62526 SOUTH ASIA PAYMENTS AND SECURITIES SETTLEMENT INITIATIVE PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN APRIL 2010 THE WORLD BANK FIRST INITIATIVE ©2010 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved. This volume is a product of the staff of the International Bank for Reconstruction and Development /The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The document is the product of a project funded by the Financial Sector Reform and Strengthening Initiative (FIRST Initiative) (www.firstinitiative.org). The views expressed are not necessarily those of FIRST. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development /The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. FOREWORD In 2008, the World Bank launched the South Asia Payments and Securities Settlement Initiative (SAPI), following a high- level mandate from the South Asia (SA) Central Banks’ Deputy Governors (Colombo Meeting, July 2007), confirmed by subsequent meetings of the SA Governors. The SAPI, which is funded by FIRST initiative, builds on the successful experience of other regional initiatives, such as the Western Hemisphere Payments and Securities Clearance and Settlement Initiative (WHI) in the Latin American and Caribbean region, the Commonwealth of Independent States Payments and Securities Settlement Initiative (CISPI), and the initiatives for the Arab Region and the Southern Africa Development Community. The SAPI objective is to describe and assess the payments and securities settlement systems of the countries of South Asia with a view to identifying possible improvement measures in their safety, efficiency and integrity. The long-term goal of the initiative is to build institutional capacity within the region in order to sustain the continued development of payment and securities settlement systems. To assure quality and effectiveness, the SAPI includes two important elements. First, all studies are conducted with the active participation of country officials and the project builds on the existing work being undertaken in the respective countries. Second, the initiative draws on international and national expertise to provide guidance, advice and alternatives to current practices. An important component of the initiative is the involvement of international experts from the Bank for International Settle- ments (BIS) and from the Committee on Payment and Settlement Systems (CPSS) central banks through the International Advisory Council (IAC). The Swiss National Bank, the National Bank of Belgium and the Hong Kong Monetary Authority have already joined the IAC. Other central banks, securities commissions and international organizations are expected to join the IAC over the course of the program. The SAPI initiative is undertaking a number of activities. These include: the preparation of public reports containing an in-depth description of each country’s payments, securities clearing and settlement systems, and remittance service arrange- ments; the delivery of recommendations reports to country authorities on a confidential basis; the organization of workshops focusing on issues of particular interest; and the promotion of working groups to ensure a continuation of the project activity. This report, Payments and Securities Settlement Systems in Pakistan, is the first of the public reports in the SAPI series and was prepared with the active support of the State Bank of Pakistan. ACKNOWLEDGEMENTS This document is the result of the work developed by an international team, in coordination with a local team. The expert in charge of payment and settlement systems at the World Bank was Ms. Luchia Christova. The local team comprised officials from the State Bank of Pakistan (SBP) and was led by Mr. Muhammed Saleem Rehmani, Director Payment Systems Depart- ment at the SBP. Mr. Abdur Rauf (SBP), Mr. Muhammad Faisal Mazhar (SBP), Mr. Massimo Cirasino (the World Bank) and Ms. Alice Zanza (the World Bank) provided useful input and comments to the report. TABLE OF CONTENTS Foreword i Acknowledgements ii Abbreviations and Acronyms vii 1 ECONOMIC AND FINANCIAL MARKET OVERVIEW 1 1.1 OVERVIEW OF RECENT REFORMS, 1 1.2 MACROECONOMIC BACKGROUND, 1 1.3 FINANCIAL SECTOR, 2 1.3.1 Recent Performance of the Banking Sector, 3 1.4 CAPITAL MARKETS, 4 1.5 MAJOR TRENDS IN PAYMENT SYSTEMS, 5 1.6 MAJOR TRENDS IN SECURITIES SETTLEMENT SYSTEMS, 7 2 INSTITUTIONAL ASPECTS 9 2.1 GENERAL LEGAL FRAMEWORK, 9 2.1.1 Payments, 9 2.1.2 Securities, 11 2.1.3 Derivatives, 12 2.2 ROLE OF FINANCIAL INSTITUTIONS: PAYMENTS, 12 2.2.1 Banking Sector, 12 2.2.2 Other Institutions that Provide Payment Services, 13 2.3 ROLE OF FINANCIAL INSTITUTIONS: SECURITIES, 13 2.3.1 Securities Market Participants, 13 2.3.2 Exchanges, Clearing Houses, Central Depositories, 14 2.4 MARKET STRUCTURE AND REGULATION, 14 2.5 ROLE OF THE CENTRAL BANK, 15 2.5.1 Monetary Policy and other Functions, 15 2.5.2 Involvement in the Payments System, 15 2.5.3 Banking Supervision, 16 2.5.4 Anti-Money Laundering Measures, 17 2.5.5 Agent of the Government, 18 2.6 ROLE OF THE SECURITIES REGULATOR, 18 2.7 ROLE OF OTHER PRIVATE AND PUBLIC SECTOR ENTITIES, 18 2.7.1 Pakistan Banks’ Association, 18 2.7.2 Association of Securities Market Participants, 19 iii iv PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN 3 PAYMENT MEDIA USED BY NON-FINANCIAL ENTITIES 21 3.1 CASH, 21 3.2 PAYMENT MEANS AND INSTRUMENTS OTHER THAN CASH, 22 3.2.1 Cheques, 22 3.2.2 Direct Credits and Direct Debits, 22 3.2.3 Payment Cards, 23 3.2.4 Initiatives taken by the Payment Systems Department of the SBP to Enhance Security in Payment Cards in Pakistan, 24 3.2.5 Postal Instruments, 24 3.2.6 Innovative Retail Payment Instruments, 25 3.2.7 Pakistan Remittance Initiative (PRI), 25 3.3 NON-CASH GOVERNMENT PAYMENTS, 26 4 PAYMENTS: INTERBANK EXCHANGE AND SETTLEMENT CIRCUITS 27 4.1 LOW-VALUE PAYMENT SYSTEMS, 27 4.1.1 Payment Cards Clearing and Settlement, 27 4.1.2 Clearing of Paper Based Instruments, 28 4.2 LARGE-VALUE PAYMENT SYSTEMS, 30 4.2.1 Pakistan Real Time Interbank Settlement Mechanism (PRISM), 30 4.2.2 Management of Credit and Liquidity Risk, 34 4.3 CROSS-BORDER PAYMENT SETTLEMENT SYSTEMS, 34 4.4 PROJECTS AT THE STAGE OF DEVELOPMENT AND IMPLEMENTATION, 36 5 SECURITIES, MARKET STRUCTURE AND TRADING SYSTEMS 37 5.1 FORMS OF SECURITIES, 37 5.2 TYPES OF SECURITIES, 37 5.3 SECURITIES IDENTIFICATION CODE, 38 5.4 TRANSFER OF OWNERSHIP, 38 5.5 PLEDGE OF SECURITIES AS COLLATERAL, 38 5.6 TREATMENT OF LOST, STOLEN, AND DESTROYED SECURITIES, 38 5.7 LEGAL MATTERS CONCERNING CUSTODY, 39 5.8 PUBLIC OFFERING OF SECURITIES, 39 5.9 PRIMARY MARKET, 39 5.9.1 Government Securities, 39 5.9.2 Corporate Securities, 40 5.10 SECONDARY MARKET, 42 5.11 STOCK EXCHANGE TRADING, 42 5.12 OVER THE COUNTER (OTC) MARKET, 43 5.13 DERIVATIVES, 43 2010 v 6 SECURITIES SETTLEMENT SYSTEMS 45 6.1 ORGANIZATIONS AND INSTITUTIONS, 45 6.1.1 Stock Exchanges, 45 6.1.2 Clearing Institutions and Securities Depositories, 45 6.2 SECURITIES CLEARING AND SETTLEMENT PROCESS, 46 6.2.1 Description of the Process, 46 6.2.2 Management of Settlement Risks, 50 6.2.3 Management of Operational Risks, 51 6.2.4 Pricing, 51 6.3 GUARANTEE SCHEMES, 52 6.4 SECURITIES LENDING, 52 6.5 INTERNATIONAL LINKS AMONG CLEARING AND SETTLEMENT INSTITUTIONS, 52 7 THE ROLE OF THE CENTRAL BANK IN SECURITIES SETTLEMENT SYSTEMS 53 7.1 SETTLEMENT, 53 7.2 PAYMENTS SYSTEM OVERSIGHT, 53 7.3 MONETARY POLICY AND PAYMENT SYSTEMS, 54 7.4 THE ROLE OF THE CENTRAL BANK IN CROSS-BORDER PAYMENTS, 54 7.5 PRICING POLICY, 55 8 SUPERVISION OF SECURITIES SETTLEMENT SYSTEMS 57 8.1 SECURITIES REGULATOR SUPERVISORY AND STATUTORY RESPONSIBILITIES, 57 8.2 REGULATORY AND STATUTORY RESPONSIBILITIES OF SELF-REGULATORY ORGANIZATIONS, 58 APPENDIX: STATISTICAL TABLES 59 Figures in the Text FIGURE 1: CURRENCY IN CIRCULATION (IN PKR BILLION), 21 FIGURE 2: VOLUME OF RETAIL PAYMENTS (IN THOUSANDS), 22 FIGURE 3: VALUE OF RETAIL PAYMENTS (IN PKR BILLION), 23 FIGURE 4: NUMBER OF PAYMENT CARDS IN CIRCULATION, 23 FIGURE 5: VOLUME AND VALUE OF NIFT CLEARING POSITIONS IN PRISM, 29 FIGURE 6: TOTAL VOLUME AND VALUE OF TRANSACTIONS IN PRISM, 31 FIGURE 7: TOTAL LISTED CAPITAL AT KARACHI STOCK EXCHANGE, 41 FIGURE 8: BREAKDOWN OF SECURITIES HELD IN THE CDS, 46 FIGURE 9: TYPES OF TRADES AND TRANSACTIONS CLEARED IN NCSS, 47 FIGURE 10: SETTLEMENT FLOWS IN SECURITIES TRANSACTIONS, 49 Table of Contents vi PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN Tables in the Text TABLE 1: FINANCIAL SOUNDNESS INDICATORS FOR THE BANKING SYSTEM, 2005-2008, 3 TABLE 2: BANK NOTES AND COINS (IN PKR BILLION), 21 TABLE 3: SETTLEMENT STATISTICS FOR INTERBANK LARGE-VALUE PAYMENTS IN PRISM, 30 TABLE 4: KARACHI STOCK EXCHANGE MARKET PERFORMANCE INDICATORS, 41 TABLE 5: SIX YEAR OPERATIONAL DATA OF THE CDS, 46 ABBREVIATIONS AND ACRONYMS ACU Asian Clearing Union FATF Financial Action Task Force AD Authorized Dealer FERA Foreign Exchange Regulations Act, 1947 AML Anti-Money Laundering FIFO First-In-First-Out ATM Automated Teller Machine FIRST Financial Sector Reform and Strengthening BCO Banking Companies Ordinance Initiative BCP Business Continuity Plan FMAP Financial Markets Association of Pakistan BIS Bank for International Settlements FX Foreign Exchange BPD Banking Policy Department GCC Gulf Cooperation Council BSD Banking Surveillance Department GDP Gross Domestic Product BSS Banking Sector Strategy IAC International Advisory Council BTB Broker to Broker ID Identity Document B2B Business-to-Business IDS Institutional Delivery System CAR Capital Adequacy Ratio ILF Intraday Liquidity Facility CDC Central Depository Company IMF International Monetary Fund CDS Central Depository System IPO Initial Public Offering CFS Continuous Funding Settlement ISIN International Securities Identification CFT Combating the Financing of Terrorism Number CISPI Commonwealth of Independent States IT Information Technology Payments and Securities Settlement Initiative IVR Integrated Voice Response CM Clearing Member KATS Karachi Automated Trading System CPSIPS Core Principles for Systemically Important KSE Karachi Stock Exchange Payment Systems KYC Know Your Customer CPSS Committee on Payment and Settlement MCR Minimum Capital Requirement Systems MF Margin Financing CRR Cash Reserve Requirement MO Money Order CSD Central Securities Depository MoU Memorandum of Understanding DFI Development Finance Institution MRTB Market-related Treasury Bill DVP Delivery versus Payment MTB Market Treasury Bill EC Exchange Company MtM Marked to Market EFTPOS Electronic Funds Transfer at the Point of Sale MTO Money Transfer Operator EMV Europay, MasterCard, VISA vii viii PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN NBFC Non-Banking Finance Company RSA Rivest, Shamir and Adleman NBFI Non-Bank Financial Institution RTGS Real Time Gross Settlement NBP National Bank of Pakistan RTOB Real Time Online Banking Transaction NCC National Clearing Company of Pakistan SA South Asia Limited SBA Stand-by Arrangement NCSS National Clearing and Settlement System SAPI South Asia Payment and Securities Settlement NIFT National Institutional Facilitation Initiative Technologies SBP State Bank of Pakistan NPL Non-performing Loan SBP Act State Bank of Pakistan Act, 1956 NSS National Saving Scheme SBP BSC SBP Banking Services Corporation OMO Open Market Operation SBP CSD SBP Central Securities Depository OTC Over the Counter SECP Securities & Exchange Commission of PB Policy Board (Securities and Exchange Pakistan Commission of Pakistan) SGLA Subsidiary General Ledger Account PBA Pakistan Banks’ Association SLR Statutory Liquid Reserve requirement PIB Pakistan Investment Bond SML Securities Markets Law PKI Public Key Infrastructure SMS Short Message Service PKR Pakistani Rupee SRO Self-Regulatory Organization PO Postal Order STP Straight-Through Processing POS Point of Sale SWIFT Society for Worldwide Interbank Financial PRI Pakistan Remittance Initiative Telecommunication PRISM Pakistan Real Time Interbank Settlement TFC Term Finance Certificate Mechanism UIN Unique Identification Number PSD Payment Systems Department VPN Virtual Private Network PSEFT Payment System and Electronic Fund Transfer VPS Voluntary Pension System (Act) WB World Bank PVP Payment versus Payment WHI Western Hemisphere Payments and Securities P2B Person-to-Business Clearance and Settlement Initiative P2P Person-to-Person ROSC Report on the Observance of Standards and Codes CHAPTER 1 ECONOMIC AND FINANCIAL MARKET OVERVIEW 1.1 OVERVIEW OF RECENT REFORMS 1.2 MACROECONOMIC BACKGROUND Economic developments in Pakistan during the last decade have—to a significant extent—been influenced by In the last decade, Pakistan’s economy witnessed a major the Government’s Program1 for poverty reduction and the economic transformation. The country’s real GDP development of markets and the real economy. increased from USD 60 billion in FY01 to USD 170 billion in FY08,2 with per capita income rising from under USD Following the liberalization of markets and the implemen- 500 to over USD 1,000. During the same period (FY01 to tation of economic reforms, the following developments in FY08), the volume of international trade increased from the economic and social sector have been identified: about USD 20 billion to nearly USD 60 billion. For most of this period, the Pakistani economy grew quite strongly and • High gross domestic product (GDP) growth registered a real GDP growth of more than 7 percent per resulting from output and sales growth; year. Buoyant output growth, low inflation, and the gov- • Monetary stability; ernment’s social policies contributed to poverty reduction. • Developments of money and securities markets; This strong macroeconomic performance resulted from • Improvements in the standard of living and the implementation of a series of important structural poverty reduction (based on economic growth); reforms. In the early 2000s, the government expanded the • Development and reinforcement of the banking role of markets in the economy, privatized a number of sector and enhancement of its role in the social large state-owned enterprises, established market-based and economic development of the country. regulatory bodies, and took steps to reduce the cost of doing business in Pakistan. However, the economic development slowed down in 2008 and 2009, as the macroeconomic situation deterio- The macroeconomic situation, however, deteriorated in rated significantly owing to adverse security developments, 2008. Specifically, real GDP growth slowed to 5.8 percent large price increase of some commodities such as oil and in FY08 (6.8 percent in FY07) reflecting weaker perfor- food, global financial turmoil, and national political and mance of the agricultural and manufacturing sectors. security issues. Headline CPI 12-month inflation rose to 25 percent in October 2008, with core inflation (excluding energy 2 In Pakistan, fiscal year starts on July 1st. For example, FY08 started in July 1 Poverty Reduction Strategy Paper: Government of Pakistan, 2003. 2007 and ended in June 2008. 1 2 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN and food) increasing to 18 percent. The external current The Government agreed on a macroeconomic stabiliza- account deficit widened to about USD 14 billion (8.5 per- tion program which was jointly implemented by the Gov- cent of GDP) in FY08. The growth of exports and workers’ ernment and the SBP from November 2009 onwards with remittances recovered, but total imports rose by more than the support of the IMF Stand-by-Arrangement (SBA). 30 percent owing to an increase of USD 4 billion (2.5 per- Implementation of the SBA and reforms undertaken by cent of GDP) in the value of oil imports and strong aggre- the SBP resulted in an improvement in the macroeco- gate demand growth. The surplus in the financial account nomic situation in the first quarter of 2009. As a conse- of the balance of payments declined to USD 7.7 billion, quence, inflation declined substantially, partly benefiting from USD 10.1 billion in FY07, which led to 40 percent from a sharp decline in international prices. The fiscal decline in the gross international reserves of the State Bank deficit and external current account deficit had improved of Pakistan (SBP) to USD 8.6 billion at end-June 2008. significantly by the end of FY09. Today, foreign exchange By then, the impact of the global crisis had also hit the reserves have reached a decent level and confidence in the economy through the contagion channels of trade and economy has improved. capital flows, as was the case for Asia in general. Reserves dwindled further to USD 3.4 billion (less than one month 1.3 FINANCIAL SECTOR of imports) as of end-October 2008. The weakening of the economic conditions also led to turbulence in the financial The current structure of the financial sector in Pakistan is markets resulting in severe liquidity shortages in both the the result of several policy shifts and developments. Prior money and foreign exchange markets. to 1971, the primary focus of the governments was on developing commercial banks in the private sector and The fiscal deficit (excluding grants) is estimated to have creating development institutions backed by government. risen from 4.3 percent in FY07 to 7.4 percent of GDP in The private sector development, however, almost clogged FY08 mainly because of a substantial increase in energy during the period 1971–1990, owing to the nationalization and food subsidies (in a context of rising international policy of the government. During this period, the banking prices that were not passed through to consumers), higher sector came under the government’s control. Since 1990s, than envisaged interest payments, and additional security- the government has followed more liberal and market- related expenditures. The deficit was largely covered based reforms. through SBP financing. The financial sector in Pakistan is dominated by banks. All these developments had an adverse impact on the According to the SBP Financial Stability Review 2007– country’s GDP growth, which declined to 2.0 percent in 2008, as of end-June 2008 banks in Pakistan owned 72 FY09. percent of the total assets of the financial sector. As of June 2009, there were 36 commercial banks, 4 special- In these circumstances, the SBP took a number of policy ized banks, 7 Development Finance Institutions (DFIs), measures. To contain inflation, the SBP increased its policy and 8 microfinance banks. The non-bank financial sector rate in several steps and took corrective actions to ease consisted of 11 leasing companies, 9 investment banks, 2 the liquidity conditions in the financial markets. Later on, housing finance companies, 3 venture capital companies, when towards the end of 2008, the economy started to pick and 102 mutual funds. In addition, there were 27 Moda- a positive turn and the outlook of the economy appeared raba and 45 insurance companies in Pakistan. encouraging, the SBP reviewed its policy and decided not to continue with the further tightening of monetary policy. 2010 3 TABLE 1: FINANCIAL SOUNDNESS INDICATORS FOR THE BANKING SYSTEM, 2005–2008 Indicator December 2005 December 2006 December 2007 June 2008 Capital adequacy Regulatory capital to risk-weighted assets 11.3 12.5 13.2 12.1 Asset composition and quality Provisions to NPLs 76.7 66.5 75.0 75.0 NPLs net of provisions to capital 14.3 13.5 8.3 10.2 Earnings and profitability Return on assets (after tax) 1.9 2.1 1.5 1.7 Return on equity (after tax) 25.8 24.2 15.5 16.7 Liquidity Liquid assets to total assets 33.7 32.0 33.6 31.6 Source: Pakistani authorities (Pakistan Request for Stand-By Agreement, November 2008) 1.3.1 Recent Performance of the Banking The National Bank of Pakistan—majority state-owned—is Sector the largest bank in Pakistan in terms of assets and deposits. Over the last 10 years, the Pakistani banking system has Other major banks are HABIB Bank Ltd, United Bank Ltd gradually evolved from a state-owned system to a predom- and MCB Bank. The four largest banks jointly constituted inantly private sector system. This has been largely due to about 45 percent of total assets and 47 percent of total the privatization program of the Government of Pakistan. deposits of the nation’s banking system as of September The liberalization of the financial markets, which resulted 2008. Second-tier banks operate in major cities and are in a number of mergers and acquisitions, was another mostly regional. The National Bank of Pakistan, HABIB driving force behind the reshaping of the banking system. Bank Ltd and United Bank also have operations in Europe and the Middle East. The scope of consolidation through mergers and acquisi- tions has not been limited to the banking sector, but has Foreign banks having a global Tier I paid up capital of been much broader, incorporating the entire financial USD 5 billion, or banks from regional groups of which sector. The mergers among banks and Non-Banking Pakistan is a member, can operate in Pakistan by opening Finance Companies (NBFCs) were further accelerated by a branch, or as a fully owned locally incorporated subsid- the raising of regulatory Minimum Capital Requirements iary. Among the commercial banks there are 6 branches (MCRs) for banks and certain tax incentives offered by the of foreign banks and two large foreign banks that have government in this regard. Over the last 7 years, the SBP established local subsidiaries. Almost half the assets of processed 10 acquisition and 40 merger transactions. Most banks are now owned by foreign banks that are introduc- of the transactions were mergers of investment banks with ing innovation and technological improvements. commercial banks, while the others involved mergers of DFIs/leasing companies with commercial banks. Foreign In general, banks in Pakistan are well capitalized, profitable participation in both ownership and management of the and liquid (see Table 1). banks increased during the last few years. As a result of the restructuring of the Pakistani banking sector, three of the Political instability and the deterioration of the global four largest state-owned banks were privatized. economic environment in 2008, however, resulted in a Chapter 1. Economic and Financial Market Overview 4 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN worsening performance of the banking sector. Some small priorities, the development of the financial infrastructure, and mid-sized banks have experienced serious liquid- especially payment systems. ity problems in 2008 because of deposit withdrawals, which prompted the authorities to reduce the cash reserve 1.4 CAPITAL MARKETS requirement by 4 percentage points in two steps dur- ing October–November 2008 and to broaden the range Capital markets followed a similar path to the banking of assets that can be used to meet the statutory liquidity sector developments described above. In the initial phase requirement. The SBP also facilitated mergers of four small of the development of the securities market, prior to the banks with sound banks. These policy initiatives resulted 1990s, the government, federal as well as provincial, used in improvement of the situation over the next couple of to finance its fiscal deficit through borrowing directly from months, and by the end of March 2009 all banks were the SBP. Companies were predominantly state owned comfortably compliant with statutory liquidity require- and there was no scope for the functioning of an efficient ments. Despite the negative influence of economic slow- securities market. The post-1990 era was marked by liberal down on banking activities (such as a sharp deceleration in and market based economic reforms, which resulted in the private sector credit, weakening deposit growth, deterio- gradual development of equities and fixed income securi- ration in asset quality, and losses in equity investments) ties markets in Pakistan. banks remained adequately capitalized and were able to post a profit of Pakistani Rupee (PKR) 43 billion for 2008. During the five-year period 2004–2008, the market reached its best performance. The overall volume of shares The State Bank of Pakistan has been playing a leading role traded at the Karachi Stock Exchange (KSE) amounted to in strengthening the regulatory framework for banking in 63.4 billion in FY08. During the last year of this period, the country. The central bank’s policies, regulations and however, financial market indicators deteriorated. After supervision systems have been substantially transformed, climbing to new record highs by end-April 2008, the thereby bringing the SBP regulatory and supervisory Karachi KSE-100 index dropped by one third, prompt- framework in line with the international best practices and ing the Karachi Stock Exchange Board to impose a floor norms. This transformation of the central bank was sup- on the decline of all stock prices on August 27, 2008. The ported by the development of capacities and induction of price floor was subsequently lifted in December 2008. highly qualified cadre of staff that has been trained abroad Following the removal of the price floor, the stock market and in-house. Basel II has been implemented in Pakistan witnessed an outflow of foreign portfolio investment and with standardized approaches for Credit and Market Risk this, coupled with a planned phase out of the Continuous and Basic Indicator/Standardized approach for opera- Funding Settlement (CFS) market, as approved by the tional risk from January 1st, 2008. The SBP is planning to Securities & Exchange Commission of Pakistan (SECP), gradually enhance capital requirements for banks and along with other factors, resulted in a sharp decline in DFIs within the next 5 years (see also section 2.5.3). stock markets and the KSE-100 Index went down as low as 4,815 points. Since then, the improvement in some key In 2008, the SBP formulated and published a 10-year economic indicators such as twin deficit, declining infla- strategy for guiding banking sector reforms. The Banking tion trend, relaxation of monetary policy, improvement Sector Strategy (BSS) is centered on reforms involving the of foreign currency reserves along with strong fundamen- SBP and the banking sector, as well as reforms which the tal base of companies has helped the recovery of stock SBP has the power and resources to implement or substan- markets. The KSE-100 Index increased by 12 percent from tially influence. The BBS strategy includes, among other March to end-June 2009. 