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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 their significance and impact on the banking industry. Stay tuned to gain valuable insights into the regulatory framework governing the operations of commercial banks in Pakistan.

Prudential Regulations Banks – Part I

Regulation – R-2: Contingent Liability Exposure Limit

Contingent Liabilities Limit

For Bank / DFI is up to 10 times equity.

Exposure to derivatives

up to 5 times of equity for Banks / DFIs designated as authorized derivative dealers.

When calculating or assessing the overall contingent liabilities of a bank/DFI, Bid/mobilization advance/performance bonds are considered to have a value equal to 50% of their actual amount.

And forward foreign exchange contracts are accounted for as having a value equal to 10% of their actual amount.

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Non-Contingent Liabilities

The following items are not considered contingent liabilities under this regulation:

a) Bills for collection.

b) Non-fund-based exposure covered by cash/liquid assets.

c) Letters of credit/guarantees secured by the State Bank of Pakistan/Federal Government or banks/DFIs with a minimum ‘A’ rating from a recognized rating agency.

d) Claims unrelated to the provision of facilities to the banks’/DFIs’ constituents, where the likelihood of these claims becoming liabilities is remote.

Weightage of bid bonds and Forward Foreign Exchange Contracts

For the purpose of this regulation, a weightage of 50% shall be given to bid/mobilization advance/performance bonds and 10% to forward foreign exchange contracts.

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Regulation – R-3: Financial Analysis and Additional Requirements

Financial Analysis:

a) When granting any exposure (including renewals, enhancements, and rescheduling/restructuring) and conducting annual reviews of long-term facilities, Banks/DFIs must obtain financial statements from every borrower.

These financial statements should be audited by a practicing Chartered Accountant.

For borrowers who are not public companies or private companies owned by public companies, financial statements audited by a practicing Cost and Management Accountant are also acceptable.

However, if the borrower is a public limited company and the total exposure from all Banks/DFIs exceeds Rs. 500 million, banks/DFIs are required to obtain audited financial statements from a Chartered Accountant firm that has received a satisfactory rating under the Quality Control Review (QCR) Program of the Institute of Chartered Accountants of Pakistan If the firm’s rating is downgraded in the QCR program, the financial statements of such borrowers should be audited in the following year by a firm with a satisfactory QCR rating.

b) For public sector entities and related government departments/divisions that are not required to prepare and audit their annual financial statements through accounting firms, banks/DFIs should establish criteria to obtain management accounts or implement alternative mechanisms to assess their financial position and performance.

c) The bank/DFI’s Board of Directors must endorse a credit policy that sets a minimum current ratio and establishes a relationship between a borrower’s equity and its total financing from all financial institutions.

The Credit Policy should prioritize stringent credit standards and provide comprehensive guidance to the management regarding these requirements for different client categories and corresponding risk mitigation measures deemed acceptable by the bank/DFI.

The policy should also outline specific circumstances or conditions under which the bank/DFI may provide financing facilities that exceed these limits if deemed necessary.

Clear provisions should identify approving authorities responsible for granting exemptions in line with the policy. Any exceptions granted must be reported to the Board of Directors at least on a quarterly basis.

d) Banks/DFIs should accurately evaluate the borrower’s credit needs through thorough financial analysis and genuine credit assessment.


Credit Report:

When evaluating proposals for any exposure (including renewals, enhancements, and rescheduling/restructuring), banks/DFIs should consider the borrower’s credit report and that of its group, obtained from the Credit Information Bureau (CIB) of the State Bank of Pakistan.

If banks/DFIs decide to provide exposure to defaulters, they must adhere to their risk management policies and credit approval criteria, and document clear reasons and justifications in the approval form.

Banks/DFIs should ensure that the CIB report is no more than two months old when approving credit limits.

Borrower Basic Fact Sheet

Banks/DFIs must obtain the Borrower’s Basic Fact Sheet (BBFS) in the provided format (Annexure-II) from prospective borrowers when granting new facilities, or when making enhancements, renewals, rescheduling, or restructuring of existing facilities.

However, if all the required information in the BBFS is already included in the Loan Application Form, a separate BBFS may not be necessary.

Regulation R-4: Security and Margin Requirements

Security Requirements

a) All exposures must have sufficient security. However, banks/DFIs, collectively, can provide a clean financing facility of up to Rs.2,000,000/- (Rupees two million only) to a single borrower.

