Part C-Credit Risk Management

C1-Strategic Risk Management
Credit Risk Management (Part-C)
By:
Shahid Abbas
ACMA
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What is Credit Risk?

• Credit risk arises from the potential that an obligor is
either unwilling to perform on an obligation or its
ability to perform such obligation is impaired
resulting in economic loss to the bank.
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What is Credit Risk Policy?

• A set of policies and procedures formalizing the credit
risk management process, the goal of which is to:
▫ protect against any unwarranted customer or counterparty
credit exposures;
▫ maintain credit risk at a manageable level; and
▫ identify and avoid a material credit failure
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Expected vs Unexpected Loss

• Expected losses are those that the bank knows with
reasonable certainty will occur (e.g., the expected
default rate of corporate loan portfolio or credit card
portfolio) and are typically reserved for in some manner.
• Unexpected losses are those associated with

unforeseen events (e.g. losses experienced by banks in
the aftermath of nuclear tests, Losses due to a sudden
down turn in economy or falling interest rates).
• Banks rely on their capital as a buffer to absorb such

losses.
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Risk faced by Banks

• While the types and degree of risks an organization may
be exposed to depend upon a number of factors such as
its size, complexity business activities, volume etc, it is
believed that generally the banks face Credit, Market,
Liquidity, Operational, Compliance / legal / regulatory
and reputation risks.
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Levels of Risk Management Activities

In every financial institution, risk management activities broadly take
place simultaneously at following different hierarchy levels.
• Strategic level:
It encompasses risk management functions performed by senior
management and BOD. For instance definition of risks, ascertaining
institutions risk appetite, formulating strategy and policies for managing
risks and establish adequate systems and controls to ensure that overall risk
remain within acceptable level and the reward compensate for the risk
taken.
• Macro Level:
It encompasses risk management within a business area or across business
lines. Generally the risk management activities performed by middle
management or units devoted to risk reviews fall into this category.
• Micro Level:
It involves ‘On-the-line’ risk management where risks are actually created.
This is the risk management activities performed by individuals who take
risk on organization’s behalf such as front office and loan origination
functions. The risk management in those areas is confined to following
operational procedures and guidelines set by management.
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Board and senior Management

oversight.
• To be effective, the concern and tone for risk management must start at the
top. While the overall responsibility of risk management rests with the
BOD, it is the duty of senior management to transform strategic direction
set by board in the shape of policies and procedures and to institute an
effective hierarchy to execute and implement those policies. To ensure that
the policies are consistent with the risk tolerances of shareholders the same
should be approved from board.
• The formulation of policies relating to risk management only would not

solve the purpose unless these are clear and communicated down the line.
Senior management has to ensure that these policies are embedded in the
culture of organization. Risk tolerances relating to quantifiable risks are
generally communicated as limits or sub-limits to those who accept risks on
behalf of organization. However not all risks are quantifiable. Qualitative
risk measures could be communicated as guidelines and inferred from
management business decisions.
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Board and senior Management

oversight.
• To ensure that risk taking remains within limits set by senior
management/BOD, any material exception to the risk management policies
and tolerances should be reported to the senior management/board who in
turn must trigger appropriate corrective measures. These exceptions also
serve as an input to judge the appropriateness of systems and procedures
relating to risk management.
• To keep these policies in line with significant changes in internal and

external environment, BOD is expected to review these policies and make
appropriate changes as and when deemed necessary. While a major change
in internal or external factor may require frequent review, in absence of any
uneven circumstances it is expected that BOD re-evaluate these policies
every year.
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Managing Credit Risk

• In a bank’s portfolio, losses stem from outright default due to inability or
unwillingness of a customer or counter party to meet commitments in
relation to lending, trading, settlement and other financial transactions.
Alternatively losses may result from reduction in portfolio value due to
actual or perceived deterioration in credit quality. Credit risk emanates
from a bank’s dealing with individuals, corporate, financial institutions or a
sovereign. For most banks, loans are the largest and most obvious source of
credit risk; however, credit risk could stem from activities both on and off
balance sheet.
• In addition to direct accounting loss, credit risk should be viewed in the

context of economic exposures. This encompasses opportunity costs,
transaction costs and expenses associated with a non-performing asset over
and above the accounting loss.
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Managing Credit Risk

• Credit risk can be further sub-categorized on the basis of
reasons of default. For instance the default could be due
to country in which there is exposure or problems in
settlement of a transaction.
• Credit risk not necessarily occurs in isolation. The same

source that endangers credit risk for the institution may
also expose it to other risk. For instance a bad portfolio
may attract liquidity problem.
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Components of Credit Risk Management

• A typical Credit risk management framework in a
financial institution may be broadly categorized into
following main components:
▫ Board and senior Management’s Oversight

▫ Organizational structure
▫ Systems and procedures for identification, acceptance,
measurement, monitoring and control risks.
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• Board and senior Management’s Oversight
▫ It is the overall responsibility of bank’s Board to
approve bank’s credit risk strategy and significant
policies relating to credit risk and its management
which should be based on the bank’s overall
business strategy.
▫ To keep it current, the overall strategy has to be