2010 5 As at end-December 2009, there were 651 companies The government debt market has grown in recent years to listed on the stock exchange with registered capital meet the government’s growing financing needs. However, amounting to PKR 814.5 billion. In 2009, the main types the framework for issuing, pricing and trading govern- of instruments traded in the stock exchange markets were ment securities remains under-developed. equities, corporate debt securities and futures contracts. The Government of Pakistan issues three types of debt The capital market of Pakistan has a triangular founda- securities: Government of Pakistan Market Treasury Bills tion comprising the three stock exchanges, namely the (MTBs), Pakistan Investment Bonds (PIBs) and Govern- KSE, the Lahore Stock Exchange and the Islamabad Stock ment of Pakistan Market-related Treasury Bills (MRTBs). Exchange, the Central Depository Company (CDC), and The Government of Pakistan MRTBs are six months the National Clearing Company of Pakistan Ltd (NCC). treasury bills, which are created when the Government There is also an Over the Counter (OTC) market in borrows directly from the State Bank. In addition, in FY09 Pakistan. the government introduced domestic Shariah compliant government instrument (Ijara Sukuk bonds). The SECP, a financially independent institution, estab- lished under the Act for the establishment of the Securi- The placement of government securities is mostly per- ties and Exchange Commission of Pakistan, No. XLII of formed via auction sales. The SBP is the Ministry of 1997, is the regulator of the securities market in Pakistan. Finance’s agent in the primary market for such securities. The SECP’s main goal is to promote the development Rates are determined by the demand and supply. The rates of a robust corporate sector, protect investors, as well as of the Government of Pakistan MRTBs are determined on mitigate systemic risk by promoting a sound and efficient the basis of weighted average from the last six month Mar- capital market in Pakistan. ket Treasury Bill auctions. Only Primary Dealers (PDs) are allowed to participate in the auctions. The placement The SECP is overseen by the Securities and Exchange of government securities among individuals is performed Policy Board (Policy Board), which is appointed by the through the PDs. Federal Government under the Act for the establishment of the Securities and Exchange Commission of Pakistan, 1.5 MAJOR TRENDS IN PAYMENT No. XLII of 1997. The Policy Board formulates policies SYSTEMS in consultation with the SECP, provides guidance to the SECP, and advises the Government on matters relating to The payments system in Pakistan is characterized by the the securities market. A regulatory framework has been use of credit transfers for interbank large-value payments put in place to create conditions for the effective func- and a cheque-based system for customer payments. The tioning and development of the securities market and is usage of payment cards has increased considerably in constantly improved. Pakistan during the last years. Three types of payment cards are issued in Pakistan: debit cards, credit cards and Securities in Pakistan can be issued in both dematerialized Automated Teller Machine (ATM) only cards (for cash and physical form. All securities traded in organized mar- withdrawals at ATMs). Most of the retail payments, how- kets and settled in Central Securities Depositories (CSDs) ever, are cash based. The Pakistani Rupee (PKR) is the sole are dematerialized or immobilized. legal tender in the country. Chapter 1. Economic and Financial Market Overview 6 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN The two major payment systems in the country are the There are four clearing sessions a day in NIFT. The net Pakistan Real Time Interbank Settlement Mechanism obligations arising from each clearing are sent to PRISM (PRISM)—the large value payment system, and the and settled through participants’ accounts in central bank National Institutional Facilitation Technologies (NIFT)— money. At that moment, the interbank settlement is con- the retail cheque clearing system. sidered final. Small value cheques are processed on T+1, while large-value payments are processed separately and PRISM is the core element of the Pakistani national pay- cleared on the same day basis (T). ment infrastructure. It was launched by the SBP on July 1st, 2008 as a fully automated Real Time Gross Settlement Electronic payment instruments and the related infra- (RTGS) system. PRISM is designed to handle all large- structure have been expanding at a fast rate in Pakistan value payments as well as government securities transac- during the last 5 years. As of end-June 2009, the share tions in the country. The payment component of PRISM of retail electronic payment transactions in the total of settles payments resulting from interbank money market, retail payments (excluding cash) reached 32.3 percent in securities market transactions, foreign exchange transac- terms of volume and 10 percent in terms of value. During tions and net settlement positions of the cheque clearing. FY09, the retail electronic payments grew by 28 percent The second component of PRISM is a securities settlement in volume. For the same period, the growth in volume of system for government securities transactions resulting paper-based payments was slower and accounted for 0.1 from sale/purchase of MTBs and PIBs in the primary percent. and the secondary market. Because of its importance to the financial sector and the economy as a whole, PRISM Electronic retail payments in Pakistan comprise various is considered a systemically important payment system instruments and channels for payments such as debit, for Pakistan. The system is owned and operated by the credit and ATM-only payment cards, Real Time Online SBP. During the first year of its operation (July 2008–June Banking transactions (RTOBs), banking through Call 2009), PRISM processed 236,412 transactions. The value Centre/Integrated Voice Response (IVR), internet and of these transactions was PKR 62.2 trillion, which is 4.8 mobile banking. times the GDP for FY09. The use of payment cards has been growing with a high NIFT is an important part of the payment infrastructure in rate. In June 2009, the number of payment cards reached Pakistan. It is a clearinghouse that is owned by commercial 6.7 million. As of that date there were around 4,000 ATMs banks and provides for centralized multilateral netting of installed across Pakistan and more than 49,715 Point-of- cheques. Although the bulk of the cheques cleared through Sale (POS) terminals installed with merchants in Pakistan NIFT are of small value, there are still large value items were accepting payment cards as a form of payment for processed through this system. In 2007, NIFT clearing goods and services. Payment cards are issued by banks operations were changed from decentralized processing licensed by the SBP. There are two interoperable ATM to centralized multilateral netting on a countrywide basis. card schemes (ATM switches) for payments with payment Under the new arrangements, the NIFT Karachi office cards issued in Pakistan: 1Link and MNet. collects and consolidates data from all NIFT automated centers (14 local offices plus the Karachi office). The International remittances are significant in Pakistan and NIFT system, however, still requires physical exchange of continue to show a rising trend. Banks, International cheques. During FY09, a total of 66.8 million transactions Money Transfer Operators (MTOs) (e.g. Western Union, amounting to PKR 23,749 billion were cleared in NIFT. MoneyGram) and Exchange Companies (ECs) are the 2010 7 main players in the market of remittances. The SBP in securities. In accordance with the legislation of Pakistan, consultation with other stakeholders has taken a number all corporate securities registered in the CDS are demate- of steps to promote the remittance business and to further rialized or immobilized. The cash leg of the transactions enhance the flows of international remittances through the is executed through commercial banks (settlement banks financial system. The efforts undertaken by the SBP have approved by the NCSS), based on the clearing instructions resulted in total remittances to reach historic high level of from the NCSS on Delivery versus Payment (DVP) basis.3 USD 7.8 billion in FY09, registering a growth of 21 per- cent over FY08. Another breakthrough related to the All government securities are issued in dematerialized remittances was the launching of the Pakistan Remittance form and are registered in accounts with the central depos- Initiative (PRI) by the Federal Government and the State itory. The SBP is the operator of the securities settlement Bank of Pakistan, which is expected to bring a fundamen- system and the central depository for government securi- tal change in the country’s remittance service regime to ties. Each bank holds government securities accounts boost and facilitate the flow of remittances sent to Pakistan with the SBP. Transactions are settled by book-entry. The by non-resident Pakistanis. system for settlement of government securities for both the primary and the secondary market transactions is part For cross-border payments, the SBP and most commercial of PRISM and as such is integrated with the settlement of banks use the SWIFT network with settlement being made funds. through foreign correspondent banks. Transactions with government securities are settled on the 1.6 MAJOR TRENDS IN SECURITIES same day basis (T). Transactions with corporate securi- SETTLEMENT SYSTEMS ties traded at the three stock exchanges and cleared in the NCSS are settled on T+2 and T+1 (for spot trades). Non- The trading, clearing and settlement infrastructure for exchange transactions are registered for clearing in the securities has been gradually modernized in Pakistan. NCSS based on the information provided by the seller and The following institutions are involved in the clearing and the buyer of securities. settlement of securities: the National Clearing Company of Pakistan Limited (NCC), the Pakistan Central Depository The NCC and the CDC in cooperation with participat- Company (CDC), the SBP Central Securities Depository ing banks, Non-Bank Financial Institutions (NBFIs), (SBP CSD), and commercial banks. and brokers have been working together to establish an efficient and transparent clearing and settlement for all A National Clearing & Settlement System (NCSS) was types of securities. Efforts are ongoing at the NCC to fully implemented in 2004 as a single and centralized introduce comprehensive risk management system and to entity to replace the separate and individual Clearing implement securities lending and borrowing through the Houses of the three stock exchanges (in Karachi, Lahore NCC. The NCC is also working with the stock exchanges and Islamabad). The NCSS is managed by the NCC. The to provide centralized clearing and settlement along with NCSS clears all book-entry securities that are registered in risk management of corporate debt securities. the Central Depository System (CDS). The CDS is an electronic book-entry system for the 3 See Delivery versus Payment in Securities Settlement Systems, the Committee registration and transfer of securities. It is operated by on Payment and Settlement Systems of the Central Banks of the Group of Ten the CDC, which also acts as a custodian for corporate Countries of the Bank for International Settlements, September 1992. The report describes three DVP models. Chapter 1. Economic and Financial Market Overview 8 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN Further strengthening of the oversight of the stock (UIN), by the NCC through centralized registration in the exchanges and the brokers is important. To this end, the NCSS, for every person who holds shares and trades on SECP plans to continue enhancing market surveillance to the market provides a powerful tool for detecting market detect insider trading and market manipulation, build an abuse. The SECP surveys trading in real time using state- effective oversight program of the three stock exchanges, of-the-art technology, and prohibition on insider trading the NCC and the CDC, as well as improve monitoring was strengthened earlier this year. The stock exchanges are and enforcement of compliance with the law by brokers. planning to adopt similar technology to replace their cur- The introduction of a Unique Identification Number rent manual systems for detecting market abuse. CHAPTER 2 INSTITUTIONAL ASPECTS 2.1 GENERAL LEGAL FRAMEWORK Furthermore, Art. 18 gives the power to the SBP to “nomi- nate one or more Clearing Houses to provide [ . . . ] services 2.1.1 Payments for a Payment System, [ . . . ] conduct audits and inspec- The legal framework related to payments, payment instru- tions”, to require information in advance of any significant ments and payment systems in Pakistan is comprised of changes in relation to the payment system and to “make laws and regulatory documents issued by the SBP. settlement rules”. Finally, the Act gives regulatory power to the SBP with respect to Electronic Money Institutions and The Payment System and Electronic Fund Transfer Act operators of retail payment schemes. (PSEFT Act), 2007, frames the legal framework for the reg- ulation of payment systems and electronic fund transfers The Banking Companies Ordinance, 1962 (BCO), the in Pakistan. It provides standards for consumer protection State Bank of Pakistan Act, 1956 (SBP Act),4 and the and determines respective rights and liabilities of financial Banking Company Rules 1963, issued under the BCO (last institutions and other payment service providers, their amended in June, 2007) provide the main legal structure consumers and participants in payment systems. The Act under which the banking system of Pakistan operates. establishes a sound legal basis for safe functioning of pay- Banking Companies are licensed under section 27 of ment systems by dealing with a broad range of risk-related BCO. Once licensed, banks are scheduled under section issues such as irrevocability of payments and settlement 37 (2) of the SBP Act after they meet strict requirements finality (Art. 21 and Art. 25), validity and enforceability of of capital adequacy, cash and liquid reserves maintenance, netting arrangements (Art. 25), and finality of settlement transactional record keeping, as well as upholding finan- of government securities. cial and managerial discipline. They are also required to establish internal control, internal audit and compliance The payment system objectives and responsibilities of systems. Banks are supervised and are required to follow the SBP derive from the PSEFT Act. The SBP may by law the guidelines/rules/regulations issued by the SBP. Articles designate a payment system or a payment instrument 35 to 39 provide the requirements for audits and rights (Art. 4 and Art. 12) as subject to its control. The SBP can for inspections of banks by the SBP. Art. 40 stipulates also issue rules, guidances, circulars, by-laws, standards the responsibility of the SBP to monitor every banking or directions with respect to such system or instrument in company in Pakistan so as to ensure that it is compliant pursuing its objectives to promote monetary stability and with the applicable statutory criteria and banking rules a sound financial structure (Art. 3). It may also establish and operate one or more RTGS systems. Art. 11 establishes 4 Efforts are underway to revise the central bank law, the main goal being to requirements for the operator of a designated payment better reflect the current functions, powers, and objectives of SPB. The draft law system. is being finalized. 9 10 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN and regulations. Art. 41 defines the powers of the SBP and by the SBP in March 2009,5 govern the operation of the Chapter III elaborates on the procedures for suspending of system and participants’ conduct. The rules also con- business and winding up of banking companies. tain provisions as regards financial and operational risk management, such as irrevocability and settlement finality To enhance the effectiveness of the SBP enforcement pow- of payments processed by the system, intraday liquidity ers, necessary amendments to the BCO have been drafted. provisions and access requirements. Several manuals have These amendments aim at strengthening the SBP’s ability been issued and provided to participants in the system, to (i) change management in banks; (ii) impose losses on such as the Manual for Operators of PRISM Terminals shareholders by writing down their capital; (iii) intervene (Operator Work Place). and take ownership of banks; (iv) appoint administrators to operate banks; and (v) restructure banks. The SBP Banking Services Corporation (SBP BSC) is a SBP subsidiary, which has been established to carry out In addition, the SBP also licenses microfinance banks all operational functions and activities of the SBP, includ- under the Microfinance Institutions Ordinance (2000– ing maintenance of the accounts of the federal Govern- 2001) in terms of the licensing criteria for microfinance ment, provincial Governments, local Governments, other banks. Commercial banks are also allowed to undertake authorities, institutions, companies, corporations and microfinance banking activities through a range of options of other banks and financial institutions. The SBP BSC’s for conducting the microfinance business. Furthermore, responsibilities are defined in the Ordinance to Provide for the SBP issues Regulations for Shariah Compliance in Establishment of SBP BSC. Islamic Banking Institutions. Under the prevalent legisla- tive structure, the SBP also has supervisory responsibili- The relevant legislation dealing with collateralized loans ties with respect to DFIs while the rest of the financial and repo transactions includes the State Bank of Pakistan institutions are monitored by other authorities such as the Act, 1956 (Art 18. Power of Direct Discount), the PSEFT Securities and Exchange Commission (see section 2.1.2). Act (Art. 22), and the Operating Rules for Participation in Pakistan Real Time Inter Bank Settlement Mechanism. In March 2008, the SBP issued Branchless Banking The latter Rules define the procedures for extending over- Regulations, with a view to encouraging innovation and night credit to participants in PRISM against collateral in increasing outreach of the banking system. The Regula- the form of repo transactions. The list of eligible collateral tions, which are applicable to all banks including Islamic includes government debt securities only. and microfinance banks, define branchless banking activities as a delivery channel to offer banking services in The foreign exchange business in Pakistan is governed a cost effective manner. The regulations also outline activi- under the Foreign Exchange Regulations Act, 1947 ties that constitute branchless banking; set out minimum (FERA). The Foreign Exchange Manual outlines the rules standards of data and network security, as well as customer for the licensing and activities of Authorized Dealers protection and risk management to be followed by banks (ADs) and ECs. desiring to offer mobile banking services. According to these regulations, only authorized financial institutions Other laws and regulations that are relevant to payments can provide branchless banking services. include: The Operating Rules for Participation in Pakistan Real Time Inter Bank Settlement Mechanism (PRISM), issued 5 The RTGS Rules have been drafted after seeking feedback from all the partici- pants via Pakistan Bankers’ Association and from relevant SBP departments. 2010 11 • Electronic Transactions Ordinance, 2002 (LI of are traded on the stock exchange market, as well as those 2002); traded on the OTC market and reported to the securities exchange, are registered in dematerialized form in the CDS • Company Ordinance, 1984; of the Central Depository Company. Art 4 of the Central • Prudential Regulations for Corporate/ Depository Act, 1997, stipulates that any security issued Commercial banks, issued by the SBP; or registered in the central depository should be kept as • Memorandum of Understanding (MoU) book-entry securities. The same article defines the account between the SBP and NIFT. structure, transfer of book-entry securities, and pledge of such book-entry securities. The title to any book-entry 2.1.2 Securities securities entered in an account or sub-account shall vest The issuance of government securities in Pakistan is gov- in the account holder and sub-account holder respectively. erned by the Public Debt Act, 1944, while the Companies The Central Depository Companies (Establishment and Ordinance, 1984 and the Central Depositories Act, 1997 Regulation) Rules, 1997, regulate, among other issues, the (XIX of 1997), govern the issuance of corporate securities. lending and borrowing of securities to support the settle- ment of market transaction. The CSD and the NCC have The Securities and Exchange Commission of Pakistan Act, been working together to implement securities lending 1997, defines the scope of responsibilities and activities and borrowing through the NCC. of the Securities and Exchange Commission of Pakistan. The SECP is entrusted with a wide range of supervisory According to the PSEFT Act, 2007, government securi- responsibilities, including the corporate sector, public ties are registered and transferred in book entry form. “A companies, stock exchanges, clearing companies and secu- Payment System” in the PSEFT Act is broadly defined to rities depositories, as well as the insurance sector, NBFCs, include not only systems for transfer of funds but also private pension funds and housing finance. “clearing, settlement or transfer of Book Entry Govern- ment Securities”. Therefore, most of the provisions of the The law stipulates that NBFCs (leasing companies, invest- law related to fund transfer systems are also applicable ment banks, discount houses, housing finance companies, and valid for clearing and settlement of government venture capital companies, mutual funds), Modarabas,6 securities. Stock Exchange and Insurance Companies fall within legal ambit of the Securities and Exchange Commission The Central Depository Act creates a two-tier depository of Pakistan. A MoU between the SBP and the SECP is the structure for corporate securities. Participants (in the stock basis for information sharing and other issues relating to exchange) are allowed to hold sub-accounts on behalf of the cooperative approach in supervising and regulating their customers and to order transfer of securities between financial institutions. accounts on their behalf. The Company Ordinance Act regulates the securities custody/nominee holding activities The Central Depository Act, 1997, provides the basic of financial institutions. principles for the functioning of CSDs. Securities that The Clearing House Companies (Registration and 6 Modaraba represents a form of partnership where one party provides the Regulation) Rules, 2005, define the requirements for the funds while the other party provides expertise and management. Any profits registration of a clearing house, its activities as well as the accrued are shared between the two parties on a preagreed basis, whereas the loss is borne by the provider of the capital. The Modaraba companies are establishment of a guarantee clearing and settlement fund. regulated through the Modaraba Companies &Modarabas (Flotation & Control) Ordinance 1980. Chapter 2. Institutional Aspects 12 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN The Securities and Exchange Ordinance, 1969, empow- Furthermore, the National Clearing Company of Pakistan ers the recognized stock exchanges, clearing houses and Limited Regulations, 2003, the NCSS Procedures, 2003, central depositories to make regulations with the prior and the Rules and Procedures of the exchanges define the approval of Securities and Exchange Commission of procedures and risk management mechanisms for trading, Pakistan. clearing and settlement of derivatives transactions. Other legal acts regulating securities clearing and settle- Derivatives were first introduced in the Karachi Stock ment include: Exchange in 2003 as Deliverable Future Contracts and later on in 2007 in the form of Non-Deliverable Future • The Non-Banking Finance Companies Contracts. However, the trading of derivatives is very lim- (Establishment and Regulation) Rules, 2003; ited due to the absence of price discovery and convergence • The National Clearing Company of Pakistan mechanics. Limited Regulations, 2003; • NCSS Procedures 2003; 2.2 ROLE OF FINANCIAL INSTITUTIONS: PAYMENTS • Operating Rules for Participation in Pakistan Real Time Inter Bank Settlement Mechanism 2.2.1 Banking Sector (PRISM); In accordance with the State Bank of Pakistan Act, the • Financial Institutions (Recovery of Finances) banking system of Pakistan is a two-tier system including Ordinance, 2001(XLVI of 2001). the State Bank of Pakistan, commercial banks, specialized banks, DFIs, microfinance banks and Islamic banks. As of In addition, the rights and obligations of participants in June 2009, the banking sector comprised 55 institutions, different payment and settlement systems are specified in among which were 36 commercial banks (including 25 bilateral or multilateral agreement between participants local private banks, 4 public sector commercial banks and and system operators. 