council committees and boards the institute of bankers

Council

Dr. Shamshad Akhtar ChairpersonMr. Zakir Mahmood MemberMr. Atif R. Bokhari MemberMr. S. Ali Raza MemberMr. Mohammad Aftab Manzoor MemberMr. Khalid A. Sherwani MemberMr. Badar Kazmi MemberMr. Aftab Ahmad Khan MemberMs. Zarine Aziz MemberMr. Zaigham Mahmood Rizvi MemberMr. Shaharyar Ahmad MemberMr. Abbas D. Habib MemberMr. Muhammad Saleem Umer Chief Executive

Committees and Boards

Academic BoardMr. Badar Kazmi ChairmanMs. Zarine Aziz MemberMr. Ozair A. Hanafi MemberMr. A.B. Shahid MemberMr. Tahir Ali Tayebi MemberMr. M. Naveed Masud MemberDr. Mirza Abrar Baig MemberDr. Khawaja Amjad Saeed MemberMr. Abdul Ghafoor Member

Finance CommitteeMr. Inam Elahi ChairmanMr. Khalid A. Sherwani MemberMr. Azizullah Memon MemberMr. Safar Ali K. Lakhani MemberMr. A. Saeed Siddiqui Member

Audit CommitteeMr. Aftab Ahmad Khan ChairmanMr. Abbas D. Habib MemberMr. Masood Karim Shaikh Member

H.R. Committee Mr. S. Ali Raza ChairmanMr. Aftab Ahmad Khan MemberMr. A. Saeed Siddiqui Member

Building CommitteeMr. M. Shafi Arshad ChairmanMr. Shameem Ahmed MemberMr. Mohammad Bilal Sheikh MemberMr. Kamran Rasool MemberMr. Tasadduq Hussain Awan MemberMr. Khalid Niaz Khawaja MemberMr. Barbruce Ishaq Member

Editorial BoardMr. Aftab Ahmad Khan ChairmanMr. M. Ashraf Janjua MemberDr. Shahid Hasan Siddiqui MemberMr. Jalees Ahmed Faruqui MemberMr. A.B. Shahid MemberProf. S. Sabir Ali Jaffery Member

Board of Turstees of Staff Provident FundMr. Inam Elahi ChairmanMr. M. Hanif Akhai MemberMr. Muhammad Saleem Umer MemberMr. S. M. Ashique Member

AuditorsMessrs Taseer Hadi Khalid & Co.Chartered Accountants

Registered OfficeThe Institute of Bankers PakistanMoulvi Tamizuddin Khan RoadKarachi — 74200 Pakistan.UAN : 111-111-564 Fax : 5683805Phones: 5680783-5689718-5686955

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The Institute of Bankers Pakistan

Published by: Mr. Muhammad Saleem Umer for the Institute of Bankers Pakistan, Moulvi Tamizuddin Khan Road, Karachi.The Journal of the Institute of Bankers Pakistan is published quarterly and is provided free to members. Non-members may obtain copies of the Journal from the Institute and/or IBP Local Centres on payment.

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Copyright by: The Institute of Bankers PakistanAll rights reserved.The material appearing in this journal may not be reproduced in any form without prior permission of the Institute of Bankers Pakistan.

January - March 2007 Issue

IBP – the knowledge institute


Journal of the Institute of Bankers Pakistan

Volume 74 - Issue No. 1 January – March 2007

ContentsEditorial:Approach To Economic Development:Emerging Consensus 1

SBP First Quarterly Report:Overview and Executive Summary 5

IBP Knowledge Endeavours 13

ISQ Examination (Winter) 2006 Result 19

Research Paper Competition(Summer) 2006 Result 22

Basel II Framework:The IRB Use Test Implementation 23

Collateralization, Risk Management and SME Financing 27

Use of Derivatives inTreasury Management 39

Opportunities and Challengesof Electronic Banking 47

Highlights of Economic Events(October - December, 2006) 69

Legal Decisions Affecting Bankers:I. Attachment of Shares of a CompanyII. Attachment of Debt:

i. before the debt is due.ii. when the debt is in joint names. 73

Questions and Answers onPractice & Law of Banking 75

Collection of Cheques - II (Article in Urdu)


Editorial

Approach To EconomicDevelopment: EmergingConsensus

At the beginning of the current century, after

more than five decades of development

experience, there appears to be more widespread

agreement on policies needed to foster growth in

the developing world than at any time during the

post-World War II period.

Policies recommended by international

financial institutions as well as by leading

development economists in this behalf emphasise

an appropriate macro-economic framework, a

realistic exchange rate which is competitive and

stable, the right set of sectoral policies and

investments, appropriate role of the state in the

economy, integration of the domestic economy

into the world economy, poverty alleviation,

recognition of environmental issues, clear

identification of priorities and peaceful resolution

of conflicts.