reviewed by the board, preferably annually.
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▫ The responsibilities of the Board with regard to
credit risk management shall, interalia, includes:
 Delineate bank’s overall risk tolerance in relation to
credit risk.
 Ensure that bank’s overall credit risk exposure is
maintained at prudent levels and consistent with the
available capital
 Ensure that top management as well as individuals
responsible for credit risk management possess
sound expertise and knowledge to accomplish the
risk management function
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▫ The responsibilities of the Board with regard to
credit risk management shall, interalia, includes:
 Ensure that the bank implements sound
fundamental principles that facilitate the
identification, measurement, monitoring and control
of credit risk.
 Ensure that appropriate plans and procedures for
credit risk management are in place.
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Factors to be Considered in Credit Strategy
• The very first purpose of bank’s credit strategy is to determine the
risk appetite of the bank. Once it is determined the bank could
develop a plan to optimize return while keeping credit risk within
predetermined limits. The bank’s credit risk strategy thus should
spell out:
▫ The institution’s plan to grant credit based on various client segments
and products, economic sectors, geographical location, currency and
maturity
▫ Target market within each lending segment, preferred level of
diversification/concentration.
▫ Pricing strategy.
• It is essential that banks give due consideration to their target
market while devising credit risk strategy. The credit procedures
should aim to obtain an in-depth understanding of the bank’s
clients, their credentials & their businesses in order to fully know
their customers.
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• The strategy should provide continuity in approach and take into
account cyclic aspect of country’s economy and the resulting shifts
in composition and quality of overall credit portfolio. While the
strategy would be reviewed periodically and amended, as deemed
necessary, it should be viable in long term and through various
economic cycles.
• The senior management of the bank should develop and establish
credit policies and credit administration procedures as a part of
overall credit risk management framework and get those approved
from board. Such policies and procedures shall provide guidance to
the staff on various types of lending including corporate, SME,
consumer, agriculture, etc. At minimum the policy should include
following:
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• At minimum the policy should include following:
▫ Detailed and formalized credit evaluation/ appraisal
process.
▫ Credit approval authority at various hierarchy levels
including authority for approving exceptions.
▫ Risk identification, measurement, monitoring and
control
▫ Risk acceptance criteria
▫ Credit origination and credit administration and loan
documentation procedures
▫ Roles and responsibilities of units/staff involved in
origination and management of credit.
▫ Guidelines on management of problem loans.
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• In order to be effective these policies must be clear and
communicated down the line.
• Further any significant deviation/exception to these
policies must be communicated to the top management
/board and corrective measures should be taken.
• It is the responsibility of senior management to ensure
effective implementation of these policies.
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Organizational Structure.
• To maintain bank’s overall credit risk exposure within
the parameters set by the board of directors, the
importance of a sound risk management structure is
second to none.
• While the banks may choose different structures, it is
important that such structure should be commensurate
with institution’s size, complexity and diversification of
its activities.
• It must facilitate effective management oversight and
proper execution of credit risk management and control
processes.
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• The CRMC should be mainly responsible for following:
▫ The implementation of the credit risk policy /
strategy approved by the Board.
▫ Monitor credit risk on a bank-wide basis and ensure
compliance with limits approved by the Board.
▫ Recommend to the Board, for its approval, clear
policies on standards for presentation of credit
proposals, financial covenants, rating standards and
benchmarks.
▫ Decide delegation of credit approving powers,
prudential limits on large credit exposures, standards
for loan collateral, portfolio management, loan review
mechanism, risk concentrations, risk monitoring and
evaluation, pricing of loans, provisioning,
regulatory/legal compliance, etc.
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• To maintain credit discipline and to enunciate credit risk
management and control process there should be a separate
function independent of loan origination function.
▫ Credit policy formulation
▫ Credit limit setting
▫ Monitoring of credit exceptions / exposures and
▫ Review /monitoring of documentation
• For small banks where it might not be feasible to establish
such structural hierarchy, there should be adequate
compensating measures to maintain credit discipline
introduce adequate checks and balances and
standards to address potential conflicts of interest.
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• Ideally, the banks should institute a Credit Risk Management
Department (CRMD). Typical functions of CRMD includes:
▫ To follow a holistic approach in management of risks inherent in
banks portfolio and ensure the risks remain within the
boundaries established by the Board or Credit Risk Management
Committee.
▫ The department also ensures that business lines comply with risk
parameters and prudential limits established by the Board or
CRMC.
▫ Establish systems and procedures relating to risk identification,
▫ Management Information System, monitoring of loan /
investment portfolio quality and early warning.
▫ The department would work out remedial measure when
deficiencies/problems are identified.
▫ The Department should undertake portfolio evaluations and
conduct comprehensive studies on the environment to test the
resilience of the loan portfolio.
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Systems & Procedures
• Banks must operate within a sound and well-defined criteria
for new credits as well as the expansion of existing credits.
Credits should be extended within the target markets and
lending strategy of the institution. Before allowing a credit
facility, the bank must make an Need assessment of risk
profile of the customer/transaction. This may include:
▫ Credit assessment of the borrower’s industry, and macro
economic factors.
▫ The purpose of credit and source of repayment.
▫ The track record / repayment history of borrower.
▫ Assess/evaluate the repayment capacity of the borrower.
▫ The Proposed terms and conditions and covenants.
▫ Adequacy and enforceability of collaterals.
▫ Approval from appropriate authority
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Systems & Procedures-Credit Origination
• In case of new relationships consideration should be
given to the integrity and repute of the borrowers or
counter party as well as its legal capacity to assume the
liability.
• Prior to entering into any new credit relationship the
banks must become familiar with the borrower or
counter party and be confident that they are dealing with
individual or organization of sound repute and credit
worthiness.
• However, a bank must not grant credit simply on the
basis of the fact that the borrower is perceived to be
highly reputable i.e. name lending should be
discouraged.
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• While structuring credit facilities institutions
should appraise the amount and timing of the cash flows
as well as the financial position of the borrower and
intended purpose of the funds.
• It is utmost important that due consideration should be
given to the risk reward trade –off in granting a credit
facility and credit should be priced to cover all embedded
costs.
• Relevant terms and conditions should be laid down to
protect the institution’s interest.
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• Institutions have to make sure that the credit is used for
the purpose it was borrowed.
• Where the obligor has utilized funds for purposes not
shown in the original proposal, institutions should take
steps to determine the implications on creditworthiness.
• In case of corporate loans where borrower own group of
companies such diligence becomes more important.
Institutions should classify such connected companies
and conduct credit assessment on consolidated/group
basis.
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• In loan syndication, generally most of the credit
assessment and analysis is done by the lead institution.
• While such information is important, institutions should
not over rely on that.
• All syndicate participants should perform their own
independent analysis and review of syndicate terms.
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• Institution should not over rely on collaterals / covenant.
• Although the importance of collaterals held against loan
is beyond any doubt, yet these should be considered as a
buffer providing protection in case of default.
• Primary focus should be on obligor’s debt servicing
ability and reputation in the market.
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Systems & Procedures-Limit Setting
• An important element of credit risk management is to
establish exposure limits for single obligors and group of
connected obligors.
• Institutions are expected to develop their own limit
structure while remaining within the exposure limits set
by State Bank of Pakistan.
• The size of the limits should be based on the credit
strength of the obligor, genuine requirement of credit,
economic conditions and the institution’s risk tolerance.
• Appropriate limits should be set for respective products
and activities.
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Systems & Procedures-Limit Setting
• Institutions may establish limits for a specific industry,
economic sector or geographic regions to avoid
concentration risk.
• Some times, the obligor may want to share its facility
limits with its related companies. Institutions should
review such arrangements and impose necessary limits if
the transactions are frequent and significant.
• Credit limits should be reviewed regularly at least
annually or more frequently if obligor’s credit quality
deteriorates. All requests of increase in credit limits
should be substantiated.
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Systems & Procedures-Credit Administration
• Ongoing administration of the credit portfolio is an essential
part of the credit process. Credit administration function is
basically a back office activity that support and control
extension and maintenance of credit.
• A typical credit administration unit performs following
functions:
▫ Documentation.
 It is the responsibility of credit administration to ensure
completeness of documentation (loan agreements, guarantees,
transfer of title of collaterals etc) in accordance with approved
terms and conditions.
 Outstanding documents should be tracked and followed up to
ensure execution and receipt.
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functions:
▫ Credit Disbursement.
 The credit administration function should ensure
that the loan application has proper approval before
entering facility limits into computer systems.
 Disbursement should be effected only after
completion of covenants, and receipt of collateral
holdings.
 In case of exceptions necessary approval should be
obtained from competent authorities.
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• A typical credit administration unit performs following functions:
▫ Credit monitoring.
 After the loan is approved and draw down allowed, the loan
should be continuously watched over. These include keeping
track of borrowers’ compliance with credit terms,
identifying early signs of irregularity, conducting periodic
valuation of collateral and monitoring timely Repayments.
▫ Loan Repayment.
 The obligors should be communicated ahead of time as and
when the principal/markup installment becomes due. Any
exceptions such as non-payment or late payment should be
tagged and communicated to the management.
 Proper records and updates should also be made after
receipt.
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functions:
▫ Maintenance of Credit Files.
 Institutions should devise procedural guidelines and
standards for maintenance of credit files.
 The credit files not only include all correspondence
with the borrower but should also contain sufficient
information necessary to assess financial health of
the borrower and its repayment performance.
 It need not mention that information should be filed
in organized way so that external / internal auditors
or SBP inspector could review it easily.
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• A typical credit administration unit performs following functions:
▫ Collateral and Security Documents.

 Institutions should ensure that all security
documents are kept in a fireproof safe under
dual control.
 Registers for documents should be maintained
to keep track of their movement.
 Procedures should also be established to track
and review relevant insurance coverage for
certain facilities/collateral.
 Physical checks on security documents should be
conducted on a regular basis.
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Measuring Credit Risk

• The measurement of credit risk is of vital importance in credit risk
management.
• A number of qualitative and quantitative techniques to measure risk
inherent in credit portfolio are evolving.
• To start with, banks should establish a credit risk rating framework
across all type of credit activities.
• Among other things, the rating framework may, incorporate:
▫ Business Risk
 Industry Characteristics
 Competitive Position (e.g. marketing/technological edge)
 Management
▫ Financial Risk
 Financial condition
 Profitability
 Capital Structure
 Present and future Cash flows
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Measuring Credit Risk-Internal Risk Rating