7 foreign banks), 4 specialized banks, 7 DFIs and 8 micro- finance banks. Among the banks, there were 6 fully fledged 2.1.3 Derivatives Islamic banks, as at end of June 2009. The Securities and Exchange Ordinance, 1969, defines the types of securities that may be issued and traded on the The SBP provides payment services to banks, to the federal organized markets, including commodity and financial and provincial Government Pakistan, the Treasury and derivatives. Normative documents issued by the SECP some other public institutions. with respect to trading and settlement of derivatives include the following: Banks in Pakistan provide settlement and cash services to individuals and companies, including correspondent- • Regulations governing deliverable future con- banking. Banks also offer domestic and cross-border tracts of the KSE, 2008; remittance services to the population. Furthermore, they • Regulations governing risk management of the provide depository services for the accounting and safe- KSE, 2008; keeping of securities. During the last few years, banks have • Regulations Governing Cash Settled Futures been paying great attention to the expansion of services Contracts’ of the Exchange. rendered to households and the enhancement of their quality and efficiency. New forms and channels of making 2010 13 payments have been introduced, such as electronic bank- • paying money resources received from over ing, use of payment cards, and Internet services. 190 countries/territories worldwide to Pakistan under a special agreement with Western Union. 2.2.2 Other Institutions that Provide Payment Services Moreover, the Pakistan Post can offer the following finan- Non-bank institutions cial services associated with servicing individuals: Exchange Companies are specialized companies that • Selling life insurance contracts; provide Foreign Exchange (FX) and remittance ser- • Offering saving account services via the vices in Pakistan. The foreign exchange business of such Pakistan Post Savings Bank. companies is governed by the FERA (1947), the Foreign Exchange Manual and the FX Circulars issued by the Exchange Policy Department of the State Bank of Paki- 2.3 ROLE OF FINANCIAL stan. As of end-September 2008, there were 24 Exchange INSTITUTIONS: SECURITIES Companies registered with the SBP. Other institutions that 2.3.1 Securities Market Participants provide cross-border payment services are MTOs (such as Western Union, MoneyGram). Professional securities market participants in Pakistan are engaged in a variety of activities. They can operate in the The newly adopted Branchless Banking Regulations securities market on instruction and on behalf of their (March 2008) allows so-called agents to intermediate pay- clients (broker activity), buy and sell securities on their ments between banks or telecom operators and customers own (dealer activity), act on instruction of an issuer in the with the objective of increasing the outreach of payment process of primary sales of securities, provide asset man- services to unbanked and rural communities. agement services and depository services. Pakistan Post The NBFCs established under the Companies Ordinance The Pakistan Post plays a broad and varied role that goes can provide securities market intermediation after obtain- beyond what is traditionally regarded as its core postal ing a license from the SECP. The Non-Banking Finance business. The Pakistan Post via its branches provides a Companies (Establishment and Regulation) Rules, 2003, secure and affordable mode to remit. The following types allow NBFCs a diverse operational spectrum, including of payment-related services are offered to the general various business activities in the securities markets. As population: of September 2009, there were 56 NBFCs and 60 insur- ance companies, many of them offering securities market • receiving money resources to make postal (tele- services. graph) transfers, including international postal transfers; Members of the stock exchanges in Pakistan can be indi- • receiving money resources to make payments to viduals or corporate companies, which meet the criteria other organizations (payments for utilities); laid down in the Rules of the exchange and which have purchased a seat. To settle securities transactions, stock • paying money resources against postal (tele- exchange members are required to become members of graph) transfers including international postal the NCC and the CDC. transfers; Chapter 2. Institutional Aspects 14 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN In order to reduce risks in securities transactions, mini- The settlement of the payment leg of the securities transac- mum capital and technical requirements to professional tions is executed through commercial banks (settlement participants have been established in various regula- banks), based on the clearing instructions from the NCSS tions and rules of the securities market institutions. Such on a DVP basis. For the OTC and free of payment transac- requirements have been developed to meet international tions participants send settlement instructions directly to standards and best practices. the CDC. 2.3.2 Exchanges, Clearing Houses, Central The CDC was incorporated in 1993 and became opera- Depositories tional in 1997. With exponential growth in the Pakistani The infrastructure for corporate securities trading, clear- capital market resulting in manifold increase in trad- ing and settlement comprises three interconnected stock ing volumes, the physical handling of paper certificates exchanges, the NCC, the CDC and settlement banks. not only became laborious but also time consuming. The manual system was no longer feasible. It was in this Corporate securities are traded at stock exchanges in perspective that CDC was incorporated to manage and Karachi, Lahore and Islamabad, where the Karachi Stock operate the Central Depository System. The CDS is an Exchange is the biggest and most liquid exchange. As of 31 electronic book entry system to record and transfer securi- December 2009, 651 companies were listed with market ties. An IBM -led consortium along with the management capitalization of PKR 2,706 billion. There were 165 active of the company implemented the CDS in Pakistan. The members of the KSE as of July 2008. The average daily CDC offices at Lahore and Islamabad are connected to the turnover for year 2009 was 179.9 million shares with aver- head office through VSAT link. As of end-June 2009 there age daily trade value PKR 7.5 billion. were 722 securities (issuers) registered with the CDC and 775 CDC members. The following securities are traded at the stock exchanges in Pakistan: corporate shares, corporate bonds7 and futures 2.4 MARKET STRUCTURE AND contracts. The OTC market transactions are agreed out- REGULATION side the exchanges and cleared in the NCSS. Two agencies are responsible for the regulation and super- The NCC was incorporated on July 3, 2001 to manage vision of entities providing financial and payment services: and operate the NCSS as a fully automated electronic the SBP and the SECP. The SBP is the sole regulator and settlement system. NCSS’ live operations commenced in supervisor of banks in Pakistan. It promotes the estab- December 24, 2001. The company became fully opera- lishment and development of safe and efficient payment tional in 2003-04 by inducting and handling clearing and systems to serve interbank markets as well as retail pay- settlement of all book-entry corporate securities. In March ments in the country. In addition, the SBP is responsible 2006, the NCC was registered under the Clearing House for supervising all transactions in the foreign exchange, Companies (Registration and Regulations) Rules, 2005. As credit and money markets. Due to its responsibility for the of September 2009 there were 421 active clearing mem- money market, the SBP, and the Ministry of Finance, have bers comprising 297 brokers and 124 non-broker clearing jurisdiction over government securities. members. The SECP is the regulator of the securities market. It was set up in pursuance of the Securities and Exchange Com- 7 Some corporate bonds termed as Term Finance Certificates (TFCs) are listed mission of Pakistan Act, 1997, as a financially independent on the stock exchange but are not traded at the stock exchange. 2010 15 institution with the main goal of promoting the develop- The SBP works in close cooperation with the Ministry ment of robust corporate sector, protecting investors and of Finance through the Co-ordination Board. The major mitigating systemic risk by promoting sound and efficient responsibilities of the Co-ordination Board is the coor- capital market in Pakistan. Since 1999, the SECP mandate dination of fiscal, monetary and exchange rate policies in has expanded considerably. Initially, the institution was the country and ensuring that these policies are consistent responsible for the regulation of corporate sector and with the macro-economic targets of growth and inflation. capital markets (public companies, financial intermediar- The Board is chaired by the Federal Minister for Finance ies, stock exchanges, clearing companies and securities and comprises members from the Government and the depositories). Over time, the SECP has been given the SBP. power to license and regulate insurance sector, NBFCs, as well as pension funds and house financing. The Securities 2.5.1 Monetary Policy and other Functions and Exchange Policy Board (Policy Board) is responsible The objective of monetary policy in Pakistan, as laid down for formulating policies in consultation with the SECP, to in the SBP Act of 1956, is to achieve the targets of inflation provide guidance to the SECP and to advise the Govern- and growth set annually by the government. In pursuit of ment on matters of the securities market. this mandate, the SBP formulates the country’s monetary policy consistently with these announced targets. Con- In 2003, the SECP and the State Bank of Pakistan signed a sidering the economic and financial market structure in MoU for close cooperation in supervising and regulating Pakistan, the SBP has for sometime pursued a monetary the financial sector. As the financial sector continues to targeting regime with broad money supply (M2) as a develop in Pakistan, coordination between these entities nominal anchor to achieve the objective of controlling will become increasingly important. inflation without any prejudice to growth. The goal is to keep M2 close to its estimated demand level. The changes 2.5 ROLE OF THE CENTRAL BANK in monetary policy are signaled through adjustments in the policy discount rate (3-day repo rate). The SBP Act (1956) designates the SBP as the central bank of Pakistan. The law empowers the SBP “to regulate the Moreover, changes in the policy rate are complemented by monetary and credit system of Pakistan [ . . . ] with a view appropriate liquidity management mainly through Open to securing monetary stability and fuller utilization of the Market Operations (OMOs) and, if required, changes country’s productive resources”. The head office of the SBP in the Cash Reserve Requirement (CRR) and Statutory is located in Karachi. Liquid Reserve requirement (SLR) are also made. As of end-June 2009, the CRR and SLR were 5 percent and The SBP responsibilities encompass issuing notes,8 conduct- 19 percent respectively. Over October-November 2009, ing monetary policy, maintaining the value of the national the SLR was abolished for time liabilities of one year and currency, supervising and regulating the banking industry, higher tenor. providing payment services, acting as a banker to the government and to banks, and acting as custodian for the 2.5.2 Involvement in the Payments System country’s foreign reserves. The governing body of the SBP The SBP is at the centre of the national payments system. is the Central Board of Directors, which formulates and It plays a major operational role as operator and owner of monitors monetary and credit policy. PRISM (the RTGS system). The SBP also operates the cen- tral depository for government securities (which is part of 8 As from July 1st, 1948, the SBP took over the management of the national PRISM). The securities settlement system for government currency from the Reserve Bank of India. Chapter 2. Institutional Aspects 16 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN securities facilitates electronic trading and settlement thus is expected that the on-going reforms in the retail payment eliminating the manual processing of securities transac- systems will take 2–3 years to be completed. tions. It reduces settlement risk by providing real-time settlement on a DVP basis (see also section 6). 2.5.3 Banking Supervision The SBP is in charge of the prudential supervision of The SBP provides safe settlement assets for all interbank banks. The SBP supervisory policies and practices are payments settled through the RTGS system. All partici- based on the Core Principles for Effective Banking Super- pants in PRISM are required to keep settlement fund vision issued by the Basel Committee on Banking Super- accounts with the SBP. vision. In recent years, the SBP has adopted a number of measures to make the banking supervision more efficient The SBP is responsible for the regulation and oversight of in order to establish a safe and sound banking system. In all recognized payment systems and payment instruments particular, the following changes and risk management in the country. As part of its oversight function, the SBP tools have been implemented: rules for acquisitions and has been working continuously to ensure that the overseen major investments of banks; market risk-related computa- systems comply with international standards and best tions and capital charges; clearer definition of “connected practices. or related parties”; requirements for banks to maintain information and management systems that allow for The on-going projects for further improvements in pay- proper identification, monitoring, and collecting of coun- ment systems in Pakistan include: try risks. • The implementation of Intraday Liquidity Facilities (ILFs) and gridlock resolution mecha- Circular No. 9 dated July 29, 2006 of the Banking Policy nisms in the RTGS system aiming at reducing Department (BPD) introduced requirements for banks/ liquidity risk; DFIs to obtain prior approval in writing from the State Bank to purchase shares of a company that exceeds 5 per- • The implementation of standards for cheque cent of the paid-up capital of the company or 10 percent of payment instruments; the capital of the investee company, whichever is lower. • Further improvements in operational risk man- agement and business continuity planning; The market risk related amendment was implemented in Pakistan via the Banking Surveillance Department (BSD) • The development and publishing the SBP Circular No. 12 of 2004 according to which banks were Payment Systems Oversight Strategy; required to maintain capital against market risk as from • The creation of a National Payments Council. December 31st, 2004. In addition, the SBP has been encouraging the intensive In terms of Prudential Regulations for corporate/com- use of efficient electronic payment instruments and chan- mercial banking, a definition of a Group has been intro- nels, such as payment cards and mobile banking, through duced to denote persons, whether natural or juridical, promoting a high level of standardization, schemes that who directly or via his dependent family members or its allow straight-through-processing and the development subsidiary have control (direct or indirect ownership) of of the infrastructure. This modernization of retail pay- more than one half of the voting powers of an enterprise or ment services is a complex task, as it involves extensive hold substantial ownership interest (beneficial sharehold- consultations with a multitude of different stakeholders. It ing of more that 25 percent) over the other. 2010 17 The requirements for identification, monitoring and In order to further strengthen the solvency of individual collecting of country and transfer risk were implemented banks and DFIs, in October 2008 the SBP decided to raise via BSD Circular No. 3 of 2004 and banks were required the MCRs as well as the Capital Adequacy Ratio (CAR) to put in place a mechanism to assess and monitor the calculated as per Basel II. The minimum Paid up Capital country risk within three months from the issuance of the requirements for all locally incorporated banks were raised Circular. to PKR 23 billion (net of losses) to be achieved in a phased manner until end-2013. DFIs were required to raise More recently, the strengthening of the consolidated their paid up capital (free of losses) to PKR 5 billion by supervision and estimation of credit risk concentra- December 2008 and PKR 6 billion by December 2009. The tions have been in the focus of banking supervisors. required minimum CAR, on consolidated as well as on Consolidated supervision is achieved through coordina- standalone basis, has been increased for banks and DFIs tion between the SBP and the SECP under a MoU. The to 10 percent. Furthermore, all banks/DFIs are required process of creating legal basis for consolidated supervision to maintain variable CAR based on CAMELS-S Rating has started with amendments proposed to the Federal assigned by the State Bank to each bank and DFI. Government in the Banking Companies Ordinance, 1962. Once amendments are approved, the SBP would have the To enhance the effectiveness of SBP enforcement powers, authority to carry out consolidated supervision as lead amendments to the Banking Companies Ordinance have supervisor. As regards the cooperation with foreign super- been proposed. These amendments aim at strengthen- visory authorities as per the requirement of the Committee ing the SBP’s ability to (i) change management in banks; on Payment and Settlement Systems (CPSS) of the Bank (ii) impose losses on shareholders by writing down their for International Settlements (BIS) Core Principles for capital; (iii) intervene and take ownership of banks; (iv) Systemically Important Payment Systems (CPSIPS), the appoint administrators to operate banks; and (v) restruc- SBP has already taken an initiative in signing MoUs with ture banks. 16 supervisory authorities of other countries especially with countries where Pakistani banks have established Transition of the Pakistani banking system to the Inter- branches. national Accounting Standards was completed prior to January 1, 2008. Islamic Banking Institutions prepare and In addition, the SBP has been playing a leading role in pro- submit to the SBP reports following the Islamic Financial moting the development of Islamic banking in the country Accounting Standard -1 “Murabaha”. and monitoring of the associated risks. 2.5.4 Anti-Money Laundering Measures Implementation of Basel II in Pakistan commenced on A standalone law on anti-money laundering, namely The January 01, 2008. In this context, all banks/DFIs were Anti-Money Laundering (AML) Ordinance was intro- required to implement the Standardized Approaches of duced in 2007, with the aim at protecting the financial Basel II from January 01, 2008. The SBP has decided that sector from being used for money laundering and other the transition to the Advanced Approaches of Basel II will financial crimes. The SBP has major contribution in draft- be discretionary for all banks/DFIs and subject to prior ing and finalization of the law. The Ordinance criminal- written approval of the State Bank. Those institutions that izes money laundering and requires financial institutions plan to make a transition to the Advanced Approaches to submit Suspicious Transaction Reports and extend within the next five years, are required to submit their mutual legal assistance on a bilateral basis. The thrust of Action Plans to the BSD. the law is to meet Financial Action Task Force (FATF) Chapter 2. Institutional Aspects 18 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN recommendations. The SBP has undertaken a develop- CSDs, stock broker companies, investment companies mental project with the objective of devising tools that and public companies. The scope of the SECP regulatory would help it in assessing the preparedness of banks to responsibilities includes also NBFIs, such as insurance effectively implement anti-money laundering measures. companies and leasing companies. 