Brief on State Bank Amendment Act 2021

BRIEF ON STATE BANK AMENDMENT ACT 2021

BACKGROUND

The role of the State Bank of Pakistan (SBP) as defined in the State Bank of Pakistan Act 1956 has undergone several changes over the years. Major revisions in the SBP Act were introduced in 1994, 1997, 2012 and 2015. These changes were carried out to bring the central bank legislation in line with best practices at that time and to enable it to deal with evolving issues effectively. For example, the SBP Act was amended in 2015 to establish an independent Monetary Policy Committee for taking decisions related to policy rates and other monetary policy measures. This this is not the first time the SBP Act is being amended.

The amendments being proposed are in line with international best practices and also take

into account the ground realities in Pakistan. By facilitating domestic economic and financial stability, the amendments will help support sustainable growth and avoid repeated booms and busts that have characterized Pakistan's past and led to painful consequences in terms of higher inflation, higher poverty, and lower growth.

KEY AMENDMENTS AND THEIR RATIONALE1

Overall, the amendments balance the provision of necessary operational and financial autonomy to the State Bank with new mechanisms for enhancing transparency and strengthening accountability. More specifically, the amendments have six key purposes: (1) to clearly define the objectives of the SBP to improve its accountability; (2) to outline the SBP's functions in line with these objectives; (3) to provide the SBP necessary financial resources to help achieve its objectives; (4) to strengthen the functional and administrative autonomy of the SBP; (5) to increase transparency in the operations of the SBP and strengthen its governance; and (6) to enhance the SBP's accountability by strengthening oversight functions and increasing reporting requirements. The rest of this document discusses these in turn.

First, the amendments identify domestic price stability as the primary objective of the SBP, followed by financial stability and support of the general economic policies of the

Government.2 The clear specification of objectives in this manner will make the SBP more accountable for achieving them. In addition, it would help the State Bank to prioritize its policy actions appropriately to ensure sustainable economic growth in Pakistan. There is strong international evidence that countries with an independent, accountable and transparent

1. See Annex for the full set of proposed amendments.
2. See bullet 2 on page 4 and bullet 6, section 4B on page 6 in Annex.

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central bank have lower and more stable inflation over long periods of time, which in turn lays the foundation for sustainable growth.3 Conversely, international experience has repeatedly shown that countries that prioritize growth at the expense of price and financial stability are not able to sustain growth and have repeated boom-bustcycles-rapid economic growth followed by a financial crisis.

Second, in order to achieve these objectives, the amendments suitably align the SBP's

functions and collate them under a new section. 4 Given the inflationary nature of government borrowing from the Central Bank, the amendments propose to exclude provisions related to Government borrowing5 as well as the quasi-fiscaloperations of the State Bank. 6 The State Bank would, however, continue to extend refinance facilities to financial institutions with appropriate checks and balances.7 Further, the lender of last resort function of the central bank has been further strengthened to enable it to provide temporary liquidity facility to banks against appropriate collateral.8

Third, the amendments seek to provide the SBP with sufficient financial resources to achieve

its objectives. A central bank's autonomy can be jeopardized if it cannot continually avail itself of sufficient financial resources to fulfill its mandate. The amendments allow SBP to be sufficiently capitalized and prescribe the necessary mechanism to achieve the desired level of capital over time, through both statutory reserves as well as retained earnings.9

Fourth, the amendments strengthen the functional and administrative autonomy of the

SBP. A key element of the functional independence of Central Banks is protection of its officials for actions taken in good faith. Provisions for protection are not only a common practice in other central banks but also exist in other domestic laws. The amendments, therefore, propose to add a provision for a general protection to SBP officials for all actions undertaken in good faith.10 In addition, the Monetary and Fiscal Policies Coordination Board

1. Among others see: (a) Ana Carolin, Garrigaa Cesar and M.Rodriguez (2020). "More effective than we thought: Central bank independence and inflation in developing countries." Economic Modelling Volume 85, Pages 87-105https://www.sciencedirect.com/science/article/pii/S0264999317318266;(b) N. Nergiz Dincer and
   Barry Eichengreen (2014). "Central Bank Transparency and Independence: Updates and New Measures." International Journal of Central Banking https://www.ijcb.org/journal/ijcb14q1a6.htm.
2. See bullet 6, section 4C on page 7 in Annex.
3. See bullet 7, section 9C on page 9 in Annex.
4. See bullet 22 on page 19 in Annex.
5. See bullet 18, clause 1A on page 17 in Annex.
6. See bullet 20, section 17G on page 18 in Annex.
7. See bullet 26, section 42 on page 20; bullet 6, section 4A on page 6; and bullet 25, section 41 on page 20 in Annex.
8. See bullet 32, section 52A on page 24 in Annex.