• Credit risk rating is summary indicator of a bank’s individual
credit exposure.
• An internal rating system categorizes all credits into various
classes on the basis of underlying credit quality.
• A well-structured credit rating framework is an important tool
for monitoring and controlling risk inherent in individual credits
as well as in credit portfolios of a bank or a business line.
• The importance of internal credit rating framework becomes
more eminent due to the fact that historically major losses to
banks stemmed from default in loan portfolios.
• While a number of banks already have a system for rating
individual credits in addition to the risk categories prescribed by
SBP, all banks are encouraged to devise an internal rating
framework.
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• An internal rating framework would facilitate banks in a
number of ways such as:
▫ Credit selection
▫ Amount of exposure
▫ Tenure and price of facility
▫ Frequency or intensity of monitoring
▫ Analysis of migration of deteriorating credits and
more accurate computation of future loan loss
provision
▫ Deciding the level of Approving authority of loan.
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• Architecture/Model of Internal Rating System
▫ The Loss Concept and the number and meaning of
grades on the rating continuum corresponding to each
loss concept.
▫ Whether to rate a borrower on the basis of ‘point in time
philosophy’ or ‘through the cycle approach†.
▫ A rating system with large number of grades on rating
scale becomes more expensive due to the fact that the
cost of obtaining and analyzing additional information
for fine gradation increase sharply.
▫ However, it is important that there should be sufficient
gradations to permit accurate characterization of the
under lying risk profile of a loan or a portfolio of loans
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The Operating Design of Rating System
• the assignment of ratings always involve element of human
judgment.
• Even sophisticated rating models do not replicate experience and
judgment rather these techniques help and reinforce subjective
judgment.
• Banks thus design the operating flow of the rating process in a
way that is aimed promoting the accuracy and consistency of the
rating system while not unduly restricting the exercise of
judgment.
• Key issues relating to the operating design of a rating system
includes:
▫ what exposures to rate;
▫ organization’s division of responsibility for grading;
▫ the nature of ratings review;
▫ the formality of the process and specificity of formal rating definitions.
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What Exposures are rated:
• Ideally all the credit exposures of the bank should be
assigned a risk rating.
• However given the element of cost, it might not be
feasible for all banks to follow. The banks may decide on
their own which exposure needs to be rated.
• The decision to rate a particular loan could be based on
factors such as exposure amount, business line or both.
• Generally corporate and commercial exposures are
subject to internal ratings and banks use scoring models
for consumer / retail loans.
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How to Arrive at Ratings?
• Theoretically ratings are based upon the major risk
factors and their intensity inherent in the business of the
borrower as well as key parameters and their intensity to
those risk factors.
• Major risk factors include borrowers financial condition,
size, industry and position in the industry; the reliability
of financial statements of the borrower; quality of
management; elements of transaction structure such as
covenants etc.
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• Few important aspects of assigning ratings are:
▫ Banks may vary somewhat in the particular factors they consider and the
weight they give to each factor.
▫ Since the rater and reviewer of rating should be following the same
basic thought, to ensure uniformity in the assignment and review of risk
grades, the credit policy should explicitly define each risk grade; lay
down criteria to be fulfilled while assigning a particular grade, as well as
the circumstances under which deviations from criteria can take place.
▫ The credit policy should also explicitly narrate the roles of different
parties involved in the rating process.
▫ The institution must ensure that adequate training is imparted to staff
to ensure uniform ratings
▫ Assigning a Rating is basically a judgmental exercise and the models,
external ratings and written guidelines/benchmarks serve as input.
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• Institutions that use sophisticated statistical models to assign
ratings or to calculate probabilities of default, must ascertain the
applicability of these models to their portfolios.
• Even when such statistical models are found to be satisfactory,
institutions should not use the output of such models as the sole
criteria for assigning ratings or determining the probabilities of
default. It would be advisable to consider other relevant inputs as
well.
Ratings Review?
• The ratings review can be two fold:
▫ Continuous monitoring by those who assigned the rating. The Relationship
Managers (RMs) generally have a close contact with the borrower and are
expected to keep an eye on the financial stability of the borrower.
▫ Secondly the risk review functions of the bank or business lines also conduct
periodical review of ratings at the time of risk review of credit portfolio.
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Empirical Findings
• Most internal risk rating systems are based on both quantitative and
qualitative evaluation. The final decision is based on many different
attributes, but usually it is not based on using a formal model those
knows how to weight all the attributes in some optimal way.
• In essence, the internal risk rating systems are based on general
considerations and on experience, and not on mathematical
modeling. Some Models are explained below:
• Heuristic Models----
▫ Heuristic models attempt to gain insights methodically on the basis of
previous experience. This experience is rooted in: — Subjective practical
experience and observations — Conjectured business interrelationships
— Business theories related to specific aspects.
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Measuring Credit Risk-Credit Risk Monitoring

Credit Risk Monitoring
• Banks need to enunciate a system that enables them to monitor
quality of the credit portfolio on day-to-day basis and take remedial
measures as and when any deterioration occurs.
• Such a system would enable a bank to ascertain whether loans are
being serviced as per facility terms, the adequacy of provisions, the
overall risk profile is within limits established by management and
compliance of regulatory limits.
• The banks credit policy should explicitly provide procedural
guideline relating to credit risk monitoring including:
▫ The roles and responsibilities of individuals responsible for credit risk monitoring
▫ The assessment procedures and analysis techniques (for individual
loans & overall portfolio)
▫ The frequency of monitoring
▫ The periodic examination of collaterals and loan covenants
▫ The frequency of site visits
▫ The identification of any deterioration in any loan
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Indicators Depicting Credit quality of Loan:
• Financial Position and Business Conditions.
▫ The most important aspect about an obligor is its financial health, as it
would determine its repayment capacity.
▫ Consequently institutions need carefully watch financial standing of
obligor.
▫ The Key financial performance indicators on profitability, equity,
leverage and liquidity should be analyzed.
• Conduct of Accounts.
▫ In case of existing obligor the operation in the account would give a fair
idea about the quality of credit facility. Institutions should monitor the
obligor’s account activity, repayment history and instances of excesses
over credit limits.
• Loan Covenants.
▫ The obligor’s ability to adhere to negative pledges and financial
covenants stated in the loan agreement should be assessed, and any
breach detected should be addressed promptly.
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Indicators Depicting Credit quality of Loan:
• Collateral Valuation
▫ Since the value of collateral could deteriorate resulting in
unsecured lending, banks need to reassess value of collaterals on
periodic basis.
▫ The frequency of such valuation is very subjective and depends

upon nature of collaterals. For instance loan granted against
shares need revaluation on almost daily basis whereas if there is
mortgage of a residential property the revaluation may not be
necessary as frequently
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Internal Credit Rating-SBP Guidelines

• Although the usage of external credit ratings is
increasing but still loans to unrated clients form the
major portion of banks’ credit portfolio.
• This necessitates that banks should simultaneously use
their internal resources to know their customers to such
extent and in such a manner, which help them to
effectively and efficiently manage their portfolios.
• Keeping in view the importance of internal risk rating
systems, all banks and DFIs are advised to develop an
objective and rigorous methodology to assign internal
risk ratings to their borrowers based on the following
instructions.
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Scope of Ratings:
• All banks/DFIs are required to assign internal risk
ratings across all their credit activities including
consumer portfolio.
• The internal risk ratings should be based on a two tier
rating system.
▫ An Obligor Rating:
 Based on the risk of borrower default and
representing the probability of default by a borrower
or group in repaying its obligation in the normal
course of business and that can be easily mapped to
a default probability bucket.
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Scope of Ratings:
▫ An Obligor Rating:
• The obligor rating must be oriented to the risk of
borrower default. Separate exposures to the
same borrower must be assigned to the same
borrower grade, irrespective of any differences
in the nature of each specific transaction.
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Scope of Ratings:
rating system.
▫ A Facility Rating:
 Taking into account transaction specific factors, and
determining the loss parameters in case of default
and representing loss severity of principal and/or
interest on any business credit facility.
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Scope of Ratings:
rating system.
▫ A Facility Rating:
• The facility rating must be oriented to the loss severity of principal
and/or interest on any exposure.
• A Bank/DFI may have extended to a single counter party a number
of credit facilities against different collaterals, having different
priority rules and legal recourse to the recovery in case of default.
• The banks should consider the relevant transactions specific facts,
based on the type of facility and collateral, while assigning the
facility rating.
• This process may result in different facility ratings to the same
entity.
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Rating Criteria:
• To ensure that banks are consistently taking into account
available information, they must use all relevant and material
information in assigning ratings to borrowers and facilities.
• They must take into consideration the maximum available
attributes of an obligor; financial as well as managerial,
quantitative as well as qualitative.
• In order to assign obligor ratings the banks are required to
consider, but not limited to, the following aspects of the
borrower:
▫ Financial Condition including:
 Economic and financial situation
 Leverage
 Profitability
 Cash flows
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Rating Criteria:
borrower:
▫ Management and ownership structure
 Ownership structure
 Management and quality of internal controls
 Promptness/ assessment of the willingness to pay
 Strength of Sponsors
▫ Qualitative factors:
 CIB report
 Sector of business
 Industry properties and its future prospects
56