2.5.5 Agent of the Government The Securities and Exchange Policy Board is responsible The SBP acts as agent to the Federal Government, Provin- for policy making, coordination with the Federal Govern- cial Governments and Local Authorities in the following ment and oversight of the performance of the SECP. It also transactions: specifies fees, penalties and other charges chargeable by the SECP. • the purchase and sale of gold or silver or approved foreign exchange; According to the Act for the Establishment of the Securi- • the purchase, sale, transfer and custody of ties and Exchange Commission of Pakistan, the Board bills of exchange, securities or shares in any and the SECP are empowered to issue regulations and company; impose penalties for the violation of rules and regulations • the collection of the proceeds, whether principal of the Act. The SECP has also the power to issue direc- or interest, profit, dividend or other return, of tives, codes, guidelines, circulars or notifications, and may any securities; conduct investigations in respect of any matter that is an offence under the Act or any other law administered by the • the remittance of such proceeds at the risk of the SECP. For more details see Section 8. principal, by bills of exchange payable either in Pakistan or elsewhere; 2.7 ROLE OF OTHER PRIVATE AND • the management of public debt; PUBLIC SECTOR ENTITIES • the transaction of special drawing rights with 2.7.1 Pakistan Banks’ Association the International Monetary Fund. The Pakistan Banks’ Association (PBA) was established in 1953 and has currently 48 members. Its main objective is In addition, the SBP is the operator of the CSD for to coordinate the efforts of the banking industry, and to government securities. share a common vision of progress and development with its members. PBA membership is institutionalized and is 2.6 ROLE OF THE SECURITIES available to all banks operating in Pakistan. Its governing REGULATOR body is an Executive Committee comprising 14 members, represented by the Chief Executives of the respective The SECP is responsible for encouraging the organized member institutions. Presently, the PBA has 10 functional development of the capital market, the corporate sector sub-committees. and the insurance market in Pakistan, and promoting and regulating development of Private Pension Schemes and The SBP consults the PBA for expert opinion in formula- Funds. tion of regulations for the banking industry. With respect to matters related to payment systems in Pakistan, the PBA The SECP is entrusted with the regulation of the busi- was involved in drafting the Operating Rules for Participa- ness of stock exchanges, clearing houses for securities and tion in PRISM and several ad hoc working groups were 2010 19 established for the implementation of the RTGS project. mission statement, namely “ . . . to actively promote the Further, the PBA is regularly consulted by the SBP in educational, professional, ethical, and social interest of the developing regulations for new retail payment instrument financial markets and the banking industry”. The FMAP and services. is consulted by the SBP on issues relating to government securities, money market, and foreign exchange markets. 2.7.2 Association of Securities Market The members of the association are drawn from dealing Participants room staff of all scheduled banks, NBFCs and FX/Money The Financial Markets Association of Pakistan (FMAP) Market Interbank Brokerage Houses. The FMAP has more was formed in 1997 as a non-commercial, non-profit and than 285 Members. The FMAP also conducts seminars, self-financed organization of dealers of financial instru- training programs, and symposia to facilitate the achieve- ments. The FMAP’s main tasks are elaborated in the ment of its stated objectives. Chapter 2. Institutional Aspects CHAPTER 3 PAYMENT MEDIA USED BY NON-FINANCIAL ENTITIES 3.1 CASH TABLE 2: BANK NOTES AND COINS (IN PKR BILLION) Cash is the most relevant payment instrument for indi- FY08 viduals, representing about 67 percent of reserve money Total currency issued 1,054.2 M0 (as of end June 2009) and 29 percent of total deposits. Total banknotes issued 1,045.8 In some rural areas, cash is the only means of payment. Coins issued 8.4 of which: The currency in Pakistan is the Pakistani Rupee (PKR) One-Rupee coins and above 7.7 which is the sole legal tender in the country. The SBP is Subsidiary Coins 0.7 the only issuer of the national currency. The SBP designs Source: SBP. and prints banknotes, distributes them, replaces damaged ones, and identifies and removes from circulation coun- terfeit notes. As of end June 2009, the exchange rate versus and coins. The amount of currency in circulation as of the US dollar was 81.2 PKR for 1 US Dollar. June 2008 was PKR 982.3 billion, which was equal to approximately 11 percent of the GDP. The upward trend Banknotes are issued in the following denominations: 10, in the amount of currency in circulation shows that cash 20, 50, 100, 500, 1000, and 5000. As of June 2009, PKR is still the preferable means of payment in Pakistan. Coins 1152.2 billion were in circulation, including bank notes are issued in denominations of 1, 2 and 5 PKR. FIGURE 1: CURRENCY IN CIRCULATION (IN PKR BILLION) 1200 1152.2 982.3 1000 840.2 800 740.4 665.9 600 400 200 0 FY 05 FY 06 FY 07 FY 08 FY 08 Source: SBP. 21 22 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN 3.2 PAYMENT MEANS AND The NIFT clearing system was recently upgraded to sup- INSTRUMENTS OTHER THAN CASH port the implementation of the Real-time Gross Settle- ment System at the SBP. For details, see section 4.1.2. During FY09, a total of 495.1 million retail payment transactions (paper-based and electronic payments) were 3.2.2 Direct Credits and Direct Debits recorded valuing PKR 155.4 trillion; this represents a The growth of electronic based payment instruments is growth of 7 percent in the volume and 2.5 percent in the gaining momentum in view of the increased investment value of transactions compared to FY08. in infrastructure by the banks, the SBP’s efforts to create an enabling policy environment, and launch of innovative 3.2.1 Cheques products by banks. Electronic retail payments in Pakistan Paper-based instruments dominate retail payments in consist of various instruments and channels for payments Pakistan. During FY09 paper-based transactions con- such as payment cards, RTOBs, banking through Call stituted 67.7 percent of the total number and around 90 Centre/IVR, internet and mobile banking. However, these percent of the total amount of non-cash transactions. services are still limited to a small portion of the popula- Both the volume and value of paper-based transactions tion in the country. was largely driven by cheques. This payment instru- ment is used for cash withdrawals and for funds transfers Electronic payment instruments and the related infra- through cheque clearing. Cheques are the preferred mode structure have been expanding at a fast rate in Pakistan of payment for commercial transactions, as well as for during the last 5 years. The number of electronic transac- government payments. The share of other paper-based tions increased year-to-year by 28 percent during FY09 instruments (Pay Orders, Demand Drafts, Telegraphic to 159.8 million, while over the same period paper-based Transfers, etc . . . ) is less than 10 percent in terms of the transactions registered a marginal increase of 0.1 percent total value and volume of paper-based transactions. In to 335.3 million. The impact of these differences in growth order to improve the efficiency of clearing and settlement rates is clearly visible from the increasing share of elec- of paper-based instruments, the SBP facilitated a consor- tronic transactions in the total number of transactions to tium of banks and a firm based in the private sector to set 32.3 percent during FY09 as compared to 27.6 percent in up a semi-automated clearinghouse namely the National FY08. Institutional Facilitation Technologies (NIFT), in 1995. FIGURE 2: VOLUME OF RETAIL PAYMENTS (IN THOUSANDS) 350,000 ■ Electronic Based ■ Paper Based 300,000 250,000 200,000 150,000 100,000 50,000 0 FY 05 FY 06 FY 07 FY 08 FY 09 Source: SBP. 2010 23 FIGURE 3: VALUE OF RETAIL PAYMENTS (IN PKR BILLION) 140,000 ■ Electronic Based 120,000 ■ Paper Based 100,000 80,000 60,000 40,000 20,000 0 FY 05 FY 06 FY 07 FY 08 FY 09 Source: SBP. In FY09 the RTOBs and ATM transactions were the major credit smart cards. Payment cards are used in Pakistan contributor to the electronic based transactions growth for making Person-to-Person (P2P) payments, withdraw due to their general acceptability among people. The ATM money from the ATMs and pay utility bills (such as gas transactions’ share in the total volume of electronic bank- payments) using the ATMs. ing transactions reached 50 percent, followed by RTOBs (29.6 percent) and POS transactions (11.4 percent). On Only banks licensed by the SBP can issue payment cards. the other hand, the value of ATM transactions was only Two domestic brands as well as international brand cards 4.7 percent while RTOB transactions constituted over 94 like VISA, MasterCard and American Express are in circu- percent of the total value of electronic retail transactions lation in Pakistan. since this channel is mostly used for Business-to-Business (B2B) transactions. The remaining electronic banking In FY09, 878 new ATMs were installed by banks, present- transactions (such as internet, mobile and call centres ing a growth of 28 percent over the year. As of June 2009, transactions) constituted only 1.9 percent in both the there were around 4,000 ATMs working across Pakistan. overall value and volume of transactions. ATMs were mostly used for cash withdrawal but also for 3.2.3 Payment Cards FIGURE 4: NUMBER OF PAYMENT CARDS IN Payment cards are gaining popularity among people with CIRCULATION bank accounts. FY09 recorded a 19.1 percent grow in the number of payment cards, which reached 8.9 million in June 2009. Three types of payment cards are in use in Paki- 19.1% stan. Debit cards that can be used both in POS terminals and ATMs represent about 72 percent of the total amount 9.9% of issued cards, followed by credit cards and ATM-only 71.9% ■ Cards with a cash function cards (see Figure 4). Most of the ATM-only cards (cards ■ Cards with a debit function for cash withdrawal) have been recently replaced with ■ Cards with a credit function debit cards. Some of the banks issue chip based debit and Source: SBP. Chapter 3. Payment Media Used By Non-Financial Entities 24 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN other purposes such as cash deposits, payment of utility was issued by the PSD to all commercial banks bills, deposit of cheques, and account to account fund to convert their POS machines into Europay transfers. As of that date, more than 49,715 POS terminals Mastercard Visa (EMV) compliant and the same installed with merchants in Pakistan were accepting pay- was accomplished in December 2008; ment cards as a form of payment for goods and services. • In the absence of PIN, as a security feature for The on-line branches (for RTOBs) constituted 68.2 percent payment card transactions, it has been made of the total branch network in FY09. compulsory for banks to issue the necessary instructions and train the merchants on signa- There are two interoperable ATM card schemes (ATM ture verification; switches) for payments with payment cards issued in Paki- stan: 1Link and MNet. Net interbank positions resulting • Developing a database on fraudulent entities; from card operations are not settled in PRISM. The settle- • Imposing limits on the amount of the transfer ment takes place via “GLOBUS” System in the State Bank for certain merchant categories (e.g. payments of Pakistan. at fuel stations); Alternative channels for making payments, such as mobile • Installing Short Message Service (SMS) alert phones and internet payments have gained popularity in system by banks. Pakistan. Call Centres/IVR are also recording continu- 3.2.5 Postal Instruments ous growth in the last few years. ATMs, POS terminals and Internet can also be used to initiate cross-border Money Order (MO) offered by the Pakistan Post Office transactions. Department is a very popular payment instrument is Pakistan. A MO is an order issued by one branch of the 3.2.4 Initiatives taken by the Payment Systems post office for the payment of a sum of money through Department of the SBP to Enhance Security in another branch. MOs provide a secure and inexpensive Payment Cards in Pakistan mode for one individual to send money to another in a Growth in the use of payment cards in Pakistan has seen different part of the country using the postal network. a corresponding increase in the number of complaints Because of the large geographical coverage of postal by customers for frauds committed on POS terminals. offices, MOs allow for the transfer of money to rural areas To address this issue, the Payment Systems Department where regular banking services are scant. Almost all post (PSD) at the SBP initiated the establishment of a commit- offices in Pakistan offer money order services. The origi- tee comprising risk managers of commercial banks and nating post office collects the amount of the MO plus a VISA Pakistan representatives. The main task of the com- commission from the money sender and sends an advice mittee is to identify and implement measures to enhance to the destination post office. There the funds are paid to security in payments by payment cards. Such measures the beneficiary. include: Another postal instrument is the Pakistan Postal Order • Transforming all POS terminals for Primary (PO). This traditional postal service is designed to fulfill Account Number masking. This measure was requirements for small payments at nominal commission. implemented in 2008; POs are a type of prepaid funds transfer facility. They are • Implementing international Chip and PIN issued in the denominations of PKR of 1, 2, 5, 10, 15, 20 standards by 2010. In this regard, an instruction and 50. POs are sold either for cash or for cheque and paid 2010 25 by all head and sub-post offices in Pakistan. MOs and POs 3.2.7 Pakistan Remittance Initiative (PRI) are both cleared outside the interbank payment systems. The Federal Government and the State Bank of Pakistan launched in August 2009 the Pakistan Remittance Initia- 3.2.6 Innovative Retail Payment Instruments tive (PRI) with the aim to boost and facilitate the flow of New retail payment instruments and alternative channels remittances sent home by non-resident Pakistanis. Remit- for making payments, such as mobile phones payments tance services depend on cross-border payment arrange- and internet payments have started to be used in Pakistan. ments for interbank retail payments for transfer of funds Internet banking in Pakistan is growing slowly, but at a and on the domestic payment infrastructure for settlement steady pace. During FY09, banks reported 2.1 million and transfer of information. Therefore, improvements in transactions involving an amount of PKR 68.4 billion. This domestic and cross-border payment arrangements have shows an increase of 59 percent in numbers and 56 per- the potential to increase the efficiency and reduce costs of cent in amount compared to the previous year. Few banks remittance services. In this context, the SBP has taken the offer transactions through mobile phones. These transac- initiative to improve the payment systems architecture of tions include utility bills payment and account-to-account the country through achieving the following objectives: funds transfers. The number of transactions was 71,240 • Automatic delivery of domestic remittances into for FY 09, showing an increase of 46 percent. In terms of beneficiary’s account/over-the-counter, generat- value, it reached PKR 16 million, registering an increase of ing real-time confirmation SMSs to the remitter 30 percent compared to FY08. and the beneficiary; The SBP plays an active role in facilitating the development • Development of robust and reliable ATM net- of the infrastructure for such payments. In this regard, the work. This would allow the beneficiary of remit- SBP issued a Regulation on Branchless Banking in March tances to withdraw cash after banking hours and 2008. The project is aiming at enhancing outreach of pay- during holidays. ment services to the population through alternative distri- • Development of integrated and secured pay- bution channels (such as retail agents and mobile phones) ment system infrastructure of Alternate that are potentially less expensive for the user compared Delivery Channels (ATM, POS, IVR, Call to conventional branch-based banking, while at the same Centre, Mobile Banking) offering options to time the design of the schemes and their implementation beneficiary to make P2P payments, payments are efficient and safe. More specifically, the Regulation at merchant sites, payment of utility bills, funds defines branchless banking activity, the role and require- transfer etc. This would also encourage benefi- ments for agents and consumer protection issues. This ciaries to maintain a minimum balance in bank Regulation is applicable to all banks including Islamic accounts eventually helping to increase savings/ banks and microfinance banks. Only “Bank-led model”9 of deposits. branchless banking is allowed for the time being. The concrete measures were set up in a Circular issued in August 2009, under the PSEFT Act, 2007. Initially five banks (ABL, HBL, MCB, NBP and UBL) have been selected to be part of this initiative. Additional participants may be added going forward subject to pilot tests. 9 “Bank-led model” of branchless banking involves both bank and nonbank institutions. Customer account relationship rests with the bank, while the non- bank institution provides the delivery channel. Chapter 3. Payment Media Used By Non-Financial Entities 26 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN Participating banks were encouraged to take the following PRI is encouraging the enhanced role of technology in initiatives: offering remittance services. • To enable a system to send SMSs to the remitter and the beneficiary, after crediting the remit- 3.3 NON-CASH GOVERNMENT tance amount in the beneficiary account or in PAYMENTS the system for the cash payment at the counter; The public sector plays an important role in the payments • To install ATMs at key locations/ branches to system of Pakistan. Non-cash government payments are facilitate cash withdrawals after banking hours executed by the Treasury and processed through the SBP and during holidays; in its role as fiscal agent of the Government, and through • To create awareness among beneficiaries to use a state-owned bank, the National Bank of Pakistan. For ATMs for cash withdrawal; the distribution of salary payments, the Treasury holds accounts with the National Bank of Pakistan. On the col- • To promote the use of E-banking/M-banking lection side, the National Bank of Pakistan is authorized channels for making payments at merchant by the Government to collect tax-related payments. The sites, transferring funds, paying utility bills etc. Treasury does not hold a settlement account in the RTGS In this regard, banks may consider issuing spe- system. Instead, the SBP processes the Treasury’s payments cial Remittance Cards and reduce/ waive various on its behalf through the central government account (and fees and charges on the use of these channels. sub-accounts) the Treasury holds with the SBP. Participating banks need to ensure adequate controls The government is in the process of completing the imple- in the process of transfer and payment of remittances mentation of a single treasury account, as part of public in/through beneficiary’s account and over-the-counter financial management reforms, in line with fiscal Report payments. Furthermore, they are also required to carry on the Observance of Standards and Codes (ROSC) out procedures to ensure strict compliance with all SBP recommendations. This will involve the consolidation of rules & regulations, including those related to Know Your government funds in its account with the SBP, from which Customer (KYC) and Anti-Money Laundering and Com- withdrawals will be made only when actual payments are bating the Financing of Terrorism (AML/CFT) measures. due. Existing funds held outside the SBP account will be A comprehensive “Complaint Handling Mechanism” has transferred by end-June 2009. also been put in place. The SBP under the auspices of the CHAPTER 4 PAYMENTS: INTERBANK EXCHANGE AND SETTLEMENT CIRCUITS 4.1 LOW-VALUE PAYMENT SYSTEMS in the current accounts that banks maintain at the Karachi Office of the SBP BSC. 1Link and MNet prepare bank- In Pakistan, retail payments are generally made with cash, wise statements of all ATM transactions executed through but the number of transactions made with payment cards respective switches on the previous day. The results of the or through electronic funds transfers is growing. clearing (multilateral net interbank intra-switch positions) are sent in electronic form to “GLOBUS” system of the 4.1.1 Payment Cards Clearing and Settlement State bank of Pakistan once a day by 12:30. For settlement There are two interoperable ATM card schemes (ATM of interbank inter-switch ATM transactions, MCB Bank switches) for payments with payment cards issued in Ltd submits to the GLOBUS system by 12:30 one com- Pakistan: 1Link and MNet. 1Link is the largest shared bined net position of receivables and payables. Automated ATM network of the country covering more than 160 cit- settlement of ATM transactions in the SBP has resulted in ies nationwide. 1Link was launched in 2003. It is owned by faster and more efficient settlement as well as reduction of the consortium of 11 major banks and is open for all banks the credit risk. operating in Pakistan. MNet (the second ATM switch) was launched by MCB Bank Ltd, one of the largest bank in For transactions made with VISA, Mastercard and cards of Pakistan. As of end-June 2008, MNet had 612 ATMs in 50 other international schemes, the clearing and calculation cities. As of the same date, 28 banks were interconnected of the net positions among member banks is made by the on 1Link and 10 banks were using the MNet switch. respective head offices. The results for all local transac- tions are sent back to the SBP for settlement through the Encouraged by the SBP the two switches of the country PRISM. Transactions made with cards issued in other were interconnected in 2005 therefore providing maxi- countries are settled abroad. mum ATM coverage to the customers of both switches. In 2007 the settlement of interbank ATM transactions On-going initiatives were transferred to the SBP.10 The net interbank positions A new service launched recently by 1Link is the Inter resulting from the clearing of card operations are settled Bank Funds Transfer service. It facilitates online pay- ments between the customers of the participating member banks directly and instantly through ATMs. In addition to 10 Since the establishment and inter-connectivity of ATM switches ABN Amro Bank and MCB Bank Ltd were acting as settlement banks on behalf of 1Link reducing the cost of transaction significantly, the service and MNet respectively. This was obligating banks to maintain their accounts eliminates the need of writing cheques, making demand with 1Link as well as with MNet causing them to block extra liquidity in the system. In addition, the banks were exposed to credit risk with respect to the drafts or using other labor-intensive instruments. The settlement banks amounting to millions of rupees (the amount banks held in Inter Bank Funds Transfer service will be available round- settlement accounts with MCB Bank Ltd and ABN Amro Bank). 