Reforming the State Bank - Dr Muhammad Yaqub - Wednesday, March 16, 2011

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The SBP, as the central bank, has a crucial role to play in the financial and economic management of the country. Its main functions are:

• Formulation and implementation of an independent monetary policy

• Approval, regulation and supervision of commercial banks

• Management of the exchange rate

• Provision of banking services to all layers of the government

As monetary and exchange rate policies play an important role in macroeconomic management of the country, and a well-functioning banking system is almost a prerequisite for smooth economic development, the future of the economy is vitally linked with the effectiveness and efficiency of the SBP.

In recognition of its importance, the SBP has been strengthened in the last two decades through several legislative reforms and its internal restructuring. At the same time, some regressive legislative measures and other steps taken on considerations of expediency, and, at times, lack of sound leadership have inhibited the SBP from playing its role effectively.

It is important that the SBP undertakes a critical evaluation of its recent performance, and introduces reforms to remove the impediments that stand in the way of its efficient and effective functioning. Fortunately, at this critical juncture, the incumbent Governor, Shahid Kadar, possesses the necessary qualities to lead it in the right direction.

The major areas that require immediate attention include:

• Administrative breakup of the SBP in 2002 into two legally independent entities.

• Non-implementation of the provisions of section 9A and 9B of the SBP Act relating to monetary policy for a long time.

• Division of authority to appoint the governor and the board between two different centers of power.

• Inadequate programme for skill development and career progression of the staff.

• Lack of sufficient progress in improving the quality of banking supervision.

The administrative breakup of the SBP into two legally independent entities, called the SBP and the State Bank Banking Services Corporation (SBP-BSC), was a real set back, and has undermined autonomy, efficiency, and cohesiveness of the SBP. It has also increased administrative costs though duplication of administrative set-ups, added to difficulties in coordination between policies and operations, and created hindrance in career development of the professional staff.

The policy and operational functions of the SBP are intricately interrelated but the two independent entities will, with the passage of time, develop their own separate staff, procedures, traditions and personalities and lose intimate touch with each.

Bifurcation of the professional staff between two legal entities requiring adoption of deputation procedures for transfer of staff from one entity to the other is cumbersome and unnecessary, stands in the way of cross-fertilisation of skills involved in policies and operations, and impedes development of the core central banking professionals having experience in both policies and operations.

A careful consideration needs to be given for reunification and integration of the central banking functions under one umbrella in the larger and long term interest of functional cohesiveness, harmony and efficiency of the SBP.

The responsibility for the formulation and implementation of monetary policy rests with the SBP as provided in section 9A and 9 B of the SBP. If these provisions were consistently and faithfully enforced in the last decade or so, monetary policy would by now be standing on solid footing and making its contribution towards controlling inflation, promoting financial discipline and accelerating economic growth. Unfortunately, for some unknown reasons, the government and the SBP lost their way and failed to follow the law of the land.

It is important that the provisions of the law are strictly followed in letter and spirit. Laws are as good as their implementation and an effective enforcement of the provisions will produce the desired results of promoting economic growth within the framework of relative price stability. The present subordination of monetary policy to meet fiscal requirements of the government is not only a violation of the law but is also directly responsible for the high rate of inflation in the country.

The division of authority for the appointment of the governor by the president and of the board of directors and deputy governors by the prime minister has in it the potential of conflict and disharmony in the functioning of the SBP. From the point of view of the SBP, it is not important whether the governor and the board are appointed by the president or the prime Minister.

What is important is that they are not arbitrarily appointed or removed without a clearly laid down due process, that they have a uniform command structure and their tenures are guaranteed. The appointment and removal of the board and the governor should therefore be consolidated in one authority under transparent rules and regulations ensuring security of their tenure.

In the selection of the members of board of directors, due weight needs to be given to representation of professional skills with diverse geographical, academic and business background, and the advice and consent of the governor should be mandatory in their appointment. The tenure of the governor should be reverted back to the original five year nonrenewable term. That provision was replaced in 1993 by the present one that restricted the duration of the tenure to three years but made it renewable for a second term.

The temptation of renewal of second term may stand in the way of some governors taking bold professional stands on policy issues and therefore it is better to restore the initial decision of a non-renewable five year term.

In the case of deputy governors, their appointment should be taken away from the Ministry of Finance and handed over to the board of directors of the SBP to minimise the interference of the Ministry of Finance in the running of the SBP.

Moreover, deputy governors should be appointed from within the career stream of the SBP both to strengthen the input of institutional memory in high level decisions and to assure a career prospect to the professional SBP staff. In fact, that was the practice in vogue for a long time in the SBP that has lately been ignored leading to demoralisation of the career staff and undermining cohesiveness and uniformity of compensation to the staff at the same level of responsibilities.

The mid-level professional staff is the backbone of any effective organisation. It is for that reason that the SBP also needs to pay more attention to the professional staff from within and avoid the practice of large scale lateral entry at senior levels. Lateral entries may reduce the skill shortage in the short run but it demoralises the career staff and reduces the promise of career progression and skill development in the long run.

There is another negligence that also needs to be corrected. For almost a decade, the SBP has not filled the position of deputy governor policy on the phony assertion that an economist-governor does not need the services of a deputy governor policy. Given some humility and better understanding of the enormity of SBP tasks, every governor should feel the need for a strong team of economists under the leadership of a qualified and experienced deputy governor to develop policy conclusions on solid economic analysis and research.

Finally, the SBP needs to give equal weight to off-site supervision as to on-site inspection. It should gradually move on from policing and penalising the banks by detecting some minor violations through inspections, to examining the macro risk indicators of banks based on reliable data flow, improving governance guidelines for them, separating the roles of owners, board of directors and management and staff of banks in their governance structure, and imparting integrity and professionalism in banking business.

The policeman approach to bank supervision has by now become obsolete and counterproductive. It has been abandoned all over the world and replaced by modern tools such as ‘stress testing’ of banks.

The writer is former governor of the State Bank of Pakistan.

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