Rating Criteria:
borrower:
▫ Others:
 Country risk
 Comparison to external ratings.
 Credit information from other sources
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Rating Criteria:
• In order to assign the facility ratings, the bank should
consider the relevant and material information
including:
• Facility
▫ Nature and purpose of loan
▫ Loan structure
▫ Product type
▫ Priority of rights in case of bankruptcy
▫ Degree of collateralization
▫ Composition of collateral
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Rating Criteria:
• In order to assign the facility ratings, the bank should
consider the relevant and material information
including:
• Collateral
▫ Nature
▫ Quality
▫ Liquidity
▫ Market value
▫ Exposure of the collateral to different risks
▫ Quality of the charge
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Prudential Regulations-Consumer Financing
Disclaimer:
• State Bank of Pakistan compiles a booklet of Prudential
Regulations from time to time for convenience of users.
Updated version of such a booklet containing
amendments in the regulations made through
circulars/Circular letters to date is being issued.
• Due care has been taken while incorporating
amendments, however, errors and omission may be
expected.
• In case of any ambiguity, users are advised to refer to the
original circulars/circular letters on the relevant
subject(s), which are available on SBP’s website
(www.sbp.org.pk)
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Contents of Consumer Financing Regulations

• Part A- Definitions
• Part B- Minimum requirements for consumer Financing.
• Part C-Regulations
▫ R-1 Facilities to related persons & proper utilization of
clean financing facilities
▫ R-2 Limit on exposure against total consumer financing.
▫ R-3 Total financing facilities to be commensurate with the
income.
▫ R-4 General reserve against consumer finance.
▫ R-5 Rescheduling / Restructuring of Performing / Non
Performing consumer financing facilities
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Contents of Consumer Financing Regulations

• Part C-Regulations
▫ R-6 Classification & Provisioning of Receivables
▫ R-7 Margin Requirements
▫ R-8 Maximum Clean Limit for Credit Card And Personal
Loan/Financing from all Banks/DFIs
• REGULATIONS FOR CREDIT CARDS
▫ O-1 Receipt of credit cards
▫ O-2 Unauthorized/wrong transactions
▫ O-3 Due date for payment.
▫ O-4 Foreign Currency Transactions
▫ R-9 Classification and provisioning.
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REGULATIONS FOR AUTO FINANCING
▫ R- 10 Prohibition on financing commercial vehicles.
▫ R-11 Regulation
▫ R-12 Maximum tenure of financing.
▫ R-13 Hypothecation of vehicles.
▫ R-14 Insurance / Takaful.
▫ O-5 Repossession of vehicles.
▫ O-6 Issuance of No Objection Certificate upon adjustment
of loan
▫ O-7 Financing the purchase of used cars.
▫ O-8 Authorized auto dealers.
63

REGULATIONS FOR PERSONAL LOANS INCLUDING
LOANS FOR THE PURCHASE OF CONSUMER DURABLES
▫ R-16 Hypothecation
▫ R-17 Maximum Tenure of Financing
▫ R-18 Running / revolving finance.
▫ R-19 Renewal of revolving finance.
▫ R-20 Adjustment of excess amount deposited.
64

(Part-A)
Definitions
• An Affordability Assessment is designed to help the lender
assess whether you can afford to make repayments over the term of
the loan.
• Banks/DFIs, with last four quarters consumer finance outstanding
portfolio in excess of Rs.5 billion, are encouraged to perform
affordability assessment tests on (reasonably representative) sample
of consumer finance portfolio with variable mark-up/profit rate.
• Affordability assessment test may include the shock to customer’s
ability to repay (e.g. DBRs) the financing facility based on plausible
changes in interest rates as observed during the last business cycle.
• The results of affordability test will be presented to Board Risk
Management Committee for review and analysis at least once a year.
65

(Part-A)
Definitions
• Bank means a banking company as defined in the Banking
Companies Ordinance, 1962.
• Borrower means an individual to whom a bank/DFI has allowed
any consumer financing during the course of business.
• Consumer Financing means any financing allowed to individuals
for personal, domestic or household purposes. The facilities
categorized as Consumer Financing are given as under, unless
specifically mentioned otherwise:
I. Credit Cards mean cards which allow a customer to make payments
on credit. Supplementary credit cards shall be considered part of the
principal borrower for the purposes of these regulations. Corporate
Cards will not fall under this category and shall be regulated by
Prudential Regulations for Corporate/Commercial Banking
II. Auto Loans / Financing means the loans or financing facilities to
purchase the vehicle for personal use.
66

(Part-A)
Definitions
I. Personal Loans / Financing means the loans to individuals for the
payment of goods, services and expenses and includes Running
Finance/Revolving Credit to individuals.
• Days Past Due means number of days consumer finance facility
is over due
• DFI means Development Financial Institution and includes, the
Saudi Pak Industrial and Agricultural Investment Company
Limited, the Pak Kuwait Investment Company Limited, the Pak
Libya Holding Company Limited.
• Documents include vouchers, cheques, bills, pay-orders,
promissory notes, securities for leases/advances
• Equity of the Bank/DFI includes paid-up capital, perpetual
non-cumulative preference shares, general reserves, balance in
share premium account, reserve for issue of bonus shares,
statutory reserves and retained earnings / accumulated losses as
disclosed in latest annual audited financial statements.
67

(Part-A)
Definitions
• Grace Period means period during which no repayments of
financing facility are scheduled.
• Islamic Banking Institutions mean islamic commercial banks, Islamic
banking subsidiaries and Islamic banking branches of conventional banks,
licensed by State Bank of Pakistan.
• Liquid Assets are the assets which are readily convertible into cash
without recourse to a court of law and mean encashment/realizable value
of government securities, bank deposits, gold ornaments, gold bullion.
• NBFC means Non-Banking Finance Company as defined in Section 282A
of Companies Ordinance 1984 (or as amended from time to time) and
includes a Leasing Company, Housing Finance Company, Investment
Bank
• Rescheduling means where bank/DFIs, due to borrower’s financial
difficulty, grants concession in the form of allowing / extending the grace
period of the existing financing facility, without changing the other terms
& conditions of the consumer financing facility.
68

(Part-A)
Definitions
• Restructuring means where bank/DFI, due to borrower’s
financial difficulty, grants concession to the borrower that the
bank/DFI would not otherwise consider. Restructuring would
normally involve relaxing the terms & conditions of the consumer
financing facility which inter-alia include repayment tenor, mark-
up/profit rate and charges/fee.
• Secured means exposure backed by tangible security with
appropriate margins. Exposure without any tangible security is
defined as clean.
• Tangible Security means liquid assets, mortgage of land and
building, hypothecation or charge on vehicle, but does not include
hypothecation of household goods, etc.
• Teaser Rate means lower/concessional mark-up/profit rate
which is employed only for short period at the inception of
consumer financing facility.
69

(Part-B)
Minimum Requirements of Consumer Financing
• Apart from the specific regulations given under each mode of
financing separately, general requirements laid down here should
also be followed by the banks/DFIs while undertaking consumer
financing.
• The Board of Directors of the banks/DFIs are required to establish
policies, procedures and practices to define’ risks, stipulate
responsibilities, specify security requirements, design internal
controls and then ensure strict compliance with them.
• PRE-OPERATIONS:
▫ Before embarking upon or undertaking consumer financing, the
banks/DFIs shall implement/follow the guidelines given below on an
on-going basis:
 Banks/DFIs shall establish separate Risk Management capacity for the
purpose of consumer financing that should be commensurate with the size,
scope and complexity of the consumer finance business and suitably staffed
by personnel having sufficient expertise and experience in the field of
consumer finance/business.
70

(Part-B)
• PRE-OPERATIONS:
▫ Banks/DFIs shall establish separate Risk Management capacity for the
purpose of consumer financing that should be commensurate with the
size, scope and complexity of the consumer finance business and
suitably staffed by personnel having sufficient expertise and experience
in the field of consumer finance/business.
▫ The banks/DFIs shall prepare comprehensive consumer credit policy
duly approved by their Board of Directors, which shall interalia cover
credit initiation principles, loan administration including
documentation, disbursement, effective monitoring and appropriate
recovery mechanism.
▫ Islamic Banking Institutions (IBIs) offering Shariah compliant
consumer financing products shall have their comprehensive consumer
credit policy duly approved by Shariah Board in addition of their Board
of Directors
71