27 28 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN the-clock. It opens up possibilities of designing various NIFT is a clearinghouse11 that provides centralized existing products and services over the basic infrastructure multilateral netting of retail cheques on a countrywide in the domain of P2P, B2B and Person-to-Business (P2B) basis. During FY08 a total of 71.25 million transactions transactions. for a value of PKR 23,749 billion were cleared in NIFT. The number of transactions cleared in NIFT during FY09 Different technology standards used by MNet and 1Link reached 73.605 million. In 2007, NIFT clearing operations are causing backlogs. Given the importance of a single were changed from decentralized processing to central- protocol, the SBP has directed both switches to map ized multilateral netting on a countrywide basis. The NIFT their transaction response codes on one-to-one basis Karachi office collects and consolidates data from all NIFT as one code of one switch must be mapped against only automated centers (14 local offices plus Karachi office). one code of the other switch. Furthermore, to encourage NIFT has set up a grid of automated clearing, which pro- interoperability between switches and the delivery of ATM vides intercity clearing involving 15 major and over 85 sat- service and operating procedures in compliance with ellite cities in Pakistan. In order to become a participant in international best practices, the SBP initiated dialogue NIFT cheque clearing, banks must have a banking license with the two ATM switch operators. As a result, standard- issued by the SBP and a current account at the SBP. ized Service Level Agreements and Standard Operating Procedures are being developed. The Service Level Agree- NIFT is currently used for clearing of large-value as well ment has built-in mechanism of compliance monitoring as retail cheques. There are no limits on the amount of through a monitoring committee consisting of representa- individual cheques to be processed through NIFT. tives of the ATM switches and banks. The NIFT system is based on physical exchange of Interoperability and Straight-Through Processing (STP) cheques. Although the processing of cheques between are key factors for achieving efficient and safe retail pay- NIFT offices is automated, most of the processes, including ments. In this context, it has been planned to inter connect the collection and submission of cheques by banks and the currently operating POS systems. Automated transfer of link to NIFT, are manual and paper-based. net balances into PRISM for settlement is planned to be implemented in the final phase. A project to connect all The countrywide netting procedure includes multilat- the banks through the automated Clearing House is being eral netting once a day for each of the four products: conceptualized. This is in addition to a proposition for Main Clearing, Same-day High-value Clearing, Intercity B2B transactions using the SWIFT network. Clearing and Clearing of Returned Cheques. High-value cheques are cleared on a same-day basis. The settlement of 4.1.2 Clearing of Paper Based Instruments the participants’ net positions occurs four times a day (one National Institutional Facilitation Technologies (NIFT) settlement for each type of clearing) in PRISM according The National Institutional Facilitation Technologies Ltd. to a pre-agreed schedule. Payments are final and irrevo- (NIFT) is an important part of the payment infrastructure cable after posting of the clearing results on participants’ in Pakistan. NIFT was incorporated in September 1995 as 11 In addition to providing cheque clearing services, NIFT is a service joint venture between a consortium of six banks and entre- provider to major utility companies for utility payment services. Both gas distribution companies of Pakistan (SSGC and SNGPL), Telecommunication preneurs from the private sector. All commercial banks company (PTCL), mobile phone companies (Mobilink and Telenor) exploit utilize NIFT’s services. As of May 2009, NIFT was operat- NIFT’s Services. One of NIFT divisions—NIFTeTRUST—is a Certification ing with 20 data centers, which provided services to 5,571 Authority of Pakistan. This division has establishes facilities to provide Public Key Infrastructure (PKI) based security solutions for e-business, e-commerce, branches of 40 commercial banks in 185 major cities. e-banking and e-government as an affiliate of VERISIGN Inc USA. 2010 29 FIGURE 5: VOLUME AND VALUE (IN PKR BILLION) OF NIFT CLEARING POSITIONS IN PRISM 4,500 1,200 4,000 1,000 3,500 3,000 800 2,500 600 2,000 1,500 400 1,000 200 500 0 0 8 08 08 8 08 09 9 9 9 9 09 08 l-0 t-0 -0 -0 r-0 -0 g- p- c- n- n- v- ar b ay Ju Oc Ap No De Au Se Ja Fe Ju M M ■ Volume Value Source: SBP accounts with the SBP. Customer accounts are credited no participant to pay its net obligation at the pre-specified later than T+2. time may result in a delay of settlement of other partici- pants. Such delay may give rise to liquidity and credit NIFT offers a web-based secured access (employing risk for participants. The risk depends on the size of net Public Key Infrastructure [PKI] Security) to the informa- debit positions. In NIFT, on certain days the net payment tion about participants’ positions to the SBP and treasury obligation of a single bank resulting from same-day clear- managers of banks. This allows banks to better manage ing can reach USD 150 million. Currently, NIFT has no their intraday liquidity needs. Payments that have not mechanisms in place to control settlement risk that may been settled during the day due to insufficient funds in the arise in case of a failure of a participant to settle its debit banks’ account in PRISM are cancelled at the end of the position when expected. The SBP, however, is performing a day. In such case, the originated net positions would be risk assessment and the introduction of such mechanisms unwound. are being considered. Credit and liquidity risk One possible way to reduce the potential net exposures, Credit risk in NIFT has been partially reduced with the that is under consideration by the SBP, is to encourage introduction of same-day clearing and settlement of high- commercial banks to route all large-value customer pay- value customer payments. Debiting and crediting current ments that are currently cleared in NIFT (for example pay- accounts that banks hold in the SBP for settlement of the ment above certain threshold) through the RTGS system. calculated net positions further reduces settlement risk (settlement in central bank money). On-going initiatives About 39 percent of paper based payment instruments Settlement of net obligations arising from the clearing of processed in NIFT (including cheques, demand drafts, cheques in NIFT is time sensitive since it occurs within payment orders, etc.) are classified as “non-standard”. specific time windows during the day. A failure of any Lack of standardization increases the processing costs for Chapter 4. Payments: Interbank Exchange and Settlement Circuits 30 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN banks and is a source of extra delay in clearing. In order to 4.2 LARGE-VALUE PAYMENT effectively address this issue and to streamline the clearing SYSTEMS process in the country, the SBP Payment Systems Depart- ment issued various instructions encouraging banks to 4.2.1 Pakistan Real Time Interbank Settlement standardize the paper based payment instruments. Mechanism (PRISM) To improve the safety and efficiency in the settlement of The standardization of payment instruments is part wholesale payments, on July 1st, 2008, the SBP launched of a broader set of initiatives, undertaken by the SBP the Pakistan Real Time Interbank Settlement Mechanism in cooperation with NIFT and commercial banks, to (PRISM), a fully automated RTGS system. PRISM is enhance efficiency in the paper-based clearing system and owned and operated by the SBP. It is designed to handle its conversion to image-based clearing. In the first phase, all large-value payments (as well as government securi- a new License Agreement has been signed between the ties settlement) in the country and is thus a systemically SBP and NIFT. A number of new covenants have been important payment system for Pakistan. For the first year incorporated to upgrade NIFT operations to conform to of operation (July 2008–July 2009), the system processed a best international practices. The development of an appro- monthly average of 19,700 transactions with an aggregate priate feasible model for Pakistan for “cheque truncation”, value of PKR 5,185 billion per month (see Table 3). The the development of the necessary regulatory framework value of all transactions processed in PRISM in FY09 was and a pilot project of image clearing have been planned for PKR 62.2 trillion, which is 4.8 times the GDP for the year. 2009–2010. TABLE 3: SETTLEMENT STATISTICS FOR INTERBANK LARGE-VALUE PAYMENTS IN PRISM (value of transactions in PKR billion) Government Securities12 RTGS13 NIFT14 Month Volume Value Volume Value Volume Value Jul-08 0 0 13525 2,815 2363 582 Aug-08 2301 1,350 14047 2,198 3573 895 Sep-08 3231 2,021 16498 3,001 3801 995 Oct-08 5592 2,964 12188 2,333 3569 939 Nov-08 4828 2,589 12594 2,286 3759 799 Dec-08 3295 1,882 10834 2,039 3240 843 Jan-09 3969 2,299 11068 1,645 3491 810 Feb-09 4073 2,430 9676 1,704 3508 742 Mar-09 4205 2,580 10693 1,715 3670 981 Apr-09 5359 2,971 11469 1,656 3966 928 May-09 4680 2,642 11696 1,919 3843 926 Jun-09 4418 2,647 13358 2,097 4032 1,004 Total 45951 26,375 147646 25,409 42815 10,443 Source: SBP 12 Volume and value of transactions with government securities (PIBs, MTBs) settled in PRISM. Figures do not include free-of-payment transactions. 13 Volume and value of only-funds transactions. 14 Volume and value of net interbank positions resulting from the NIFT clearing and settled in PRISM. 2010 31 FIGURE 6: TOTAL VOLUME AND VALUE (IN PKR BILLION) OF TRANSACTIONS IN PRISM 30000 7,000 6,000 25000 5,000 20000 4,000 15000 3,000 10000 2,000 5000 1,000 0 0 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 ■ Volume Value 4.2.1.1 Settlement in PRISM PRISM, although a significant portion of these payments With the introduction of PRISM, banks holding accounts are still processed through the paper exchange of cheques at the SBP are able to settle their interbank transactions in NIFT. Cash positions arising from trades with corpo- in real time on a transaction-by-transaction basis. Until rate securities and financial instruments of term deals are recently, inter-bank payments were made manually settled outside PRISM. between current accounts and securities accounts of banks at the SBP based on cheques with end-of-day settlement. Participants PRISM rules define the criteria for entry into and exit from In view of the sensitivity and criticality of the system and the system based on safety and soundness considerations. to ensure a smooth transition of all participants from the There are four participation categories in PRISM. All com- existing to the new settlement system, it was decided to mercial banks can be direct participants in PRISM. Direct launch the system in several steps. This allowed banks to participants have access to all facilities offered by the slowly adjust to the new system and the SBP to carefully system rules, such as ILFs, the settlement of government monitor the situation and effectively provide support to securities transactions in PRISM and the settlement of system participants. PRISM started operations with the customer based transactions. All other financial institu- settlement of interbank money market transactions and tion can become indirect participants (with an account the domestic leg of FX market operations. Since July 2008, in PRISM but without a direct connection to the RTGS the SBP has gradually enhanced PRISM’s functionality by system). An indirect participant is able to transact in the introducing the settlement of interbank government secu- system through the Service Bureau (an entity established rities transactions and the net positions from retail clear- by the SBP to enter transactions manually in PRISM on ing (NIFT). In addition, some large banks’ customers have behalf of indirect participants). As of June 2009, the total started to require processing of their payments through number of direct participants in PRISM was 39 (36 banks Chapter 4. Payments: Interbank Exchange and Settlement Circuits 32 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN and 3 development financial institutions). Clearing enti- and between the SBP and a participant. The participants’ ties, such as NIFT or ATM operators are granted a status of accounts are updated on in the General Ledger of the SBP special participants. The SBP is also a direct participant in BSC Offices, based on the transactions in the settlement PRISM and can act as Authorized Third Party. account. The RTGS has real time interface with GLOBUS banking (the software that supports the SBP accountant Operating rules system). RTGS operations are governed by the Operating Rules for Participation in PRISM, issued by the SBP, and several The operation day of the PRISM starts at 9:00. The cut-off operating guidelines and procedures. The rules cover the time for accepting payments is 15:30. All payments are admission procedures for participants, liquidity manage- settled on a gross basis in real time in PRISM. In case of ment tools employed by the system, operational require- insufficient funds in a participant’s settlement account ments etc. The rules and procedures as regards financial in PRISM, the payment is placed in a central queue. All and operational risks and its management, information on payments which are not settled by the end of the operating the system design, system timetable and technical proce- hours of PRISM are rejected by the system. Once they are dures are documented. settled by PRISM (the settlement accounts of participants are debited/credited), payments are irrevocable. Credit and Transaction types debit electronic confirmations are sent automatically by Direct participants can submit the following transaction the PRISM system to the participants and considered as types to PRISM: official settlement finality confirmations. • Inter-bank fund transfers; Opening balances and funds received from other partici- • 3rd Party funds transfers; pants during the operational day are the main sources of liquidity for participants in PRISM. The participants can • DVP, Delivery versus Free (Free of Payment) use the CRRs and SLRs they hold in accounts with the SBP and ILF transactions; to make payments during the day. These funds are avail- • Own Account transfer transactions; able free of charge. As of end-June 2009, the required CRR • Multilateral net settlement batches transactions. level for all banks including Islamic banks/branches was the weekly average of 5 percent (subject to daily minimum 4.2.1.2 Settlement procedures and liquidity support of 4 percent) of total Demand Liabilities (including Time Each direct participant is required to open a settlement Deposits with tenor of less than 1 year). Over October- account in PRISM. This account has to be funded at November FY09, the SBP abolished the 19 percent SLRs the beginning of each RTGS processing day from the for time liabilities of one year and higher tenor. Each par- participant’s current account with the SBP (the sum of all ticipant can manage its payment queues via its front-end regional current accounts that a participant is maintain- system by designing different priority levels to its payment ing with the SBP BSC Offices across the country). Settle- instructions. The system maintains 99 priority levels, ment accounts cannot have a debit balance. Participants some of which (from 1 to 10) are reserved for the ancillary are responsible to maintain sufficient funds to settle systems, the settlement of DVP transactions and the SBP their payments in the system. They can transfer their payments. Participants may change the priority or cancel own funds from one regional current account to other their payments before the payment instructions are settled. regional current accounts. Settlement accounts can only Payments are settled on First-In-First-Out (FIFO) basis be used for the transfer of funds between participants, within each priority level. 2010 33 Payments with priority levels 1 to 9 which remain unset- charges. Banks are free to determine the charges that they tled within the pre-specified time window may be liable apply for sending customer payments via PRISM. to pay interest/penalty charges. Currently no interest or penalty is charged. 4.2.1.4 Management of Operational Risk in PRISM PRISM is a fully automated electronic transfer system. Participant can avail the collateralized ILF offered by the Participants can send payment instructions from their SBP to support their intraday liquidity needs in an RTGS own premises via a computerized private network between environment. The ILF is available only on a fully collat- the SBP and the participating banks. There are identifica- eralized basis against approved government securities as tion and authentication procedures in place. The informa- specified by the SBP. Following a bank’s request for ILF, tion technology (IT) security component of the system PRISM automatically transfers ILF eligible securities from provides PKI infrastructure and transactional and link bank’s own portfolio to SBP’s ILF portfolio and simultane- encryptions for data security. The information security ously credits funds against these securities to the bank’s model includes access control model, data integrity model, settlement account in PRISM. Participants are required to and information flow model. The data exchange between settle their ILF transactions by sending an ILF buy back PRISM and its workplaces, central and remote nodes as request on the same day. All the unsettled ILF transactions well as external systems, is implemented via XML-format are automatically settled at the end of the day, subject to message exchange, which corresponds to SWIFT mes- the availability of sufficient funds in the accounts of par- saging standards. The availability of the service is further ticipants. In case of insufficient funds, the SBP reserves the supported by the existence of an independent electricity right to apply penalties or redeem any securities acquired generation facility. PRISM security policies and opera- through ILF. Participants have also the option of inter- tional procedures are fixed in a number of normative bank borrowing (clean or repo) during the day, or to use documents and instructions of the SBP. the discount window facilities during a specified period during the day. Discount window facilities can be available Business Continuity related activities for PRISM have after approval by the SBP. been established and documented in the PRISM Detailed Design Document and PRISM Business Continuity All payments still pending in the queue at the end of a Guide. Procedures are in place for periodical backing-up business day are canceled by the system. The system pro- and storage of data. A secondary processing site has been cesses only same-day value transactions. established close to the main operational office. Full sys- tem recovery is expected in 30 minutes to four hours with All the participants have online access to information on no data loss. Another full-fledged disaster recovery side the payments processes, their settlement account balances, in another city is under implementation. In addition to portfolio balances, payments pending in the queue and telephone lines that can be used to back up telecommuni- liquidity alerts about their net positions resulting from the cation links, wireless infrastructure including radio/VSAT clearing systems. is in process of implementation. 4.2.1.3 Pricing In order to ensure technical integrity in PRISM, the SBP The development cost for the system was fully borne by has established Service Bureau facilities, which can be used the SBP. The SBP does not charge entry, membership by any participant, facing temporary operational prob- or transaction fees. However, the Operating Rules for lems of using its own front-end system, to send payment Participation in PRISM include provisions for transaction messages to the central server. In addition, the SBP has Chapter 4. Payments: Interbank Exchange and Settlement Circuits 34 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN developed requirements and recommendations for system accepting only high quality collateral for the ILF (Market participants. All participants are required to have in place Treasury Bills and Pakistan Investment Bonds) and by the necessary business resumption and recovery tools, applying haircuts to the eligible collateral. such as Business Continuity Plan (BCP) procedures, BCP sites for RTGS system related activities and provision of Furthermore, the integration and final settlement of Uninterrupted Power Supply at their main and backup other payment systems, such as retail cheque payments sites. (the NIFT clearing), DVP transactions for government securities, FX transactions as well as card payments into 4.2.2 Management of Credit and Liquidity Risk the RTGS reduces credit and liquidity risk present in these The PRISM rules include a wide range of risk manage- systems. However, settlement of multilateral net posi- ment tools. Since the payments of each participant are tions in RTGS may pose liquidity risk for participants processed on a gross basis (payment by payment) via the in case one or more of participants are unable to settle banks’ settlement accounts in the SBP using the available their debit balances in a timely manner. In case of lack of balances, the participants do not run credit risk. funds for immediate settlement of the net positions, the system generates and sends to the participants liquidity However, the shift from end-of-day to intraday settlement alerts, followed up by phone calls to the banks to arrange and the gradual introduction of time critical payments the required funds from the interbank market. The SBP is may considerably increase liquidity needs in PRISM in considering introducing mechanisms to control such risk certain days or certain hours during the day. This might in particular with respect to the settlement of the NIFT happen—for example—at the last day of the weekly main- clearing. One tool for reducing settlement risk currently tenance periods for cash reserves and securities reserves in place is that the PRISM system automatically assigns requirements or settlement dates of primary auctions the highest level of priority to the net settlement positions for government securities. Settlement of net positions from the NIFT system. Therefore participants’ other pay- resulting from clearing of retail cheque payments (the ments cannot be settled before the settlement of the NIFT NIFT clearing), DVP transactions, as well as settlement of clearing. card payments occurs in narrow time windows in specific hours during the day, and may put liquidity pressure on 4.3 CROSS-BORDER PAYMENT some participants. SETTLEMENT SYSTEMS The system offers central queue facilities for managing Foreign Exchange Settlement Systems liquidity. Payments that cannot be settled immediately Foreign currencies are traded on the foreign exchange because of lack of sufficient funds in the settlement interbank market, which is dominated by one foreign cur- accounts of participants are placed in a central queue. rency, the USD. In 2007, the total amount of the interbank Queue management tools include reprioritization of foreign exchange market in the most traded currency pair payments and payment cancellation by participants. The USD/PKR reached USD 126 billion. The domestic leg of availability of ILF further facilitates the timely settlement the transaction is settled in the RTGS system through the of payments. debit/credit of the domestic currency accounts maintained by the banks with the SBP, while the settlement of the To control the credit risk when extending intraday credit, foreign currency leg occurs through a foreign correspon- the SBP requires full collateralization through intraday dent bank. repo-based operations. The risk is further reduced by 2010 35 There is no Payment versus Payment (PVP) process in Worldwide data,16 total costs (including service charges place for the execution of FX deals. The counterparties and exchange rate margin) of bank transfers of USD 200 involved are exposed to normal FX settlement risk as there vary from less than 2 percent from the UK to Pakistan to are time differences between the final settlement of the two 16.4 percent from the US to Pakistan, while costs of using legs i.e. USD and PKR, which given the geographical loca- international MTOs is between 4 percent and 13 percent. tion of both countries is particularly large The cheapest are services offered by some domestic and international MTOs (e.g. from the UAE, Saudi Arabia and Cross-border payment instructions are normally sent and the US). Other methods include a hand delivery by family received through SWIFT and are settled through foreign members or friend, and arrangements such as hawala. correspondents. As at the end of 2008, 13 banks and financial institutions in the country were SWIFT members The insufficient presence of Pakistani banks in overseas and 38 financial institutions were connected to FIN.15 In jurisdictions and lack of marketing efforts are consid- 2008, messages sent and received by members in Pakistan ered the major impediments to a greater role of banks amounted to 2.4 million and 4.4 million respectively, in this segment of the payments system. To promote the which represents a total growth of messages (both sent and remittance business, the SBP has activated a continuous received) of 4.3 percent compared to 2007. dialogue with banks and Exchange Companies. Banks have been encouraged to submit individual strategic plans International Remittances and a special SBP Task Force on International Remittances International remittances are significant in Pakistan, has been established. In FY08, the SBP initiated a reform representing 3.8 percent of the GDP in FY08. In FY09 process in the Exchange Companies sector with a view they continued to show a rising trend reaching a historic to generating better market discipline through enhanced high level of USD 7.8 billion, which represents a growth transparency, disclosure, strong monitoring, supervision, of 21 percent over FY08. The major remittance sending and enforcement. In addition, the SBP has approved the countries are the United States of America, Saudi Arabia Remittance Card Scheme of Askari Bank. The feasibility to and other Gulf countries such as Bahrain, Kuwait, Qatar, connect Pakistan’s ATM network with Gulf Cooperation Oman and the United Arab Emirates, as well as some Council (GCC) countries’ ATM network, in order to facili- European Union countries. tate remittance flows, is being studied. Pakistanis working abroad can use various channels for Another important step related to the remittances was the sending cross-border payments. Transfers through banks launch of the PRI by the Federal Government and the State are the most popular way (among channels using the Bank of Pakistan. A call centre has been established which financial system) for sending remittances. International is now operational 24 hours, 7 days a week. All overseas MTOs (e.g. Western Union, MoneyGram) and ECs are Pakistanis and their families can inquire about the remit- other channels for sending remittances. The latter are tance services of banks and submit their complaints to regulated institutions and there are safety and efficiency the call centre. Toll free services are already available to requirements in place related to the services they provide. Pakistanis living in North America. In addition, the gov- The costs of sending money to Pakistan vary depend- ernment set up a comprehensive website, which provides ing on the sending country and the transmitting channel information about the processes involved in the remit- used. According to the World Bank Remittance Prices tance transactions. 