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is proposed to be abolished, as its terms of reference overlap with the work that has been assigned to the Monetary Policy Committee under the existing Act and such a mechanism for coordination goes beyond provisions in the acts of other central banks. Instead, a new mechanism for coordination is being proposed between the Finance Minister and the Governor, under which they would establish a close liaison and keep each other informed of matters that jointly concern the Ministry of Finance and the State Bank.11

Fifth, the amendments increase transparency in the operations of the SBP and strengthen

its governance. To do so, the amendments prescribe qualification and experience requirements 12 , tenure 13 , conflict of interest 14 and disqualification criteria 15 for all appointments16, including the directors on the Board of State Bank, members of the Monetary Policy Committee, the Governor and the Deputy Governors. In addition, to introduce a collegial decision-making process, the amendments propose to establish an Executive Committee at State Bank consisting of the Governor and the Deputy Governors. 17 This committee will be responsible for formulating policies related to the Bank's core functions as well as those related to administration and management matters, excluding those matters falling in the purview of the Monetary Policy Committee or the Board of Directors. All policy decisions will be taken by the Executive Committee.

And sixth, the amendments enhance the SBP's accountability by strengthening oversight

functions and increasing reporting requirements. In particular, the amendments strengthen provisions related to accountability of the State Bank to the Parliament, constitution of an Audit Committee18, designation of a Chief Internal Auditor19 and appointment of External Auditors20. In addition, it is proposed that the oversight role of the Board of Directors of State Bank be strengthened and its scope broadened, including by giving them explicit oversight over the affairs and functions of the Bank; the power to supervise the management, Bank's administration, operations; and right of access to all activities of the Bank.21

1. See bullet 10, section 9G on page 12 in Annex.
2. See bullet 7, section 9(5) on page 8; bullet 8, sub-section (c) on page 10; and bullet 11, section 10(5) on page 13 in Annex
3. See bullet 14, section 14 on page 14 in Annex.
4. See bullet 17, section 16A on page 16 in Annex.
5. See bullet 13, section 13 on page 13 in Annex.
6. See bullet 12, section 11A on page 13 in Annex.
7. See bullet 10, section 9F on page 11 in Annex.
8. See bullet 29, section 45 on page 22 in Annex.
9. See bullet 30, section 45A on page 22 in Annex.
10. See bullet 27, section 43 on page 21 in Annex.
11. See bullet 7, sections 9 and 9A on page 8 in Annex.

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ANNEX

A

BILL

further to amend the State Bank of Pakistan Act, 1956

WHEREAS it is expedient further to amend the State Bank of Pakistan Act, 1956 (XXXIII of 1956), in the manner and for the purposes hereinafter appearing;

It is hereby enacted as under:-

1. Short title and commencement.- (1) This Act shall be called the State Bank of Pakistan (Amendment) Act, 2021.

(2) It shall come into force at once.

2. Substitution of preamble, Act XXXIII of 1956.- In the State Bank of Pakistan Act, 1956 (XXXIII of 1956), hereinafter referred to as the said Act, for the preamble, the following shall be substituted, namely:-

"WHEREAS it is necessary to provide for the constitution of State Bank to achieve domestic price stability by way of regulating the monetary and credit system of Pakistan and, without prejudice to said primary objective, contribute to the stability of the financial system of Pakistan and supporting the general economic policies of the Federal Government to foster development and fuller utilization of the country's productive resources;".

3. Amendments of section 2, Act XXXIII of 1956.- In the said Act, in section 2,-

1. after the omitted clause (a), the following new clause shall be inserted, namely:-

"(aa) "advanced degree" means a postgraduate qualification;";

(b) after clause (ff), the following new clause shall be inserted, namely:-

"(ffa) "development finance activity" means to undertake an activity to promote any activity of any priority sector such as agriculture, small and medium enterprises, housing or other such sectors;";

1. after clause (i), the following new clause shall be inserted, namely: -
   (ia) "international reserves" mean the Bank's foreign exchange reserves;";
2. after clause (k), the following new clauses shall be inserted, namely: -

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""(ka)"monetary liabilities" means the total liabilities of the Bank as reflected in the annual audited financial statements at the balance sheet date as reduced by the sum of following liabilities of the same date, namely: -

1. deposits of the Government;
2. amounts owing to the International Monetary Fund, the World Bank, Asian Development Bank or other such institutions;
3. deposits of foreign central banks or sovereign wealth funds;
4. utilized swap lines of foreign central banks; and
5. balances of participant central banks under any clearing union;

(kb) "price stability" means the maintenance of low and stable inflation guided by the government's medium-term inflation target;

(kc) "recognized university" means a university or equivalent academic institution recognized by the Higher Education Commission of Pakistan;";

1. after clause (o), the following new clause shall be inserted, namely: -
   "(oa) "Government" means the Federal or a Provincial Government or a
   Local Government, as the case may be;".

4. Amendment of section 3, Act XXXIII of 1956. -In the said Act, in section 3, after sub-section (2), the following new sub-section shall be added, namely:-

"(3) Subject to this Act, the Bank shall have the power to acquire, hold and dispose of movable and immovable property of any kind, to enter into contracts and to undertake all activities necessary for the achievement of its objectives.".

5. Substitution of section 4, Act XXXIII of 1956.- In the said Act, for section 4, the following shall be substituted, namely: -

"4. Share capital.- (1) The authorized capital of the Bank shall be five hundred billion Rupees, divided into five billion shares of one hundred Rupees each. The authorized capital may be increased by the resolution of the Board, subject to the approval of the Federal Government.

1. The paid-up capital of the Bank shall be one hundred billion Rupees, divided into one billion shares of one hundred Rupees each, which shall be made up through issuance of bonus shares by capitalizing of profits or general reserve or through subscription of shares in cash by the Federal Government.

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