(Part-B)
• PRE-OPERATIONS:
▫ For every type of consumer finance product, the bank/DFI shall
develop a specific product program. The program shall include the
objective/quantitative parameters for the eligibility of the borrower
and determining the maximum permissible financing limit per
borrower.
▫ Banks/DFIs shall put in place an efficient and adequately automated
computer based MIS for the purpose of consumer finance, which
should be commensurate with the size, scope, complexity of the
consumer finance business.
▫ The banks/DFIs shall develop comprehensive recovery procedures for
the delinquent consumer financing facilities. The recovery procedures
may vary from product to product.
▫ The banks/DFIs desirous of undertaking consumer finance will become
a member of at least one Consumer Credit Information Bureau.
72

(Part-B)
• PRE-OPERATIONS:
▫ The financial institutions starting consumer financing are encouraged
to impart sufficient training on an ongoing basis to their staff to raise
their capability regarding various aspects of consumer finance.
▫ The banks/DFIs shall prepare standardized set of borrowing and
recourse documents (duly cleared by their legal counsels) for each type
of consumer financing.
▫ Banks/DFIs carrying out consumer finance, in coordination with their
association (Pakistan Banks’ Association), shall develop a common
glossary of important terms along with their definitions, in both
English & Urdu Versions.
73

(Part-B)
• OPERATIONS:
▫ Consumer financing, like other credit facilities, must be subject to the
bank’s/DFI’s risk management process setup for this particular
business. The process may interalia include, identifying source of
repayment and assessing customers’ ability to repay, his/her past
dealings with the bank/DFI, the net worth, objectives of obtaining
finance and information obtained from a Consumer Credit Information
Bureau.
▫ Before allowing any facility, the banks/DFIs shall obtain a consumer
credit report(s) from the Credit Information Bureau of State Bank of
Pakistan or from any consumer Credit Information Bureau(s) of which
they are member, provided the report(s) incorporates credit data
reported by all Banks/DFIs.
▫ At the time of granting finance facility under various modes of
consumer financing, banks/DFIs shall obtain a written declaration on
the prescribed format from the borrower divulging details of various
finance facilities already obtained from other banks/financial
institutions.
74

(Part-B)
• OPERATIONS:
▫ Banks/DFIs shall provide to the customer the statement of account at
appropriate intervals e.g. on monthly basis to the credit card/revolving
credit customers, unless there has been no transaction or no
outstanding balance on the account since last statement, and at least
yearly to other product customers.
▫ A detailed repayment schedule, where payment is due in installments,
should be provided to the borrower at the outset. Where alterations
become imminent because of prepayments, change in benchmark rate
or any other reason, the revised schedule should be provided to the
borrower at the earliest convenience of the bank/DFI but not later than
15 days of the change.
▫ Internal audit and control function of the bank/DFI, apart from other
things, should be designed and strengthened so that it can efficiently
undertake an objective review of the consumer finance portfolio from
time to time to assess various risks and possible weaknesses
75

(Part-B)
• OPERATIONS:
▫ Banks/DFIs are encouraged to consider the feasibility of adopting the
tiered mark-up rates or risk based pricing according to the credit
worthiness of individual borrowers.
▫ The banks/DFIs shall ensure that their accounting and computer
systems are well equipped to avoid charging of mark-up on mark-up.
▫ The banks/DFIs shall ensure that any repayment (full or partial) made
by the borrower is accounted for, as per agreed terms and conditions,
before applying mark-up/profit on the outstanding amount.
▫ To bring uniformity in calculation and reporting of Days Past Due
(DPDs), Banks/DFIs shall ensure that counting of DPDs for all
consumer financing products starts from payment due date.
▫ Banks/DFIs shall not increase a borrower’s aggregate credit limit, for
revolving facilities (credit card/overdraft/finance facilities of similar
product structure), unless the borrower has specifically requested for
the limit enhancement.
76

(Part-B)
• Disclosures
▫ The banks/DFIs must clearly disclose, all the important terms,
conditions, fees, charges and penalties, which interalia include
Annualized Percentage Rate, prepayment penalties and the conditions
under which they apply.
▫ For the purposes of this regulation, Annualized Percentage Rate means
as follows:
 (Mark-up or Profit paid for the period/outstanding p. amount) x (365 x 100)
▫ Minimum Payment Due (MPD) of the credit card or of any other
product of revolving credit nature shall be sufficient, so as to avoid the
negative amortization.
77

(Part-C)
Regulation-1
FACILITIES TO RELATED PERSONS AND PROPER UTILIZATION
OF CLEAN FINANCING FACILITIES
• Facilities to Related Persons:
▫ The consumer finance facilities extended by banks/DFIs to their
directors, major shareholders, employees and family members of these
persons shall be at arm’s length basis and on normal terms and
conditions . The banks/DFIs shall ensure that the appraisal standards
are not compromised in such cases and market rates are used for these
persons.
▫ This condition shall not apply to the consumer financing allowed by the
banks/DFIs to their employees as part of compensation package
provided the detailed terms and conditions of the benefits which the
banks/DFIs want to give to their employees are specifically mentioned
in the Employees Service Rules/HR Policy.
78

(Part-C)
Regulation-2
LIMIT ON EXPOSURE AGAINST TOTAL CONSUMER FINANCING
• Banks/DFIs shall ensure that the aggregate exposure under all consumer financing
facilities at the end of first year and second year of the start of their consumer
financing does not exceed 2 times and 4 times of their equity respectively. For
subsequent years, following limits are placed on the total consumer financing
facilities:
PERCENTAGE OF CLASSIFIED MAXIMUM LIMIT
CONSUMER
FINANCING TO TOTAL CONSUMER
FINANCING
a) Below 3% 10 times of the equity

b) Below 5% 6 times of the equity
c) Below 10% 4 times of the equity
d) 10% and above 2 times of the equity

79

(Part-C)
Regulation-3
• TOTAL FINANCING FACILITIES TO BE COMMENSURATE WITH
THE INCOME
• While determining the credit worthiness and repayment capacity of the prospective
borrower, the banks/DFIs shall ensure that the total monthly amortization payments
of consumer financing facilities should not exceed 50% of the net disposable income
of the prospective borrower.
• Banks/DFIs may consider the income of spouse of the borrower, while
calculating the DBR, provided specific consent of the spouse is obtained and
he/she is reported as co-borrower in eCIB database.
• Banks/DFIs may waive the requirement of 50% Debt Burden in case a
Credit Card and Personal loan/financing limit is properly secured through
liquid assets (as defined in prudential regulations) with minimum 30%
margin.
80

(Part-C)
Regulation-4
• GENERAL RESERVE AGAINST CONSUMER FINANCE:
• The banks/DFIs shall maintain a general reserve at least equivalent to the percentages
given below of both secured and un-secured consumer finance portfolio (net of cash
collateral, govt. securities and gold), to protect them from the risks associated with the
economic cyclical nature of this business.
• The above reserve requirement will, however, be maintained for the performing portion
only of consumer portfolio:
Category of NPL / Gross Loans Rate of General
Financing Provision
Ratio<=5% 4%
5%< Ratio <=10% 5%
Unsecured Portfolio 10%< Ratio <=20% 6%
Ratio>=20% 7%
Ratio<=5% 1%
5%< Ratio <=10% 1.5%
Secured Portfolio
10%< Ratio <=20% 2%
Ratio>=20% 2.5%
81

(Part-C)
Regulation-5
RESCHEDULING/RESTRUCTURING OF PERFORMING / NON-
PERFORMING CONSUMER FINANCING FACILITIES:
• Banks/DFIs should frame policy that should inter-alia include definition and types of
rescheduling/restructuring, criteria to assess the financial distress or income
impairment warranting the rescheduling / restructuring, the reduced mark-up/profit
rates applicable on restructured accounts and specify the limits on the amount of
rescheduled / restructured performing financing facilities as percentage of total
outstanding consumer financing.
• For the purpose of rescheduling/ restructuring, banks/DFIs may:
▫ Club or consolidate outstanding amounts on account of personal loans/financing and
credit cards and create one financing facility.
▫ Convert revolving facility into an installment based financing facility with maximum
repayment tenor of 5 years.
• If the borrower defaults (i.e. reaches 90 DPD) again within one year after
declassification, the financing facility shall be classified as under:
Type Classification
Unsecured Loss
Secured Same category/downgrade the classification based on their own internal policies.
82