15 FIN is SWIFT’s core store-and-forward messaging service. 16 http://remittanceprices.worldbank.org/. Third quarter 2009 Chapter 4. Payments: Interbank Exchange and Settlement Circuits 36 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN The PRI formed a focused group of five large banks in 2009, An internal Payment System Policy committee has which developed, in consultation with the SBP, arrange- been established wherein all the key SBP departments ments to instantly credit the bank account of the benefi- involved in the operation, regulation and oversight of ciary once they receive the funds. These banks have also payment systems and instruments are represented. The completed arrangements for instant payments of cash over SBP is in the process of drafting a strategic document for the counter. To address the issue of delay in interbank set- Payment Systems Policy and Oversight, which will cover tlement of remittance transactions, the SBP has put in place the various aspects of payment systems development in a mechanism for exchange of information between banks the country. about the bank accounts to be credited with the remittances received while the funds are routed simultaneously through Some key on-going projects and issues under consider- the RTGS system. Furthermore, a comprehensive “Com- ation include: plaint Handling Mechanism” has been established. Finally, • Further development of risk management tools the SBP has been encouraging the use of technological in PRISM and NIFT; innovations in offering remittance services. • Strengthening the oversight function of the SBP The SBP is a member of the Asian Clearing Union (ACU), over payment and settlement systems; established to facilitate cross-border trades and regional • Further modernization and improvement of cooperation of the South Asian countries. ACU is a system efficiency in cheque clearing; for clearing payments among the member countries on a multilateral basis. See also section 7.4. • Expanding the use of electronic payment instru- ments and STP; 4.4 PROJECTS AT THE STAGE • Further increase of the outreach of payment OF DEVELOPMENT AND facilities to areas with limited traditional bank- IMPLEMENTATION ing infrastructure; • Further improvements in the legal framework The SBP plays a leading role in developing safe and effi- for both retail and large-value payments. cient payment and settlement infrastructure in Pakistan. CHAPTER 5 SECURITIES, MARKET STRUCTURE AND TRADING SYSTEMS 5.1 FORMS OF SECURITIES of the company or recommendation of the directors. In accordance with the Companies Ordinance, 1984, • Preference Shares—the company pays a fixed the Securities and Exchange Ordinance, 1969 and the amount of dividend, irrespective of its earn- Central Depositories Act, 1997, securities can be issued in ing profit or loss. The shareholders generally both paper and dematerialized form. Dematerialized or have no voting rights. book-entry security is a security which is transferable by book-entry in the central depository register. The owner of • Corporate bonds: Term Finance Certificates book-entry securities is determined on the basis of records (TFCs) are issued by the companies under the in the central depository. Company Ordinance, 1984 and represent a liability of the company to the securities owner. The form of issuance of securities chosen by the issuer • Government securities: these are issued by must be defined in its founding documents and/or in the the Federal Government or any Provincial securities issue prospectus. All corporate securities that Government or are guaranteed by the Federal or are traded at the stock exchanges need to be registered any Provincial government, and include: at the CSD (the CDS of the CDC) and therefore are kept • Market Treasury Bills (MTBs). These are in dematerialized form. Similarly, government securities short term instruments of the Government of are registered in book-entry form in the SBP’s Central Pakistan with maturity of 3, 6 and 12 months. Depository. All transfers of such securities are handled by MTBs are zero-coupon securities and are electronic book entries. sold at discount to the face value. • Pakistan Investment Bonds (PIBs): These are 5.2 TYPES OF SECURITIES the long term instruments of the Govern- The following types of securities are available at the stock ment of Pakistan with maturity available of market in Pakistan: 3, 5, 10, 15 and 20 years. PIBs are coupon bearing instruments and issued in book- • Shares of listed companies, which can be: entry (without physical certificates) form • Ordinary Shares—the most common term with interest payment on biannual basis. of shares that entitles their holders to have They were introduced in 2000 by the govern- ownership in the company. Holders may ment in order to enhance the corporate debt receive dividends depending on profitability market in Pakistan. 37 38 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN • Government of Pakistan Market-related rate securities, or the Central Depository of the SBP in the Treasury Bills (MTBRs). These are the instru- case of government securities. A record of an entry in an ments created when Government borrows account or a sub-account shall be prima facie evidence from the State Bank. They are six month of the truth of the matters so recorded. The depository is T-bills and their rates are determined on the responsible for correct and timely reflection in depository basis of weighted average arrived in the last accounts of securities ownership transfers. six months Market Treasury Bill auction. They are also called “Market Replenishment 5.5 PLEDGE OF SECURITIES AS Treasury Bills”. COLLATERAL • Sukuk bonds: These are short and medium term Shariah compliant government Based on the essence of pledge as a means of securing instruments. liabilities, when securities are pledged, no securities own- ership rights are transferred from one person to another. • Sovereign domestic debt of Pakistan: also At the same time it is possible that ownership rights are includes securities issued under various transferred to another person if the liability secured with national saving schemes. the pledge is not met. • Derivative securities: securities whose value is linked to the value of underlying shares or debt Art. 12 of the Central Depositories Act, 1997, governs securities, other financial instruments, indexes, the pledge of book-entry securities, while the Contract or rights thereto. Act, 1872 governs the pledge of any other securities. The book-entry securities to be pledged shall be blocked when • Mutual funds certificates. an account holder or a participant (when the pledgor—the person pledging securities—is a sub-account holder) in 5.3 SECURITIES IDENTIFICATION the central depository gives instructions to the central CODE depository system. A pledgee (the person in whose favor a pledge of securities is made) shall, in addition to the The National Clearing and Settlement System has imple- powers available to him under the Contract Act, 1872, mented the UIN functionality for all its clients including have the power, upon the default of the pledgor, to transfer individual investors, brokers, companies and funds. the pledged book-entry securities or any part thereof. The Act stipulates that the participant in the central depository 5.4 TRANSFER OF OWNERSHIP system shall not create a pledge over any book-entry secu- rities entered in any sub-account maintained under his The legal basis for ownership transfer and custody arrange- account with the central depository of his clients without ments is included in the Central Depositories Act, 1997, the authorization of the sub-account holder concerned. and the PSEFT Act, 2007. In accordance with the Central Depositories Act, 1997, Art. 6, “the transfer of ownership 5.6 TREATMENT OF LOST, STOLEN, of book-entry securities from accounts (or sub-accounts) AND DESTROYED SECURITIES to other accounts (sub-accounts) shall be effected by mak- ing an appropriate entry in the central depository register”. Securities that are kept in book-entry form cannot be lost This procedure is applicable to all securities held in book- or stolen. The central depository is responsible for accurate entry form. In practice, the transfer of ownership occurs and timely reflection in depository accounts of securities by means of book entries in the CDS in the case of corpo- ownership transfers. 2010 39 5.7 LEGAL MATTERS CONCERNING out the purposes of this act. Such rules may provide for CUSTODY the forms and types in which government securities may be issued, the manner in which such securities may be The protection of custody arrangements against custody transferred, and the manner in which payment of interest risk in Pakistan is supported by regulations through the of such securities can be made. segregation of securities holdings. In central depository systems separate accounts are held for securities of partici- 5.9 PRIMARY MARKET pants and for those of their clients. 5.9.1 Government Securities According to the Central Depositories Act, 1997, the title The debt securities market in Pakistan is dominated by to any book-entry securities entered in an account shall government securities, issued in the form of short-term vest in the account holder and the title to any book- securities with less than 1 year maturity (MTBs and entry securities entered in a sub-account shall vest in the MRTBs) and long-term securities (PIBs). The placement sub-account holder. The General Regulations of the KSE, of government securities is performed via auction sales 2007, stipulate that the broker shall ensure that the assets carried out by the SBP. Only Primary Dealers (institutions belonging to their client are kept separated from the assets appointed by the SBP) can participate in government of the brokers. For this purpose brokers shall maintain securities auctions. a separate fund account, which will include all the cash deposits of their clients along with record/breakdown of Auctions for PIBs are announced and organized on a client position. Further margins deposited in the form of quarterly basis. PIBs can be purchased by individuals, securities shall be maintained in a separate sub-account institutions and corporate companies including banks, as or investors account of the individual client at the CDC. well as by foreign individuals and institutions. The SBP The clients’ cash deposit and margin securities shall not be announces the auction 14 days prior to the auction date. used by the broker for any purpose other than as autho- The SBP and the Ministry of Finance decide the coupon rized by the client in writing. The broker shall be obliged to rates and the target amounts after consulting each other. furnish documentary evidence in support of implementa- tion of the above regulation as and when required by the MTBs are issued on a fixed schedule on a fortnightly basis Exchange. (Wednesday) and on a multi-priced basis. Announcement of auctions are done two days prior to auction date. The 5.8 PUBLIC OFFERING OF SBP decides the target and cut offs. Like PIBs, MTBs are SECURITIES eligible for purchase by domestic and foreign individuals and companies through non-competitive bids. The Companies Ordinance, 1984, establishes the legal basis for public offering of corporate securities in Pakistan. When the Government borrows from the SBP, it cre- Part V of the ordinance regulates the issuance and registra- ates MRTBs. Their rates are determined on the basis of tion of prospectus and the procedures for the issuance of weighted average in the last six month MTBs auction. shares and corporate debt securities. Another (non-marketable) retail debt instrument, which makes up the largest share of the domestic debt, is the The issuance of government securities is regulated by the National Saving Scheme (NSS) Instrument issued by Public Debt Act, 1944. According to Art. 12 of the Act, the the Central Directorate of National Saving Institutional Federal Government of Pakistan may issue rules to carry investors, which previously were restricted from investing Chapter 5. Securities, Market Structure and Trading Systems 40 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN in NSS instruments, are currently eligible to do so. This Banks dominate the primary and the secondary market of is likely to drain investments from market-based instru- government securities in Pakistan. The share of non-bank ments (such as MTBs and PIBs). institutions in the total amount of outstanding govern- ment securities was only 22.9 percent as at 30 June 2009. The Government of Pakistan issues 3-, 6- and 12-month In June 2009, the SBP decided to increase the ratio of MTBs. By the end of FY08, short-term government debt non-competitive bids from 10 percent to 15 percent. This amounted PKR 1,368 billion, of which PKR 537 billion measure was aimed at encouraging non-bank financial outstanding MTBs and PKR 1,101 billion MRTBs. Com- institutions and individuals to directly invest funds in pared to PKR 1,108 billion, PKR 656 billion and PKR 452 government securities, thus broadening their distribution billion respectively in FY07, this represents a considerable base. As a result, the share of the non-bank sector in the increase in both the stock and the share of the Govern- total holding of government securities has increased since ment debt, mainly due to an increase by 143 percent of then and it is expected that this trend would continue in direct Government borrowing from the SBP. The main fac- the future. tor for such development was the reluctance of commer- cial banks and other institutions to invest in government Another instrument in the primary market is the Govern- papers given the risks in a rising interest rate scenario. This ment of Pakistan Ijara Sukuk for which three auctions were trend continued in the second half of 2008. However, due held between September 2008 and June 2009. Aggregate to better liquidity conditions in subsequent months, banks bids of PKR 38.3 billion were offered by market partici- started to offer higher amounts in MTB auctions con- pants and accepted. ducted during 2009. In FY09, the Government of Pakistan issued 1,865 billion MTBs through 26 auctions held by the 5.9.2 Corporate Securities SBP. This shift in market preference enabled the govern- A combination of factors such as the deterioration in the ment to reduce the stock of MRTBs. macroeconomic environment since FY08, the monetary tightening until the reversal of the stance in April 2009 and In contrast, the share of PIBs in total domestic debt in heightened security concerns, all served to dampen inves- FY08 declined compared to FY07 despite rise in its stock tor confidence in Pakistan capital market in FY09. The to more than PKR 410 billion due to similar consider- total value of Initial Public Offerings (IPOs) of corporate ations (reluctance to invest in long-term debt). In addition, shares declined from PKR 15.38 million as of end-Decem- the non-issuance of PIBs for two year (FY05 and FY06) ber 2008 to PKR 8.8 billion as of end-December 2009 and had a negative impact on both the primary and second- the listed value of new debt issues (Term Finance Certifi- ary market activities of longer-term securities. Regular cates) was only PKR 3.0 billion as compared to PKR 26.5 primary issuance of PIBs resumed from May 2006, and billion in 2008. During the second half of the calendar year amounts of PKR 59.1 billion and PKR 29.4 billion were 2009, capital markets partially recovered. During 2009, the accepted during FY08 and FY09 respectively. By end FY09, number of companies listed at the Karachi Stock Exchange the outstanding long-term portfolio of government securi- remained steady (651 listed companies as of end-Decem- ties included PIBs with maturity of 3, 5, 7, 10, 15, 20 and ber 2009) and the total value of the capital registered 30 years, with the 10-year PIBs being markets’ preferred increased from PKR 750.5 billion to PKR 814.5 billion at instrument with a cumulative investment of PKR 290 bil- the end of 2009. Changes in the total listed capital in the lion (66 percent of the total outstanding PIBs portfolio). period 2004–2009 are presented on Figure 7. 2010 41 FIGURE 7: TOTAL LISTED CAPITAL AT KARACHI STOCK EXCHANGE (IN PKR BILLION) 1,000 800 600 400 200 0 2004 2005 2006 2007 2008 2009 Source: KSE In 2009, the KSE listed shares of 4 new companies and 1 The corporate bond market in Pakistan is still at an early new debt instruments. As compared to 2008, the number stage of development with total public corporate debt of newly registered companies as well as the value of the issues accounting for just over one percent of GDP. newly registered shares has decreased. Table 4 provides information about new registrations and new issues at the KSE in the period 2004–2009. TABLE 4: KARACHI STOCK EXCHANGE MARKET PERFORMANCE INDICATORS (In PKR million except companies, index and bonds data) 31-12-2004 30-12-2005 29-12-2006 31-12-2007 31-12-2008 31-12-2009 Total No. of Listed Companies 661 661 652 654 653 651 Total Listed Capital—PKR 405,646.32 470,427.47 519,270.17 671,255.82 750,477.55 814,478.74 Total Market Capitalisation—PKR 1,723,454.36 2,746,558.97 2,771,113.94 4,329,909.79 1,858,698.90 2,705,879.83 KSE-100™ Index 6,218.40 9,556.61 10,040.50 14,075.83 5,865.01 9,386.92 KSE-30™ Index 12,521.54 16,717.10 5,485.33 9,849.92 KSE All Share Index 4,104.86 6,444.64 6,770.06 9,956.76 4,400.76 6,665.55 New Companies Listed during the year 17 19 9 14 10 4 Listed Capital of New Companies—PKR 66,837.0 30,090.28 14,789.76 57,239.92 15,312.12 8,755.73 New Debt Instruments Listed during the year 5 8 3 3 7 1 Listed Capital of New Debt Instruments—PKR 4,775.0 10,900.00 3,400.00 6,500.00 26,500.00 3,000.00 Average Volume of Daily Turnover—Shares 343.70 365.64 260.69 268.23 146.55 179.88 in million Average Value of Daily Turnover—PKR 17,408.95 33,583.29 31,610.71 25,262.97 14,228.35 7,450.75 Average Daily Turnover (Future™) YTD17 69.64 117.16 82.68 61.69 30.76 1.03 Average Value of Daily Turnover—YTD 4,914.25 15,461.42 13,587.63 9,077.61 5,229.97 89.66 Source: KSE 17 YTD—Year to date Chapter 5. Securities, Market Structure and Trading Systems 42 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN 5.10 SECONDARY MARKET ing market conditions, short selling was also suspended in 2008. While these various developments were taking place In accordance with the legislation of Pakistan, all the activ- on the domestic market, the impact of the global financial ity of securities trading in the secondary market must be crisis also led to a substantial outflow of portfolio invest- carried out only through professional securities market ment. Notwithstanding, the market capitalization partially participants. recovered during 2009 reaching PKR 2,705 billion at end- December 2009. The KSE calculates three market indexes. Professional securities market participants can include The KSE-100 Index was introduced in November 1991 to legal entities and individuals carrying out one or several represent price movements of top 100 shares traded at the types of activity (such as broker activity, dealer activity, KSE and was recomposed in November 1994. The KSE-All asset management, depository services etc) and having Share index was introduced in September 1995 and the been licensed to operate professionally in the securities KSE -30 Index was calculated for the first time in 2006. market. These include banks licensed by the SBP and During the last two years the market was very volatile. Due NBFCs licensed by the SECP. to the deteriorated market conditions, the Karachi KSE- 100 stock index, after climbing to record highs by end- The principal investors in the market are local banks, bro- April 2008, dropped by 40 percent by late August 2008. kers, mutual funds, pension funds and insurance compa- In response, on August 27, 2008, the authorities imposed nies. There is a small pool of about 0.5 individual investors a price floor on all stock prices. Over the year 2008, the who hold about 5 percent of free float. The average free KSE-100 lost 140 percent of its value. In 2009, the market float is 20–25 percent. The foreign investors, primarily of partially recovered, which led to an increase of the KSE- Pakistani nationality residing abroad and some large insti- 100 by 60 percent to 9251.19 at the end of 2009. tutional investors, hold about 1/5 to 1/4 of the free float. The secondary market for Government bonds is thin The secondary market of corporate securities is concen- and is dominated by the financial institutions i.e. banks. trated at the three stock exchanges, in which the Karachi Retail investors and foreign investors have much smaller Stock Exchange plays a leading role. The overall volume participation in the bond market. Many of the investors of shares traded at the Karachi Stock Exchange decreased exhibit buy-and-hold behavior. Among the different types from 97.0 billion in FY04 to 63.3 billion in FY08 with a of government bonds, the T-bills are more actively traded, lowest level of 54.0 billion registered in FY07. During cal- (about 99 percent of the turnover). The repo market is the endar year 2009, the average daily turnover increased from most active segment of secondary market trading. During 146.6 million shares to 180.0 million shares. 2009, the total value of repo transactions was PKR 13,736 billion, which accounted for 66.3 percent of the turnover Market capitalization of listed companies has been grow- trading. ing steadily from 2004 until 2007 to reach 49 percent of GDP in 2007. Following a sustained period of growth, 5.11 STOCK EXCHANGE TRADING market prices have fallen sharply in 2008 resulting in a decline of market capitalization to PKR 1, 858.7 billion as The Karachi Stock Exchange has introduced a computer- of end-December 2008, down from PKR 4,329.9 billion as ized trading system known as Karachi Automated Trading of end-December 2007 (see Table 4). Average daily turn- System (KATS) to provide a fair, transparent, efficient, over in both volume and value in 2008 contracted to a half and cost effective market for the investors. The Exchange of the corresponding values in 2007. Because of deteriorat- makes available KATS to the Members by providing trad- 2010 43 ing workstation connections. The clearing of all the three ties, the trading is shifted to the Ready Board Counter stock exchanges of the country is centralized and handled under the T+2 segment. by the NCSS. Spot / T+1 Transactions: Currently, the exchange conducts one trading session For about 5 days before the date of closure of shares trans- from Monday to Thursday and two sessions on Friday. fer book, notified by the company, transactions are settled Members send their orders from their trading workstation on T+1 basis. to the central unit of KATS. Orders entered during the pre-opening period (from 9:15 to 9:30) are queued and Transaction Costs not executed at the time of entry. As each order is queued, Brokerage fees on transactions are freely negotiable the price at which it is expected to open will be calculated between the brokers and clients. See also section 6.2.4. through KATS. Once the opening price is chosen, all trading shall take place at that single opening price and no Stamp duty price level transition will be allowed. During the nor- There is no stamp duty for transfer settled through the mal trading hours (9:30 to 15:30), orders that cannot be Central Depository System, however, there is a one-time immediately executed are queued for future execution in stamp duty at the rate of One Paisa per share at the time of a specific order of priority mainly based in price and time deposit of securities in the CDS. Stamp duty is charged at of entry. 