Financing facilities granted without collateral, including those based on personal guarantees, are considered ‘clean’ under this regulation.

When granting a clean facility, banks/DFIs should obtain a written declaration stating that the borrower has not exceeded the prescribed limit of Rs 2,000,000/- by availing of such facilities from other banks/DFIs.

b) When it comes to clean placements with banks/DFIs in Pakistan, it is important to adhere to the single obligor limits outlined in Prudential Regulation R-1.

However, banks and financial institutions (DFIs) with ratings below ‘A-3’ (short term) or ‘BBB’ (long term) should comply with the clean exposure limit specified in paragraph a) of this regulation.


Is this a good credit rating for a bank “‘A-3’ (short term) or ‘BBB’ (long term)?

Yes, ‘A-3’ (short term) or ‘BBB’ (long term) credit ratings are generally considered good ratings for a bank. These ratings indicate a moderate level of risk associated with the bank’s short-term and long-term creditworthiness, respectively. They suggest a relatively stable financial position and a lower likelihood of default compared to lower-rated categories.

c) For Nostro Balances held with financial institutions abroad, banks should prudently establish limits approved by their Board of Directors, which are exempt from the aforementioned limits.

d) Banks/DFIs must ensure that the total exposure from all clean facilities does not exceed the disclosed equity amount stated in their latest audited financial statements.

However, the following are excluded/exempted from the aggregate limits for unsecured/clean exposure:

  • Facilities provided to finance eligible commodities under the Export Finance Scheme, backed by Letters of Credit (LCs).
  • Financing covered by guarantees from the Pakistan Export Finance Guarantee Agency, up to the guaranteed amount.
  • Loans/advances granted to employees of the banks/DFIs in accordance with their entitlement/staff loan policy.
  • Investments in Certificates of Investments (COIs)/interbank placements with Non-Bank Financial Companies (NBFCs), provided the invested NBFC has at least an ‘A’ long-term rating and ‘A2’ short-term rating or equivalent from a recognized rating.
  • Investments by Banks/DFIs in subordinated and unsecured Term Finance Certificates (TFCs) issued by other banks/DFIs for the purpose of raising Tier-II Capital, in accordance with the guidelines of the State Bank of Pakistan.

e) Banks and DFIs have the flexibility to determine whether to require security/collateral for Letter of Credit (L/C) facilities during the interim period, starting from the L/C opening date until the receipt of title documents for the goods.

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Requirement of Personal Guarantee

Banks and DFIs are encouraged to establish a policy, approved by their Board of Directors, regarding the acquisition of personal guarantees from directors of private limited companies.. This requirement can be linked, at the bank’s/DFI’s discretion, to the borrower’s credit rating, past relationship, financial strength, and operational performance.

Margin Requirements

a) Banks/DFIs have the freedom to determine margin requirements for their clients’ facilities based on the borrower’s risk profile to protect their interests. However, if the State Bank/Government of Pakistan has prescribed a margin, the appropriate margin should be at least equal to the prescribed margin.

b) Exposure against shares of listed companies must have a minimum margin of 30% of their current market value.

Banks/DFIs may set higher margin requirements and maintain a list of shares acceptable as collateral, considering factors such as liquidity, trading activity, and other relevant aspects.

Banks and DFIs will conduct regular weekly monitoring of the margin and implement appropriate measures for top-up and sell-out in accordance with their Board of Directors approved credit policy, following prior written authorization from the borrower.

c) Exposure against TFCs/Sukuks rated ‘BBB’ and above by a credit rating agency approved by the State Bank of Pakistan requires a minimum margin of 20%.

d) The mandatory cash margin requirement of 100% for Caustic Soda (PCT heading 2815.1200) when initiating an Import Letter of Credit, as recommended by the Federal Government and communicated in BPD Circular Letter No. 5 dated May 4, 2002, will remain in effect.


I would like to dedicate this article to my teacher Mr. Mohammed Farooq Arbiani who passed away today on May 19, 2023.

SBP Prudential Regulations Link

Please Also Read:

Prudential Regulations Banks– Part I

PR – Consumer 1

PR – Microfinance Banks

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Ali Murtaza

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