(Part-C)
Regulation-6
CLASSIFICATION & PROVISIONING OF RECEIVABLES
• Receivables outstanding in other assets or any other head of balance sheet, on
account of, insurance or takaful / recovery charges / or any other item (other than
those amounts which are already transferred to memorandum account) against the
non-performing loans/financing facilities shall also be classified with 100%
provisions maintained there against.
Regulation-7
MARGIN REQUIREMENTS:
• Banks/DFIs are free to determine the margin requirements on consumer facilities
provided by them to their clients taking into account the risk profile of the
borrower(s) in order to secure their interests.
REGULATION R-8
MAXIMUM CLEAN LIMIT FOR CREDIT CARD AND PERSONAL
LOAN/FINANCING FROM ALL BANKS/DFIs
• Banks/DFIs may take total clean exposure on a customer under Credit Card and Personal
loan/financing up to Rs 2,000,000 in aggregate from all banks/DFIs.
• Further, banks/DFIs shall also ensure that overall credit card and personal loan/financing limits,
both on secured as well as on unsecured basis, availed by one person from all banks/DFIs in
aggregate should not exceed Rs 5,000,000, at any point in time.
83

(Part-C)
Regulation for Credit Cards
• REGULATION O-1
▫ The banks/DFIs should take reasonable steps to satisfy themselves that
cardholders have received the cards, whether personally or by mail. The
banks/DFIs should advise the card holders of the need to take reasonable steps to
keep the card safe and the PIN secret so that frauds are avoided.
• REGULATION O-2
▫ Banks/DFIs shall be liable for all transactions not authorized by the credit card
holders after they have been properly served with a notice that the card has been
lost / stolen. However, the bank’s/DFI’s liability shall be limited to those amounts
wrongly charged to the credit card holder’s account. In order to mitigate the risks
in this respect, the banks/DFIs are encouraged to take insurance / takaful cover
against wrongly charged amounts, frauds, etc.
• REGULATION O-3
▫ Due date for payment must be specifically mentioned on the accounts
statement. If fine/penalty is agreed to be charged in case the payment is
not made by the due date, it should be clearly mentioned in the
agreement
84

(Part-C)
REGULATION O-4 (FOREIGN CURRENCY TRANSACTIONS)
• Banks/DFIs shall convert the foreign currency denominated
transactions, carried out by customers, based on the foreign
exchange conversion rate as per their approved policy which should
be consistently followed.
• The Banks/DFIs shall not charge any such additional fee/spread,
over and above the conversion rate, which is not disclosed to
customer.
• Banks/DFIs shall disclose in monthly bill statement total value of
transaction in foreign currency, exchange rate applied (inclusive of
foreign exchange conversion fee) and total transaction amount in
Pak Rupees.
85

(Part-C)
• REGULATION R-9 (CLASSIFICATION AND PROVISIONING)
86

(Part-C)
Regulation for Auto Loans /Financing
• REGULATION R-10 (CLASSIFICATION AND PROVISIONING)
▫ The vehicles to be utilized for commercial purposes shall not be covered
under the Prudential Regulations for Consumer Financing.
▫ Any such financing shall ensure compliance with Prudential Regulations
for Corporate/Commercial Banking or Prudential Regulations for Small
& Medium Enterprise Financing.
▫ These regulations shall only apply for financing vehicles for personal use
including Light Commercial Vehicles (LCVs) also used for personal
purposes.
• REGULATION R-11
▫ The maximum tenure of the auto finance facility shall not exceed seven
years.
87

(Part-C)
• REGULATION R-12
▫ While allowing auto loans/financing, the banks/DFIs shall ensure
that the minimum down payment does not fall below 15% of the
value of vehicle.
▫ Further, banks/DFIs shall extend auto financing only for the ex-
factory tax paid price fixed by the car manufacturers and the cost
of ancillary item(s) e.g. (CNG kits, vehicle tracking device i.e.
Global Positioning System commonly known as ‘Tracker’ etc.)
desired by the borrower to be installed in the car/vehicle.
88

(Part-C)
• REGULATION R-13
▫ In addition to any other security arrangement on the
discretion of the banks/ DFIs, the vehicles financed by the
banks/DFIs shall be properly secured by way of
hypothecation.
▫ Payments against the sale orders issued by the
manufacturers are allowed till the time of delivery of the
vehicle subject to the condition that payment will directly
be made to the manufacturer/authorized dealer by the
bank/ DFI and upon delivery, the vehicle will immediately
be hypothecated to the bank/ DFI.
89

(Part-C)
• REGULATION R-14
▫ The banks/DFIs shall ensure that the vehicle
remains properly insured at all times during the
tenure of the financing facility.
90

(Part-C)
• REGULATION O-5
▫ The clause of repossession in case of default
should be clearly stated in the loan/financing
agreement mentioning specific default period after
which the repossession can be initiated.
• REGULATION O-6
▫ After repayment/adjustment/settlement of the
financing facility by the borrower as per the
agreed terms & conditions, Bank/DFI shall return
the vehicle registration file and issue a No
Objection Certificate within the shortest possible
time.
91

(Part-C)
• REGULATION O-7
▫ The banks/DFIs desirous of financing the purchase of used cars shall
prepare uniform guidelines for determining the value of the used
vehicles. In no case the bank/DFI shall finance the cars older than nine
years.
▫ However, cars older than five years and up to nine year can only be
financed subject to the condition that complete repayment of financing is
restricted within 12 years of such car age.
• REGULATION O-8
▫ The banks/DFIs should ensure that a good number of authorized auto
dealers are placed at their panel to eliminate the chances of collusion or
other unethical practices.
92

(Part-C)
• REGULATION R-15
▫ The auto loans shall be classified and provided for in the following manner:
CLASSIFICATION DETERMINANT TREATMENT OF PROVISIONS TO
INCOME BE MADE*
1. Substandard. Where mark- Unrealized markup/ Provision of 25% of
up/ interest/profit to be the difference
interest/profit kept in Memorandum resulting from the
or Account and not to be outstanding
principal is credited to Income balance of
overdue by 90 Account except when Principal
days or more realized in cash. less the amount of
from the due Unrealized mark liquid assets.
date. up/interest already
taken
to income account to be
reversed and kept in
Memorandum Account.
93

(Part-C)
• REGULATION R-15
INCOME BE MADE*
2. Doubtful Where mark- Unrealized markup/ Provision of 50% of
up/ interest/profit to be the difference
overdue by Account except when principal less the
180 days or realized in cash. amount of
more Unrealized mark liquid assets.
from the due up/interest already
date. taken
Memorandum Account.
94

(Part-C)
• REGULATION R-15
INCOME BE MADE*
3. Loss Where mark- Unrealized markup/ Provision of 100%
up/ interest/profit to be of the difference
overdue by Account except when principal
one realized in cash. less the amount of
year or more Unrealized mark liquid assets.
from up/interest already
the due date taken
Memorandum Account.
95

(Part-C)
REGULATIONS FOR PERSONAL LOANS/FINANCING
INCLUDING LOANS/FINANCING FOR THE PURCHASE OF
CONSUMER DURABLES
• REGULATION R-16
▫ In cases, where the financing facility has been extended to
purchase some durable goods/items, including personal
computers and accessories thereof, the same will be
hypothecated with the bank/DFI besides other securities,
which the bank/DFI may require on its own.
• REGULATION R-17
▫ The maximum tenure of the loan financing facility shall not
exceed 5 years.
▫ However, this period may be extended to 7 years for
loans/advances/financing given for educational purposes,
provided that disbursement of such loans shall directly be
made by the bank/DFI to the educational institution
96

(Part-C)
CONSUMER DURABLES
• REGULATION R-18
▫ In case of Running Finance/Revolving Finance, it shall be
ensured that at least 15% of the maximum utilization of the
financing facility during the year is cleaned up by the borrower
for a minimum period of one week. In case the clean-up is not
made by the borrower, the financing facility will be appropriately
classified.
97