1.5 percent of the face value of the shares under the physi- cal form of transfer. The trading at the KSE is divided into four distinct seg- ments, each of which has its own clearing and settlement 5.12 OVER THE COUNTER (OTC) procedure. These are: T+2 segment on which most of the MARKET securities are traded, Provisionally Listed Companies’ Seg- ment, Spot (T+1) Transactions and Future Contracts. The OTC market of corporate securities in Pakistan is governed by the Regulation Governing the Over the T + 2 Segment Counter (OTC) Market, 2005, issued by the KSE. A On this segment transactions are settled through the company may apply to the KSE for listing and trading on Clearing House that nets out the purchases and sales and the OTC market. The regulation provides for minimum the financial obligations thereon of each member/firm conditions that the company should meet to be eligible for for the notified clearing period and issues instructions for listing. OTC market trading is quote-based and there are deliveries of netted outstanding business. Payment from market makers appointed by the KSE among the members and to members are routed through the Clearing House. of the KSE. According to the regulation, the securities listed on the OTC market shall be traded through KATS Trading in Provisionally Listed Companies system with suffix “OTC” added to its symbol. OTC The shares of companies which make a minimum public transactions are settled in accordance with the settlement offering of PKR 150 million are traded on this segment procedures applicable for the respective market segment. from the date of publication of public offering documents. The period of contracts is notified by the Exchange. The 5.13 DERIVATIVES outstanding contracts carried out under the provisionally listed companies are settled on the settlement date. Start- The Securities and Exchange Ordinance, 1969, defines ing from the date of formal listing of new issue of securi- types of securities that may be issued and traded on the Chapter 5. Securities, Market Structure and Trading Systems 44 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN organized markets, including commodity and financial Future Contracts (with maturity of 30, 60 and 90 days) derivatives. Further, the stock exchanges are empowered to introduced in 2007 (also called Non-Deliverable Future issue regulations for the trading, clearing and settlement of Contracts). However, the trading with derivatives is very derivatives. limited due to the absence of price discovery and conver- gence mechanics. Derivatives at Karachi Stock Exchange include Deliverable Future Contracts (with maturity 30 days) and Cash Settled CHAPTER 6 SECURITIES SETTLEMENT SYSTEMS 6.1 ORGANIZATIONS AND automated electronic system for clearing of transaction INSTITUTIONS from the three stock exchanges in a centralized manner. 6.1.1 Stock Exchanges There are two central securities depositories in Pakistan, Pakistan has three stock exchanges located in Karachi, one for government and one for corporate securities. Both Lahor and Islamabad with the Karachi Stock Exchange depositories hold securities in book entry (dematerialized being the biggest and most liquid. Only licensed broker- form). age companies can be members of the stock exchange. The stock exchanges are Self-Regulatory Organizations (SROs); The SBP owns and operates the central securities deposi- accordingly, their members are regulated by the rules of tory for government securities and plays the role of custo- the exchange. The three stock exchanges are supervised by dian. The securities settlement is integrated into PRISM. the SECP. Banks maintain a SGLA with the SBP and so-called DEPO (securities) accounts in PRISM for the settlement 6.1.2 Clearing Institutions and Securities of government securities. Different type of accounts that Depositories participants hold with the SBP for settlement purposes are The process of clearing and settlement of a securities trade explained in section 7.1. Debt Policy Coordination Office includes several key steps: the confirmation of the terms is responsible for the oversight of the government securi- of the trade by direct market participants; the calculation ties market and the implementation of the debt manage- of the obligations of the counterparties resulting from the ment strategy. confirmation process, known as clearance or clearing; and the final transfer of securities (delivery) in exchange for The Central Depository Company (CDC) operates the final transfer of funds (payment) in order to settle the obli- Central Depository System (CDS) for corporate securities gations. Each of these steps can typically be accomplished (equities and bonds). Almost all transactions negotiated in one or more ways: in some countries one institution at the three stock exchanges are settled through the CDS, performs all the clearing and settlement activities, while upon instructions received from the NCSS. The CDC is in other cases, like in Pakistan, these functions are divided supervised by the SECP. The CDC is the sole National between several institutions. Numbering Agency for Pakistan and issues International Securities Identification Number (ISIN) to standardize There is one clearing company in Pakistan—the National identification of local securities for trading and settlement Clearing Company Ltd (NCC). It operates the National in the country and abroad. Clearing and Settlement System (NCSS), which is a fully 45 46 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN TABLE 5: SIX YEAR OPERATIONAL DATA OF THE CDS Year Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Account Holders/Participants 420 461 539 541 591 611 CDS Live Securities 542 573 613 658 695 722 Shares available in CDS (No. in billions) 11.27 17.68 33.27 46.11 55.69 65.08 Investor Accounts (individual and corporate) 13,483 29,155 41,266 41,079 43,985 51,984 Number of Securities in Investor Accounts (in billions) 3.15 5.46 8.99 11.45 15.41 20.20 Source: CDC. The CDS maintains accounts of both its members and 6.2 SECURITIES CLEARING AND their customers (individuals and companies). As at the SETTLEMENT PROCESS end of FY09, there were 611 participants in the CDS and 51,984 individual accounts. The number of shares 6.2.1 Description of the Process registered and transferred in book-entry form in the CDS Corporate Securities reached 65 billion of which 20 billion were held in investor The NCSS is an electronic clearing and settlement system account. Table 5 shows six years operational data of the which was developed to replace the individual clearing CDS. houses of Pakistan’s three stock exchanges. Members of the NCSS (clearing members or CMs) are brokers and non- Out of 695 securities held in the CDS system as at end- broker companies. As of September 2009, the NCSS had June 2008, 72 percent were ordinary shares, 17 percent 297 broker and 124 non-broker clearing members (includ- constituted TFCs with the remainder made up of prefer- ing 21 banks, 7 DFIs and 82 mutual funds). ence shares, mutual funds units and Modaraba certificates (see Figure 8). Trades and transactions cleared by the NCSS, under Balance Order Multilateral Netting with T+2 and T+1 settlement cycle, are of three types, namely Exchange Transactions, Exchange Trades, and Non-exchange Trans- FIGURE 8: BREAKDOWN OF SECURITIES HELD IN THE actions. Exchange Trades are locked-in contracts between CDS broker CMs executed through exchange trading system 2% 4% 1% in the regular market. Exchange Transactions are locked- 4% in contracts between broker CMs executed through exchange trading system in the CFS Market. In addition, 17% net buy or net sell position of broker CMs based on their ■ Preference Shares ■ Mutual Funds futures contracts at the close of Futures Contract Period (Closed-End) Units are transmitted to the NCSS for clearing and settlement.18 ■ Mutual Funds (Open-End) Units Trade data are received in the NCSS from the exchanges ■ Modaraba Certificates on a real time basis. 72% ■ Ordinary Shares ■ TFCs 18 The CFS and future contracts market was discontinued in 2009. Trades with Source: CDC financial futures were re-introduced in 2009. 2010 47 Non-Exchange Transactions are generated and recorded in • Institutional Delivery System (IDS) facilitates the NCSS based on underlying Exchange Trades/Transac- non-Exchange transactions between broker tions and are classified into three categories handled by CMs and non-broker CMs based on underlying three sub-systems: Ready and Spot market trades; • Broker to Broker (BTB) Delivery System facili- • Margin Financing (MF) facilitates Broker CMs tates non-Exchange transaction between broker to arrange funds from other Broker/Non-broker CMs of different exchanges based on underlying CMs based on their purchases. exchange trade; Types of trades and transactions cleared in the NCSS are shown in the figure below. FIGURE 9: TYPES OF TRADES AND TRANSACTIONS CLEARED IN NCSS NCSS Exchange Non-Exchange Trades Transactions Future Cash Regular MF BTB IDS Settlement Regular Regular Regular Market Market Market Source: NCSS In the third quarter of 2009, the NCSS cleared 7,463,056 CDC, the Settling Bank and a CM, the Designated Branch exchange trades, 64,420 BTB transactions and 640,637 debits/credits the settling account of the CM for NCSS IDS transactions, valuing PKR 656.1 billion, 5.2 billion money settlement, in accordance with NCSS Procedures and 134.9 billion respectively. for Pay&Collect. As of September 2009, there were 14 Settlement Banks with 26 Settlement Bank Branches. For the purpose of cash settlement, each CM maintains a settlement account with one of the Designated Branches of 19 A Settlement Bank is a bank approved by the NCC to provide settlement a Settlement Bank.19 As per the standing instructions pro- accounts to NCC clearing members. The NCC approves the list of branches of the Settlement Banks (Designated Branches) that are allowed to offer settlement vided under the Tripartite Agreement signed between the services to the CMs. Chapter 6. Securities Settlement Systems 48 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN Settlement Flow Net MtM losses are collected from members in cash on After the transaction is executed at one of the stock T+0 (at the end of the trade day) through the NCC. Net exchanges between brokers, the stock exchange sends MtM profits are disbursed to members in cash on T+1 information to the NCSS in electronic form on the date of through the NCC. The final clearing occurs on the last day the trade (T). The NCSS performs trade matching and cal- of the Contract Period at Final Settlement Price of that day culates brokers’ positions on a multilateral net basis. These on T+2 settlement basis through the NCC. However, MtM activities are performed on day before the settlement day losses are collected daily, based on the closing price of the (S -1). The NCSS generates Balance Order information security in the spot market, till the time, the net positions which is sent to the buying and selling broker and to the are settled. depository of securities. The securities are then blocked after satisfaction of all money and delivery obligations of Members participating in the derivatives markets are sub- a particular clearing member. At the same time the NCSS ject to margin requirements. There is Initial Margin and generates payment orders and money receive orders for Exposure Margin (MtM margin) requirement. The NCC the buying and selling broker respectively. keeps the deposited margin separately for each market and the margin deposited for trades in one market can not The buying broker is obliged to make the payment by be used by the NCC for purpose other than to meet any 12:00 on the settlement date and needs to ensure that the obligations of the member in this specific market. Mar- securities are available in its CDS account. Once the pay- gin requirements and risk management procedures are ment is made and a confirmation is received by the NCSS, defined in the Regulations Governing Risk Management the securities are unblocked and delivered to the account of Karachi Stock Exchange. of the buyer. The NCSS settles securities trades on DVP Model 3 basis. 20 Whenever a broker has executed an order Margins payable by a member can be in the form of cash, of a client, the broker shall transmit confirmation of such Margin Eligible Securities, and Bank Guarantee as speci- execution to the said client within 24 hours of the execu- fied in the SE regulations. tion through any previously agreed mode of communica- tion. A broker failing to deliver the above confirmation in Other risk management tools include exposure limits for time is subject to penalties, stipulated in the Rules of the all markets, implementation of position limits in each NCC. Figure 10 shows the settlement flows of funds and market separately (for members and their clients) based on securities. specified percentage of free-float of shares of a company, and circuit breakers. Derivatives Continuous Funding Settlement CFS MK-II Future contracts are marked to market (MtM) at the Daily Settlement Price and the calculated amounts are settled as In 2005, the NCC introduced the CFS mechanism that was detailed here below. replaced later by the CFS MK-II. CFS MK-II creates an institutional pool of funds with the aim to providing liquid- ity to the market. It allows institutions to directly provide 20 The three basic models of DVP settlement are described in Delivery versus financing in the equity market through the NCC. The pool payment in securities settlement systems, CPSS, September 1992. In DVP Model is available to investors and financier at any of the stock 1, the system settles transfer instructions for both securities and funds on a exchanges. As mentioned above, due to unfavorable market trade-by-trade (gross) basis. In DVP Model 2, securities transfer instructions are settled on a gross basis while funds transfer instructions are settled on a conditions and the potential risk for participants and inves- net basis. Finally, in DVP Model 3 transfer instructions for both securities and tors, the CFS MK-II market was discontinued in 2009. funds are settled on a net basis. 2010 49 FIGURE 10: SETTLEMENT FLOWS IN SECURITIES TRANSACTIONS T Buying Broker Selling Broker Execution of Trades at the Stock Exchange Online trade feed Generation of to NCSS NE Transactions Netting of Trades T+1 NCSS Payment orders and Money Receive Orders SD–1 Delivery Receive Order and Delivery Order Buying Broker CDS Selling Broker Delivery of NCSS eligible securities Payment to NCSS Collect Payment Release Payment Source: NCSS. Government securities types of sub-accounts, namely Own accounts and IP For settlement of government securities transactions accounts. Own accounts are used by participants in the banks maintain two types of accounts with the SBP—a RTGS system to settle own securities. IP accounts are used SGLA and a DEPO account in PRISM. Government by banks to hold and transfer securities on behalf of their securities balances in the SGLA accounts are uploaded customers. The securities balances in each sub-account are into the DEPO accounts in PRISM at the beginning of further divided in 4 sub-categories: available, restricted, each business day. DEPO accounts are divided into two blocked and other. Participants may transfer securities Chapter 6. Securities Settlement Systems 50 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN between their Own account and SGLA or IP account of nated Time pursuant to the NCSS Regulations. Selling-out another participant, and from its IP account to any SGLA may be effected on failure by a CM to pay money obliga- or IP account of another participant. tion on date S by the designated time, or any extension granted in the designated time pursuant to the NCSS A transfer of government securities through PRISM is Regulations. The procedure takes place by noon on date S. effected by making an appropriate entry in the DEPO Buying broker who already made the payment will receive accounts of the participant selling securities and the par- the delivery the next day subject to square-up. In case ticipant receiving the transferred securities. The settlement securities are not deliver the next day, such failed delivery occurs on a DVP Model 1 basis and is executed immedi- shall be closed on S+1 whereby the buyer will get market ately and irrevocably, subject to availability of funds and value on the basis of highest price (between S-1 and S+1). securities. In case of lack of funds or securities the respec- tive DVP transaction will remain in a queue. Pending Blocked securities: As part of the DVP settlement mecha- instructions may be canceled before the settlement occurs, nism, bought securities are delivered to buying CM’s CDS and all pending transaction will be canceled by the system account in blocked status. Blocked securities are avail- at the end of the day. able to buying CMs only after discharging their payment obligations. 6.2.2 Management of Settlement Risks Corporate securities Short delivery debits: In case of delay/non delivery by 15:30, the system additionally debits CMs’ accounts with To eliminate principal risk in securities settlements, that is, 15 percent margin of late/fail delivery of the previous day the risk that the seller of a security delivers a security but closing price. does not receive payment or that the buyer of a security makes payment but does not receive delivery of the secu- Retrieval status: In case of money default by a CM, rity, trades concluded at the stock exchanges are settled on blocked securities in his CDS account are retrieved by the a DVP Model 3 basis. Several additional tools are available NCC for selling out. to control settlement risk. Lending and borrowing of securities: Participants at the Payment Notice: As for the cash leg of the transactions, stock exchange can borrow from or lend to each other, each settlement bank has to reserve in the account of the or pledge securities, registered in book-entry form in the clearing member the amount the CM intends to use for CDC, against the market transactions in order to facilitate trading activities. In case of non-payment, a Payment the timely settlement. To further reduce the settlement risk Notice of 30 minutes is generated and in case of failure to in market transactions, the NCC is planning to implement comply with this Notice, the CM is suspended or restricted securities Lending and Borrowing mechanism. by the NCC. To control the risk of failure of a participant to pay its Recalculations of failed deliveries: A CM who fails to obligations resulting from price fluctuations in the futures deliver securities at the settlement date is reported to market, the NCC has established margin requirements for NCSS. NCSS Securities may be bought-in or sold-out participants. NCSS Pay&Collect is an automated system on failure by a CM to comply with NCSS Regulations. related to money settlement. It calculates single net settle- Buying-in may be effected on failure by a CM to deliver ment position for CMs who trade on more than one SE securities (fully or partially) on the settlement day S by the and disburses profits and losses of marked-to-market Cash designated time, or any extension granted in the Desig- Settle Future Contracts (Stock index Future Contracts). 2010 51 Settlement of the cash leg of the securities transactions As part of its BCP arrangements, the NCSS has established occurs in commercial bank money, thus the participants a secondary site which also serves as Disaster Recovery are exposed to the risk of failure of the settlement bank. site. The risk is partially controlled by the NCC establishing eligibility criteria for settlement banks. Such risk can be Some of the features implemented by the CDC and NCC eliminated by moving the settlement of funds to the SBP include: through the RTGS system (settlement in central bank • CDS/NCSS Identity Documents (IDs) and pass- money). words: All CDS elements and CMs are allocated unique IDs and passwords through which to For a description of the existing guarantee schemes see enter the system; also section 6.3. • Dial-in IDs and passwords: This feature is an Government securities additional layer of security for those clients All transactions are executed in real time gross settlement who are connected to the CDS/NCSS through mode in PRISM for both the securities leg and the pay- telephone lines; ment leg of the transaction, thus eliminating credit risk. • Terminal authentication: CDS elements can only Payments and deliveries executed in PRISM are final and get connected to us through their designated irrevocable. Further, settlement on DVP Model 1 basis21 terminals; ensures simultaneous transfer of securities against receipt • Two factor authentication—RSA (Rivest, of funds, thus eliminating principal risk. Shamir and Adleman) and VPN (Virtual Private 6.2.3 Management of Operational Risks Network); The institutions providing the infrastructure for securities • Daily tape back-ups made to keep record of the trading, clearing and settlement in Pakistan (i.e. the stock CDS/NCSS status; exchanges, the NCC, the CDC and the central depository • A fully operational secondary processing site for government securities) have implemented various in Karachi. This site is installed with redundant measures to ensure informational security, operational hardware, software and requisite network to reliability and business continuity of systems they oper- provide cost effective connectivity and sup- ate. Operational security and reliability is ensured by the port to all CDS users and CMs of the NCSS. A use of secured communication networks, access controls, reliable data communication link is deployed systems’ performance is monitored and incidents are to connect the remote site with the primary site reported regularly. All softwares (server side and client and transmit the latest CDS and NCSS status to side) are documented and user manuals are provided to the remote site at the shortest possible intervals. respective stakeholders. Business continuity measures include a hardware and software backup, contingency plan Government securities are settled through PRISM. For for business continuity and recovery procedures and data operational risk management in PRISM see section 4.2.3. storage and warehousing. 6.2.4 Pricing 21 Settlement for both securities and funds on a trade-by-trade (gross) basis, with final (unconditional) transfer of securities from the seller to the buyer New members of Karachi Stock Exchange have to (delivery) occurring at the same time as final transfer of funds from the buyer to the seller (payment). See Delivery versus payment in securities settlement systems, purchase a seat from existing members. The price of the CPSS, September 1992. membership seat is freely negotiable between the buyer Chapter 6. Securities Settlement Systems 52 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN and the seller. Investors pay brokerage commission on 6.4 SECURITIES LENDING transactions, which is freely negotiable between the bro- kers and clients. In addition, stamp duty is charged at 1.5 Participants at the stock exchange can borrow from or percent of the face value of the shares under the physical lend to other participants, or pledge securities, registered form of transfer. There is no stamp duty for transfer settled in book-entry form in the CDC, in order to facilitate through the CDS. the timely settlement of market transactions. Rules for securities lending are framed in the SECP Directive With The NCSS charges its members a transaction fee. The CDS Regards to Transfer of Book-entry Securities at the Central charges participants and other account holders an account Depository System, September 2008. To further reduce opening fee, initial deposit fee, transaction fee, custody the settlement risk in market transactions, the NCC has fee, CDS connection fee and documentation fees. Issuers/ started developing a securities Lending and Borrowing Asset management companies are charged a new issue fee, mechanism as part of its strategic development plan. fixed annual fee on eligible securities and other adminis- trative/documentary fees. 6.5 INTERNATIONAL LINKS AMONG CLEARING AND SETTLEMENT With respect to government securities, the development INSTITUTIONS cost for PRISM was fully borne by the SBP. The SBP does not charge entry fee, membership fee or transaction fee. At present, the two CSDs in Pakistan are not linked to for- However, the Operating Rules for Participation in PRISM eign or international CSDs: the two depositories do not include provisions for transaction charges. hold accounts with foreign CSDs, nor do foreign CSDs hold accounts with local depositories. 6.3 GUARANTEE SCHEMES To enhance coordination with international depositories, According to the Clearing House (Registration and the CDC has signed a number of MoUs with regional and Regulation) Rules, 2005, the NCC is required to establish international depositories. These include Japan Security a clearing and settlement fund from which a clearing Depository Centre, Depository Trust & Clearing Corpo- member’s obligation to the clearing house may be satisfied, ration, USA, Thailand Securities Depository, Thailand, in case of default of such member. This is a loss-sharing Abu Dhabi Securities Market, U.A.E and Dubai Financial arrangement funded by a part of clearing and settlement Market, U.A.E. These MoUs entail cooperation in the fee paid by the members. areas of technology exchange, customer care, operational procedures, mechanism for cross-border listing of securi- The clearing and settlement fund may be divided into sub- ties and exchange of information and provide an excellent funds, each of which can be utilized to discharge obliga- opportunity to the CDC to learn and share experiences tions for any particular service for which the clearinghouse with the world’s largest depositories. has assumed responsibility. CHAPTER 7 THE ROLE OF THE CENTRAL BANK IN SECURITIES SETTLEMENT SYSTEMS 7.1 SETTLEMENT introduction of new payment instruments and channels for making retail payments and for increasing the security Operation of PRISM and operational reliability of the existing instruments in line The SBP is at the centre of the national payment and with the international standards and best practices. Further- securities settlement systems. It plays a major operational more, the SBP has contributed considerably to the improve- role as operator and owner of the PRISM and the CSD for ments to the legal and regulatory framework for payments. government securities, which is part of PRISM. PRISM was launched in July 2008 with the aim to reduce systemic Finally, the SBP is engaged in educational efforts to raise risks that could arise from wholesale funds and govern- awareness among consumers of the new payment instru- ment securities transfer activities. The SBP’s power, rights ments and services. The SBP issues guidelines both in and responsibilities with respect to payment and securities the English and Urdu languages and requests banks to settlement systems derive from the PSEFT Act, 2007. disseminate this information to their consumers. The SBP is also encouraging the financial institutions to appro- Provision of settlement asset and accounts priately educate their customers on the launch of new The SBP offers the asset that is used for the settlement of payment products and services. A notable example is the interbank obligations originating from financial market comprehensive media campaign launched by the United transactions or from the clearing of cheque transactions. Bank Limited Pakistan to educate customers on their new The SBP offers central bank accounts in both funds and mobile banking and prepaid VISA cards services intro- securities to all banks. Banks maintain current accounts duced for the first time in Pakistan. with the SBP for maintaining their cash reserve balances in accordance with the CRRs. In order to facilitate the settle- 7.2 PAYMENTS SYSTEM OVERSIGHT ment of government securities, the SBP offers to banks DEPO and SGLA, in addition to cash settlement accounts. The PSEFT Act, 2007 entrusts the SBP with powers to oversee payment systems, payment instruments and Facilitation of innovation providers of payment services. According to Art. 1, the The introduction of the RTGS system for the settlement SBP is responsible for supervising and regulating Payment of interbank payment and the introduction of electronic Systems and Electronic Fund Transfers in Pakistan, as book-entry system for government securities constitute well as providing standards for protection of consumers. only part of a broader program of the SBP to modern- In carrying out its mandate, the SBP may designate or ize payment and settlement systems in Pakistan. The SBP revoke the designation of a payment system in Pakistan. has been working together with the private sector for the In doing so, the SBP can issue rules, guidelines, circulars, 53 54 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN by-laws, standards or directions as it may consider appro- 7.3 MONETARY POLICY AND priate in respect of payment systems, the conduct of all or PAYMENT SYSTEMS any of the service providers, operators of payment systems or issuers of payment instruments. See Chapter 2.5.1. The SBP is the overseer of the cheque clearing system 7.4 THE ROLE OF THE CENTRAL NIFT and other retail payment systems, such as payment BANK IN CROSS-BORDER PAYMENTS card switches, remittance service providers and providers of mobile payment services. The SBP is playing an active role in promoting safe and efficient international remittance services. The SBP The SBP is in the process of developing a comprehensive has developed continuous interaction with banks and oversight strategy and methodology for conducting over- Exchange Companies to promote the remittance business. sight activities with respect to PRISM and retail payment The SBP established a Task Force on Remittances in 2008. systems. The SBP is not currently involved in the oversight In FY08, the SBP initiated reform process in the Exchange of clearing and settlement of corporate securities. Companies sector with a view to bringing better market discipline through enhanced transparency, disclosure, An internal Payment System Policy committee has been strong monitoring, supervision and enforcement. In 2009, established wherein all the key stakeholders (SBP depart- the SBP approved the Remittance Card Scheme of Askari ments) are represented. There are plans to expand the Bank. The scheme has been designed to increase the scope of the committee by including representatives of key outreach of remittance services to underserved population external stakeholders from the private and public sector. and to reduce costs. Another breakthrough related to the remittances was the launch of the Pakistan Remittance Ini- The SBP cooperates with the SECP in regard to the over- tiative by the government and the State Bank of Pakistan sight and regulation of NBFCs. The responsibilities, work- with the goal to boost and facilitate the flow of remittances ing relationships and information sharing between the two sent home by non-resident Pakistanis. institutions are defined in a MoU between the SBP and the SECP (September 2003). The SBP senior management The SBP is a member of the ACU, which was established meets regularly with the banking community to discuss in 1974 to facilitate cross-border trades and regional coop- issues relating to payment systems development. Ad-hoc eration of the South Asian countries. ACU is a system for working groups on specific payment-related topics (such clearing payments among the member countries on a mul- as the implementation of the RTGS project) have been tilateral basis. All transactions to be cleared through the formed with the participation of experts from the central ACU are handled by authorized banks in the same manner bank and commercial banks. as other foreign exchange transactions. Authorized banks may enter into correspondent arrangements with banks in Information on the development of payment infrastruc- the other countries participating in the clearing union. ture and payment instruments in the country is included in the annual report of the SBP, which is published on its For settlement and accounting purposes the banks main- website. tain ACU dollar accounts.22 The excess liquidity in either direction is required to be settled by the central banks in 22 The common unit of account of ACU is the Asian Monetary Unit which is equivalent in value to one USD. 2010 55 the countries concerned through the ACU mechanism. tive January 1st, 2009. Further, to encourage the banks to Each central bank receives and pays US dollars from/ maintain reasonable/sufficient balances in their accounts to the domestic participants for the purpose of funding to ensure timely payments, the ADs have been permitted or for repatriating the excess liquidity in the ACU dollar to pay/receive interest, at their discretion, on ACU dollar accounts maintained by the participants with their cor- and ACU Euro accounts as per mutually agreed terms and respondents in the other participating countries. Simi- conditions. larly, the central banks receive or deliver US dollars for absorbing liquidity or for funding the ACU dollar (vostro) 7.5 PRICING POLICY accounts maintained by the domestic participants on behalf of their overseas correspondents. Costs for the development and the implementation of the RTGS system were fully borne by the SBP. The SBP does ACU Euro has been included as the second ACU cur- not charge entry fee, membership fee or transaction fee. rency effective from January 1st, 2009. The ACU Euro is However, the Operating Rules for Participation in PRISM equivalent in value to one Euro. Accordingly, transactions include provisions for transaction charges. Banks are free under ACU Mechanism, in addition to ACU dollar, may to determine charges they apply for sending customer pay- also be denominated and settled in ACU Euro effec- ments via PRISM. Chapter 7. The Role of the Central Bank in Securities Settlement Systems CHAPTER 8 SUPERVISION OF SECURITIES SETTLEMENT SYSTEMS 8.1 SECURITIES REGULATOR • promoting and regulating SROs including secu- SUPERVISORY AND STATUTORY rities industry and related organizations such RESPONSIBILITIES as stock exchanges and associations of mutual funds, leasing companies and other NBFCs; The Securities and Exchange Commission of Pakistan (SECP) is responsible for encouraging the organized • ensuring and monitoring compliance by development of the capital market, the corporate sector insurers, insurance surveyors and insurance and the insurance market in Pakistan, and promoting and intermediaries of all laws, rules and regulations regulating development of Private Pension Schemes and pertaining to insurance; Funds. • regulating professional organizations connected with the insurance business; The SECP is entrusted with the performance of the follow- • calling for information from and undertaking ing functions among others: inspections, conducting inquiries and audits • regulating the issuance of securities; of the stock exchanges and intermediaries and • regulating the business of stock exchanges and SROs in the securities market; any other securities markets; • considering and suggesting reforms of the law • supervising and monitoring the activities of relating to companies and bodies corporate, any central depository and stock exchange securities markets, including changes to the clearinghouse; constitution, rules and regulations of companies and bodies corporate, stock exchanges or clear- • registering and regulating the stock brokers, ing houses; sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an • promoting investors’ education and training of issue, underwriters, portfolio managers, invest- intermediaries of securities markets. ment advisers and such other intermediaries who may be associated with the securities mar- According to the Act for the establishment of the Securi- kets in any manner; ties and Exchange Commission of Pakistan, Act No. XLII of 1997, the Federal Government shall appoint a Securities • proposing regulations for the registration and and Exchange Policy Board consisting of nine Members. regulating the collective investment schemes, Five of the members shall be executive officers and four including unit trust schemes; shall be appointed by the Federal Government from 57 58 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN the private sector, each of whom is well-known for his All policy decisions and directives of the Board and the integrity, expertise and experience in the spheres of com- SECP respectively are published in the official Gazette merce and industry (including in particular the securities and the Board and the SECP shall make such publications industry), corporate law, accountancy, financial services, available to the public. investment, insurance, banking, academia or other related relevant fields of expertise. 8.2 REGULATORY AND STATUTORY RESPONSIBILITIES OF SELF- The Board is responsible for policy making, coordination REGULATORY ORGANIZATIONS with the Federal Government and oversight of the per- formance of the SECP. It also specifies fees, penalties and The securities exchanges, the NCC and the CDC are con- other charges chargeable by the SECP. sidered SROs in Pakistan. As such, they are empowered by the respective laws to issue regulations, operating rules, The Board and the SECP are empowered to issue regula- procedures and manuals, as well as to establish require- tions under the Act for the establishment of the Securi- ments for access and membership. The regulation and ties and Exchange Commission of Pakistan (Art. 40) and operating procedures allow the SROs to control risks (as impose penalties for the violation of rules and regulations required by the law) associated with the services they pro- of the Act (Art. 40A). The SECP also is mandated to issue vide to the participants in the securities markets, including directives, codes, guidelines, circulars or notifications, and clearing and settlement of funds and securities, to oversee may conduct investigations “in respect of any matter that market participants and to collect and publish information is an offence under the Act or any other law administered about trading, clearing and settlement activities. by the SECP”. APPENDIX STATISTICAL TABLES Series A tables are statistics on payments and securities clearing and settlement in Pakistan and were completed following a standard model prepared in the context of SAPI. They slightly differ from the model due to data availability constraints. Series B tables are more general statistics related to the financial sector. PAYMENTS AND SECURITIES CLEARING AND SETTLEMENT STATISTICS SERIES A 60 Table A1: Basic Statistical Data, 60 Table A2: Settlement Media used by Non-Banks, 60 Table A3: Settlement Media Used by Credit/Deposit Taking Institutions, 61 Table A4: Institutional Framework, 61 Table A5: Bank Notes and Coins, 61 Table A6: ATMs, EFTPOS Terminals and RTOBs, 62 Table A7: Number of Payment Cards in Circulation, 62 Table A8: Indicators of Use of Various Cashless Payment Instruments, 63 Table A9: Indicators of Use of Various Cashless Payment Instruments, 63 Table A10: Payment Instructions Handled by Selected Interbank Transfer Systems, 63 Table A11: Payment Instructions Handled by Selected Interbank Transfer Systems, 64 Table A12: Securities and Accounts Registered in Central Securities Depositories, 64 Table A13: Securities Holdings in Central Securities Depositories, 64 Table A14: Transfer Instructions Handled by Securities Settlement Systems, 65 Table A15: Transfer Instructions Handled by Securities Settlement Systems, 65 SERIES B 66 Table B1: Number of Financial Entities, 66 Table B2: Banking Sector Assets, 66 Table B3: Deposits, 66 Table B4: Equity, 67 Table B5: Loans, 67 59 60 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN SERIES A TABLE A1: BASIC STATISTICAL DATA* FY04 FY05 FY06 FY07 FY08 Population (in millions) 149.65 152.53 155.37 158.17 160.90 GDP (USD billion) 98.00 109.60 127.50 144.00 167.60** GDP per Capita (USD) 655.00 719.00 817.00 909.00 1,042.00 Real GDP (annual change in %) 9.00 5.80 6.80 5.80 Consumer price (annual change in %, 9.30 7.90 7.80 12.00 period average) Exchange rate PKR vs. USD Year end 58.2 59.7 60.2 60.4 68.2 Average 57.6 59.4 59.9 60.6 62.5 Source: SBP. * The following conventions for notation are used in all Tables throughout the Appendix: “n.a.” indicates data that are not available; “. . .” stands for data that are not applicable; “neg” indicates where data are very small relative to other relevant data in the table concerned; “prov” stands for provisional data ** Estimated. TABLE A2: SETTLEMENT MEDIA USED BY NON-BANKS (in PKR billion) FY04 FY05 FY06 FY07 FY08 FY09 Total notes and coins issued 617.5 712.5 791.8 901.4 1054.2 1231.9 Currency in circulation 578.1 665.9 740.4 840.2 982.3 1152.2 Total deposits excluding RFCDs 1759.6 2111.1 2466.1 3010.7 3439.1 3700.0 of which: Time deposits 1,056.6 1,280.5 1,498.9 1,893.3 2,162.4 2,162.4 Resident foreign currency deposits 145.7 180.3 195.5 207.3 263.4 280.4 Money aggregate M2 2485.5 2960.6 3406.9 4065.2 4689.1 5137.2 Source: SBP. 2010 61 TABLE A3: SETTLEMENT MEDIA USED BY CREDIT/DEPOSIT TAKING INSTITUTIONS (in PKR billion) FY04 FY05 FY06 FY07 FY08 FY09 Required reserves at the Central Bank In domestic currency 95.6 114.4 133.7 186.6 253.5 263.5 In foreign currency 0.5 0.7 0.7 0.8 0.8 0.8 Excess reserves at the Central Bank: In domestic currency 13.9 23.8 9.3 56.8 91.9 91.9 In foreign currency .003 .015 .028 .000 .018 .018 Institutions’ borrowing from the Central 173.2 189.7 200.3 268.9 216.5 216.5 Bank23 Transferable deposits at other institutions Source: SBP. 23 Including repos with the SBP. TABLE A4: INSTITUTIONAL FRAMEWORK (As of end June 2009) Number of Number of Institutions branches Central Bank 1 Commercial Banks 36 8238 Of which State-owned banks 4 1608 Foreign banks 7 88 Development Finance institutions 7 Specialized banks 4 536 Micro-finance banks 8 270 Non-bank financial institutions 127 n.a. Postal Office 1 n.a. Source: SBP, SECP. TABLE A5: BANK NOTES AND COINS (in PKR billion) FY04 FY05 FY06 FY07 FY08 FY09 Total currency issued 617.5 712.5 791.8 901.4 1054.2 1231.9 Total banknotes issued 611.9 705.7 784.2 893.3 1045.9 1223.5 Coins issued 5.6 6.7 7.6 8.1 8.3 8.4 Notes and coins circulating outside 578.1 665.9 740.4 840.2 982.3 1152.2 banks Source: SBP. Appendix. Statistical Tables 62 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN TABLE A6: ATMS, EFTPOS TERMINALS AND RTOBS FY05 FY06 FY07 FY08 FY09 Cash dispensers and ATMs Number of networks n.a. n.a. 2 2 2 Number of ATMs 1,028 1,612 2,294 3,121 3,999 Volume of transactions (in millions) 27.9 35.0 51.5 67.9 91.1 In foreign currency In local currency 27.9 35.0 51.5 67.9 91.1. Value of transactions 153.7 211.0 316.2 453.0 668.5 In foreign currency (US$ million) In local currency (PKR billion) 153.7 211.0 316.2 453.0 668.5 EFTPOS Number of networks n.a. n.a. 2 2 2 Number of terminals n.a. n.a. n.a 43,903 49,715 Volume of transactions (in millions) 12.9 10.9 15.6 17.5 18.3 Value of transactions (PKR billion) 42.8 32.4 53.7 68.9 89.6 RTOBs Number of branches 2,897 3,555 4,179 5,282 6,040 Volume of transactions (in millions) 2.9 21.0 30.7 36.9 47.3 Value of transactions (PKR billion) 1,094.7 6,773.7 10,089.7 13,317 13,543 Source: SBP. TABLE A7: NUMBER OF PAYMENT CARDS IN CIRCULATION FY04 FY05 FY06 FY07 FY08 FY09 Total number of cards (million) n.a. n.a. 3.785 5.815 7.471 8.9 Cards with a cash function n.a. n.a. 0.071 0.134 0.789 0.881 Cards with a debit function n.a. n.a. 2.740 3.983 4.905 6.4 Cards with a credit function n.a. n.a. 0.973 1.698 1.777 1.7 Source: SBP. 2010 63 TABLE A8: INDICATORS OF USE OF VARIOUS CASHLESS PAYMENT INSTRUMENTS (volume of transactions, in thousands) FY05 FY06 FY07 FY08 FY09 Electronic Based 43,687 67,774 99,367 125,379 159,800 Paper Based 206,423 300,988 324,219 334,965 335,300 Total 250,150 361,292 423,586 462,212 495,100 % Composition Electronic Based 17.50 18.80 23.50 27.10 32.30% Paper Based 82.50 60.60 76.50 72.90 67.70% Source: SBP. TABLE A9: INDICATORS OF USE OF VARIOUS CASHLESS PAYMENT INSTRUMENTS (value of transactions, in PKR billion) FY05 FY06 FY07 FY08 FY09** Electronic Based 1,291 7,040 10,497 13,688 15,540 Paper Based 70,363 87,851 113,655 137,874 139,860 Total 71,642 91,936 124,152 151,562 155,400 % Composition Electronic Based 1.80 7.70 8.50 9.20 10.00% Paper Based 98.20 95.60 91.50 90.80 90.00% Source: SBP. TABLE A10: PAYMENT INSTRUCTIONS HANDLED BY SELECTED INTERBANK TRANSFER SYSTEMS (volume of transactions, in thousands) FY05 FY06 FY07 FY08 FY09 Low value system (NIFT) n.a. 52,835 62,397 71,250 73,605 In domestic currency n.a. 52,835 62,397 71,250 73,605 Large value system24 n.a. n.a. n.a. 178 236 In domestic currency n.a. n.a. n.a. 178 236 Source: SBP. 24 The new large-value payment system PRISM was introduced on 1 July 2008. Appendix. Statistical Tables 64 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN TABLE A11: PAYMENT INSTRUCTIONS HANDLED BY SELECTED INTERBANK TRANSFER SYSTEMS (value of transactions, in PKR billion) FY05 FY06 FY07 FY08 FY09 Low value system (NIFT) n.a. 15,745 19,033 23,749 n.a. In domestic currency n.a. 15,745 19,033 23,749 n.a. Large value system 25 n.a. n.a. n.a. 51,086 62,226 In domestic currency n.a. n.a. n.a. 51,086 62,226 Source: SBP. 25 See footnote 2. TABLE A12: SECURITIES AND ACCOUNTS REGISTERED IN CENTRAL SECURITIES DEPOSITORIES FY04 FY05 FY06 FY07 FY08 Number of securities registered SBP CSD n.a n.a n.a n.a n.a CDS 542 573 613 658 695 Number of participants SBP CSD n.a n.a n.a n.a n.a CDS 420 461 539 541 591 Number of investor accounts SBP CSD n.a n.a n.a n.a n.a CDS 13,483 29,155 41,266 41,079 43,985 Number of foreign investors n.a. n.a. n.a. n.a. n.a. Sources: SBP, CDC. TABLE A13: SECURITIES HOLDINGS IN CENTRAL SECURITIES DEPOSITORIES FY04 FY05 FY06 FY07 FY08 SBP CSD Government Securities 717.92 790.02 780.94 1,068.82 990.77 (in PKR billion) CDS Corporate Shares 447.39 692.26 1115.86 2102.29 2097.72 (value in PKR billion) Units of TFCs/WAPDA Bonds/ 9.42 11.39 65.09 52.15 69.24 Sukuks and Open-End Mutual Funds (Number in million) Source: SBP, NCC, CDC. 2010 65 TABLE A14: TRANSFER INSTRUCTIONS HANDLED BY SECURITIES SETTLEMENT SYSTEMS (volume of transactions in millions) FY04 FY05 FY06 FY07 FY08 SBP CSD Government Securities 46,636 49,178 42,924 40,598 37,944 CDS Corporate Shares 96,957.75 88,301.20 79,454.30 54,042.38 63,316.12 Units of TFCs/WAPDA Bonds/ n.a n.a n.a n.a n.a Sukuks and Open-End Mutual Funds Source: SBP, NCC, CDC. TABLE A15: TRANSFER INSTRUCTIONS HANDLED BY SECURITIES SETTLEMENT SYSTEMS (value of transactions, in PKR million) FY04 FY05 FY06 FY07 FY08 SBP CSD Government Securities 9,271,915 9,496,921 3,700,567 3,143,609 3,029,869 CDS Corporate Shares n.a n.a n.a n.a n.a Units of TFCs/WAPDA Bonds/ n.a n.a n.a n.a n.a Sukuks and Open-End Mutual Funds Source: SBP, NCC, CDC. Appendix. Statistical Tables 66 PAYMENTS AND SECURITIES SETTLEMENT SYSTEMS IN PAKISTAN SERIES B TABLE B1: NUMBER OF FINANCIAL ENTITIES Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Central Bank 1 1 1 1 1 1 Commercial Banks 36 35 35 36 36 36 Of which State-owned banks n.a. 4 4 4 4 4 Foreign banks n.a. 11 7 6 6 7 Development Finance institutions n.a. 5 5 5 6 7 Specialized banks 3 4 4 4 4 4 Micro-finance banks n.a. 5 6 6 6 8 Non-bank financial institutions n.a. 82 74 93 117 127 Modarabas n.a. 30 29 27 27 27 Postal Office 1 1 1 1 1 1 Source: SBP, SECP TABLE B2: BANKING SECTOR ASSETS (year-end, in domestic currency, in billions) Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Deposit money in banks—Total assets 2799.6 3349.2 4029.2 4952.0 5513.0 6086.9 Deposit money in banks—foreign n.a. n.a. n.a. n.a. n.a. n.a. currency denominated assets Commercial Banks—Net Loans 1337.1 1795.0 2207.0 2427.3 2845.9 3090.9 Source: SBP. TABLE B3: DEPOSITS (year-end, in domestic currency, in billions) Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Demand deposits 604.7 756.7 842.9 991.2 1154.1 1257.1 Time deposits 405.4 564.1 836.9 1107.4 1290.2 1479.6 Savings deposits 1088.7 1203.1 1253.0 1397.5 1513.4 1580.1 Source: SBP. 2010 67 TABLE B4: EQUITY (year-end, in domestic currency, in billions) Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Deposit money banks 143.4 221.3 326.6 489.2 561.3 622.5 Other banking institutions n.a. n.a. n.a. n.a. n.a. n.a. Non banking financial institutions n.a. n.a. n.a. n.a. n.a. n.a. Source: SBP. TABLE B5: LOANS (year-end, in domestic currency, in billions) Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Total credit to businesses 1208.6 1557.3 1839.2 2076.0 2508.0 3058.2 Total credit to individuals 142.3 246.6 339.8 403.0 412.0 397.6 Source: SBP. Appendix. Statistical Tables