(Part-C)
CONSUMER DURABLES
• REGULATION R-19
▫ In Revolving / facilities of similar nature, banks/DFIs may
renew the facility annually as per international industry
best practices
▫ During every three years period cycle, once a complete
assessment of the borrower will be carried out afresh and
necessary documentation will be obtained.
▫ ECIB/bureau report(s) will be obtained at annual review
date and due weightage should be given to any overdue as
reported in the ECIB/bureau report(s).
98

(Part-C)
CONSUMER DURABLES
• REGULATION R-20
▫ Excess amount deposited/repaid by the customer in
revolving credit account shall be adjusted towards the loan
account on the date of deposit of such amount.
99

(Part-C)
CONSUMER DURABLES
100
Prudential Regulations-
Corporate/Commercial Banking
• Part-A Definitions
• Part-B Regulations
101
▫ (Risk Management)
• R-1 Exposure limits.
• R-2 Limit on exposure against contingent liabilities.
• R-3 Financial analysis & other conditions.
• R-4 Security and margin requirements .
• R-5 Monitoring
• R-6 Exposure in shares and TFCs/Sukuk.
• R-7 Guarantees.
• R-8 Classification and provisioning for assets.
• R-9 Assuming obligations on behalf of NBFCs.
• R-10 Payment of dividend.
102
▫ (Operations)
• O-1 Undertaking of cash payments outside the bank’s authorized
place of business.
• O-2 Window dressing.
• O-3 Reconciliation of inter-branch accounts and settlement of
suspense account entries.
• O-4 Maintenance of assets in Pakistan.
• O-5 Foreign currency deposits under FE 25-1998
103
Corporate/Commercial Banking(Part-A)
• Account Holder means a person who has opened any account with
a bank directly or through branchless banking agent or is a holder of
deposit/deposit certificate or any instrument representing
deposit/placing of money with a bank/DFI or has borrowed money
from the bank/DFI.
• Branchless Banking Agent means an agent providing banking
services to the customers of a bank/DFI on behalf of the
bank/DFI/MFBs under a valid agency agreement.
• Bank means a banking company as defined in the Banking
Companies Ordinance, 1962.
• Borrower or Obligor means a person on whom a bank/DFI has
taken any exposure during the course of business.
104
• Chief Executive Officer (CEO) in relation to bank/DFI means an
individual who, subject to the control and directions of the Board of
Directors, is entrusted with the whole, or substantially the whole, of the
powers of management of the affairs of the bank/DFI occupying the
position of Chief Executive Officer
• Contingent Liability means possible obligation that arises from
past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the enterprise
• Control refers to an ownership directly or indirectly through
subsidiaries, of more than one half of voting power of an enterprise.
• Corporate Card means credit card issued to the employees of an
entity where the repayment is to be made by the said entity.
105
• Derivative means a type of financial contract the value of which is
determined by reference to one or more underlying assets or
indices.
• Documents include vouchers, cheques, bills, pay-orders,
promissory notes, securities for leases/advances
• Director means any person occupying the position of a director on
the Board of a bank/DFI and includes sponsor, nominee and
alternate director or by whatever name called.
• Equity of the Bank/DFI includes paid-up capital in respect of
ordinary shares, general reserves, balance in share premium
account, reserve for issue of bonus shares, statutory reserves, and
retained earnings/accumulated losses as disclosed in latest annual
audited financial statements.
•
106
• Exposure shall include :
▫ Financing Facilities whether fund based or non-fund based extended by
a bank/DFI and include:
 Any form of financing facility extended or Bills purchased/discounted,
Bills purchased/discounted on the guarantee of the person.
 Credit facilities extended through Corporate Cards.
• Forced Sale Value (FSV) means the value which fully reflects the
possibility of price fluctuations and can currently be obtained by
selling the mortgaged/pledged assets in a forced/distressed sale
conditions.
• Large Exposure means an exposure of 10% or more of a
bank’s/DFI’s equity to a single obligor or a group.
• Major Shareholder of a bank/DFI means any person holding 5%
or more of the share capital of a bank/DFI either individually or in
concert with family members.
107
• Recognized Rating Agency means rating agency either on the
approved panel of State Bank of Pakistan or Standard & Poor’s,
Moody’s, Fitch or Japan Credit Rating Agency (JCRA)
• Sponsor Shares mean 5% or more paid-up shares of a bank,
acquired by a person(s) individually or in concert with his family
members (including his spouse, lineal ascendants and descendents
and dependent brothers and sisters), group companies, subsidiaries,
and affiliates/associates.
• Sponsor Director means the member of the Board of Directors of
a bank holding sponsor shares.
108
Corporate/Commercial Banking(Part-B)
109
• R-1 (Large Exposure Limit)
▫ The aggregate amount of large exposures of a bank/DFI
shall not, at any point in time, exceed 50% of its total gross
advances and investments (excluding investment in
government securities and loans secured against GOP
guarantees). Large exposure limits shall not be applicable
to investment in government securities and loans secured
against GOP guarantees.
▫ Different concentration limits may be assigned to different
banks/DFIs by SBP based on their supervisory assessment.
110
R-2 LIMIT ON EXPOSURE AGAINST CONTINGENT
LIABILITIES
• Contingent liabilities of a bank/DFI shall not exceed at any point in
time 10 times of its equity.
R-3 FINANCIAL ANALYSIS & OTHER CONDITIONS
Financial Analysis
• At the time of allowing any exposure (including renewal,
enhancement and rescheduling / restructuring) and annual review
of long term facilities, Banks/DFIs shall, as a matter of rule, obtain a
copy of financial statements relating to the business of every
borrower.
• The financial statements should be duly audited by a practicing
Chartered Accountant. In case of a borrower other than a public
company or a private company which is a subsidiary of a public
company, financial statements audited by a practicing Cost and
111
Financial Analysis
• However, if the borrower is a public limited company and aggregate
exposure from all Banks/DFIs exceeds Rs. 500 million, banks/DFIs
should obtain the financial statements duly audited by a firm of
Chartered Accountants which has received satisfactory rating under
the Quality Control Review (QCR) Program of the Institute of
Chartered Accountants of Pakistan.
• Subsequently, if the firm’s rating is downgraded in QCR program,
then the financial statements of such borrowers should be audited
in the subsequent year by a firm having satisfactory rating under
QCR.
112
Financial Analysis
• The Board of Directors of the bank/DFI shall approve a credit policy
prescribing a minimum current ratio and linkage between
borrower’s equity and its total financing facilities from all financial
institutions.
• Banks/DFIs are advised to properly assess the credit need of the

borrower based on their financial analysis and genuine credit
requirements.
113
• Credit Report
• While considering proposals for any exposure (including renewal,
enhancement and rescheduling/restructuring), banks/DFIs should
give due weightage to the credit report relating to the borrower and
its group obtained from Credit Information Bureau (CIB) of State
Bank of Pakistan.
• If the banks/DFIs decide to take exposure on defaulters, they should
strictly follow their risk management policies and credit approval
criteria and properly record reasons and justifications in the
approval form.
• The banks/DFIs shall ensure that CIB report is not older than two
months at the time of approval of credit limits.
114
• Borrower Basic Fact Sheet
• Banks/DFIs are required to obtain Borrower’s Basic Fact Sheet
(BBFS) as per format given at Annexure-II from their prospective
borrowers at the time of sanctioning fresh facility, or enhancement,
renewal, rescheduling and restructuring of an existing facility.
However, if the Loan Application Form already contains all the
information as required in BBFS, then no separate BBFS may be
required.
115
R-4 SECURITY AND MARGIN REQUIREMENTS
• Security Requirements
• All exposures shall be adequately secured. However, banks/DFIs, in
aggregate, may provide clean financing facility in any form up to Rs
2,000,000/- (Rupees two million only) to any single obligor.
• Financing facilities granted without securities including those
granted against personal guarantees shall be deemed as ‘clean’ for
the purpose of this regulation.
• Further, at the time of granting a clean facility, banks/DFIs shall
obtain a written declaration to the effect that the borrower, has not
availed of such facilities from other banks/DFIs so as to exceed the
prescribed limit of Rs 2,000,000/- in aggregate.
116
R-4 SECURITY AND MARGIN REQUIREMENTS
• Margin Requirements
▫ Banks/DFIs are free to determine the margin requirements on
facilities provided by them to their clients taking into account the
risk profile of the borrower(s) in order to secure their interests.
▫ However, in cases where margin has been prescribed by State
Bank/Government of Pakistan, appropriate margin shall at least
be equal to the prescribed margin.
▫ Exposure against the shares of listed companies shall be subject
to minimum margin of 30% of their current market value.
However, the banks/DFIs may consider to set higher margin
requirements, and maintain list of shares acceptable as security,
117
R-5 Monitoring
• Collateral Management
• The banks/DFIs shall have in place Collateral Management Policy
duly approved by the BOD or Country Head.
• The policy shall clearly delineate the responsibilities in various
scenarios, including safe custody & inspection of collateral, where
bank/DFI is a sole lender or where it is one of multiple lenders.
• The Banks/DFIs shall devise an appropriate mechanism to ensure
that the financing extended is utilized for the intended purpose.
Further, they will also ensure that financing is not used for non
productive purpose like hoarding, speculation etc.
118
R-5 Monitoring
• Joint Inspection of Pledged Stocks
• All the banks/DFIs financing any particular customer against pledge
of stocks of below mentioned commodities shall conduct joint
inspection of the pledged stocks at least once in a quarter, where
aggregate exposure against such stocks equals or exceeds the
amount shown against each commodity:
Commodity Aggregate Committed Exposure
(limits)
Cotton (bales), excluding phutti Rs. 500 million

Sugar Rs. 500 million
Wheat Rs. 250 million
Rice/Paddy Rs. 150 million
Edible Oil Rs. 250 million
119
R-5 Monitoring
• Joint Inspection of Pledged Stocks
• The bank/DFI with the largest committed exposure (limit) shall act
as the lead bank/DFI to coordinate the quarterly joint inspection.
• In case two or more banks/DFIs have the same level of highest
committed exposure, they shall mutually agree on which bank/DFI
to assume the responsibility.
• The Borrower’s Basic Fact Sheet (BBFS) shall serve as the main
source for obtaining information on exposures committed by the
banks/DFIs against pledged stocks for any particular customer.
120
R-6 EXPOSURE IN SHARES AND TFCs/SUKUK
• Acquisition of Shares/Mutual Funds (Single Company Investment Limit)
• Banks / DFIs shall not own shares of any single company in excess
of 5% of their own equity. This limit will also be applicable to units
of all types of mutual funds and REITs.
• The Borrower’s Basic Fact Sheet (BBFS) shall serve as the main
source for obtaining information on exposures committed by the
banks/DFIs against pledged stocks for any particular customer.
• Banks/DFIs will obtain prior approval from the State Bank for
purchasing shares of a company exceeding, in aggregate, 10% of the
capital of Investee Company or 5% of their paid-up capital,
whichever is lower. These limits will be calculated as under:
▫ In the case of investee company, limit will be calculated by taking 10% of
the number of its paid-up shares,
▫ In the case of investing bank/DFI, limit will be calculated by taking 5% of
paid-up shares of the bank/DFI, and then multiplying with their face
value.
121
• Acquisition of Shares/Mutual Funds (Aggregate Investment Limits)
• Aggregate equity investment limit for banks, and DFIs which are
mobilizing funds as deposits/COIs from general public/individuals,
shall be 30% of their respective equity.
• For Islamic banks, and DFIs which are not mobilizing funds as
deposits/COIs from general public/individuals, the aggregate
investment limit will be 35% of their respective equity.
• Aggregate investment limit in units of REIT shall be 10% of equity of the

bank/DFI, exclusive of the above aggregate limits.
122
• The limits prescribed in para 1 above shall not apply to the shares
acquired due to the underwriting commitments, satisfaction of
debts or debt-equity conversion scheme.
• However these will be sold off/off loaded within a period of

eighteen months; otherwise the same will be counted towards the
above limit from the expiry of that period. The banks/DFIs are
required to plan their disposal to ensure compliance within the due
date
123
124
R-7 GUARANTEES
• All guarantees issued by the banks/DFIs shall be fully secured, except in the
cases mentioned at Annexure-IV where it may be waived up to 50% by the
banks/DFIs at their own discretion, provided that banks/DFIs hold at least
20% of the guaranteed amount in the form of liquid assets as security.
• The banks/DFIs can issue guarantees on behalf of Pakistani firms and

companies functioning in Pakistan against the back to back/counter-
guarantees of banks/DFIs rated at least ‘A’ or equivalent by a credit rating
agency on the approved panel of State Bank of Pakistan.
• Cases where payments are not received within 20 working days by the
banks/DFIs when the guarantees of overseas banks are invoked, shall be
reported to SBP indicating the steps being taken by the bank/DFI to recover
the amount due under the guarantee.
125
R-7 GUARANTEES
• Banks/DFIs shall ensure that counter-guarantees received are properly

evaluated and their own guarantees against such guarantees are issued with
due care.
• Cases where payments are not received within 20 working days by the
banks/DFIs when the guarantees of overseas banks are invoked, shall be
reported to SBP indicating the steps being taken by the bank/DFI to recover
the amount due under the guarantee.
126
127
128
129
130
131
132
133
• REGULATION R-10
• PAYMENT OF DIVIDEND
• Banks/DFIs shall not pay any dividend on their shares
unless and until:
• They meet the minimum capital requirement (MCR) and
capital adequacy ratio requirement (CAR) as laid down
by the State Bank of Pakistan from time to time;
• All their classified assets have been fully and duly
provided for in accordance with the Prudential
Regulations and to the satisfaction of the State Bank of
Pakistan; and
• All the requirements laid down in Banking Companies
Ordinance, 1962 relating to payment of dividend are
fully complied.
134
• REGULATION O-1
UNDERTAKING OF CASH PAYMENTS OUTSIDE
THE BANK’S AUTHORIZED PLACE OF BUSINESS
• Banks shall not undertake any business of cash payments,
other than the authorized place of business, except through
the installation of Automated Teller Machine.
• Banks may do collection and payment of cash for their prime

customers through cash carrying companies registered with
concerned Government department. This facility should,
however, be provided through designated branches of the
banks and after the banks have devised procedures including
necessary security measures.
135
REGULATION O-2
WINDOW DRESSING
• Banks/DFIs shall refrain from adopting any
measures or practices whereby they would either
artificially or temporarily show an ostensibly
different position of bank’s/DFI’s accounts as given
in their financial statements.
• Particular care shall be taken in showing their
deposits, MCR, non-performing loans/assets,
provisioning, profit, inter-branch and inter-bank
accounts, or any other method to artificially inflate
balance sheet or show improved profitability.
136
137
REGULATION O-4
MAINTENANCE OF ASSETS IN PAKISTAN
• Every bank/DFI shall maintain in Pakistan not less than 80% of the
assets created by it against such time and demand liabilities as
specified in Part-A of Form X (prescribed under Rule 17 of the
Banking Companies Rules, 1963).
REGULATION O-5
FOREIGN CURRENCY DEPOSITS UNDER FE 25-1998
• Banks shall not invest FE 25 deposits in foreign currency/local
currency denominated instruments below investment grade.
Neither, shall they invest/place such deposits in fund management
schemes of other banks/DFIs/NBFCs whether in Pakistan or
abroad.
• Banks shall be required to maintain the prescribed ratio of Cash
Reserve/Special Cash Reserve against FE 25 deposits in US Dollars.
Thank you
138

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C1-Strategic Risk Management

Credit Risk Management (Part-C)

What is Credit Risk?

What is Credit Risk Policy?

Expected vs Unexpected Loss

• Unexpected losses are those associated with

• Banks rely on their capital as a buffer to absorb such

Risk faced by Banks

Levels of Risk Management Activities

Board and senior Management

• The formulation of policies relating to risk management only would not

Board and senior Management

• To keep these policies in line with significant changes in internal and

Managing Credit Risk

• In addition to direct accounting loss, credit risk should be viewed in the

Managing Credit Risk

• Credit risk not necessarily occurs in isolation. The same

Components of Credit Risk Management

▫ Board and senior Management’s Oversight

Components of Credit Risk Management

▫ To keep it current, the overall strategy has to be

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

Components of Credit Risk Management

▫ Collateral and Security Documents.

Measuring Credit Risk

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Internal Risk Rating

Measuring Credit Risk-Credit Risk Monitoring

Measuring Credit Risk-Credit Risk Monitoring

Measuring Credit Risk-Credit Risk Monitoring