Macro-economic development

Sustained economic development is only

possible in a stable macro-economic environment

wherein large fiscal deficits are avoided, inflation

remains low, exchange rate is competitive and

stable and foreign exchange and debt crises are

eschewed.

Fiscal policy has a key role in successful

macro-economic management. It is concerned

with government’s programmes for public

spending and its resource mobilisation strategy.

One important objective of fiscal policy is the need

to abjure unsustainable fiscal deficits in view of

their inflationary and balance of payments

consequences. Fiscal policy has also an important

role in promoting savings not only in the

household and corporate sectors through

modulated tax policies but also as an instrument

for enhanced public savings through a well

designed tax policy and through obtaining

adequate resources from the operation of public

enterprises by levying appropriate user charges.

Public policies on the spending side can determine

the investment pattern and can thus play an

important role in the development of human

resources. The allocation of public funds is no less

important than mobilising them.

Experience in several developing countries

indicates that large fiscal deficits have led to

excessive claims on the government sector, thereby

crowding out the private sector and leading to an

unplanned and excessive monetary expansion.

Most of the major inflations of post-World War

II period have had their roots in excessive fiscal

deficits, which the governments could only finance

by resort to the printing press.

Inflation undermines growth in two ways. First,

it disturbs the most basic process whereby prices

guide resources from lower valued to higher

valued uses. The key to the process of growth is

clear signals about relative prices. Inflation,

especially when it is unanticipated, disturbs those

signals by obscuring the differences between

relative and absolute prices.

Second, inflation tends to generate capricious

transfers of income and wealth among economic

sectors and groups. This breaks the link between

earnings and efforts, and has been known to cause

political upheavals sparked by embittered losers.

A particularly pernicious aspect of inflation is

discrimination against public services who are its

most unrelieved victims apart from those living on

pensions and other fixed provisions for personal

economic security. Social imbalance is also a

natural offspring of inflation. In the words of Prof.

J.K. Galbraith: “In a free market in an age of

endemic inflation, it is unquestionably rewarding

in purely pecuniary terms to be a speculator or a

prostitute rather than a teacher, preacher or

policeman”.

January - March 2007 Issue 1

The exchange rate

Exchange rate plays a crucial role in

establishing market incentives for exports and for

regulating imports. Again, the stability of the

exchange rate is a potential monetary anchor and

an important anti-inflationary factor.

Often governments afraid of unleashing

uncomfortable inflationary pressures in the

economy hold the nominal exchange rate constant

or devalue it too slowly with the result that the

domestic currency appreciates and the pressures

on the balance of payments assume disconcerting

proportions. When the inflation control and export

incentive roles of the exchange rate conflict,

attention should turn to the underlying source of

inflationary pressure, often the budget.

Intermediate steps such as crawling peg in

conjunction with appropriate fiscal policy can

provide some monetary stability without tending to

produce an over-valued currency.

Sectoral Policies and investments

Sectoral policies include investment decisions,

pricing and regulatory policies and institutional

development.

Investments in agriculture, manufacturing,

infrastructure and human resources development

have long formed the core of development efforts.

The traditional approach was to prepare and

implement projects in sectors with the aid of cost-

benefit analysis. It is now generally appreciated

that aside from sound project formulation and

implementation, the effectiveness of projects

depends on the policy environment affecting the

sector and the degree of institutional development.

Measures to bring domestic relative prices closer to

international levels and to establish a relatively

neutral framework that does not favour particular

industries, regions or factors of production are

often necessary for improving sectoral

performance. In agriculture, for example, incentives

were historically suppressed by low agricultural

procurement prices. Perhaps, more important, in

many countries, over-valued exchange rates have

often resulted (frequently unintended) in taxation

of this sector. Adjustment programmes of the

World Bank and regional development banks have

therefore, focused on both macro-economic

policies and sectoral pricing policies (eliminating

price controls on agricultural output, for example).

It is also now universally recognised that

human resource development is both an

independent goal of development and an essential

instrument of economic progress.

High rates of population growth in the post-

World War II era have contributed to low per

capita income growth in many countries in Asia

and Africa. As such reducing the rate of population

growth remains a priority area in development

policy in many low income countries.

Integration with the world economy

Many of the star development performers in

recent decades have been newly industrialising

economies (South Korea, Taiwan, Hong Kong,

Singapore, Malaysia and Thailand), characterised

by relative openness and links with the world

economy. To strengthen these links, they have had

to remain competitive in a rapidly changing world

environment. Common to successful competition

strategies is the reduction or elimination of

discrimination against tradeables-permitting

exports and import substitutes to be produced on

a similar footing with non-tradeables.

Interventions to encourage new technologies

and to industrialise have also paid off in many

countries.

Developing countries with more open and

efficient trade regimes have generally won long

term economic gains. Openness to trade, investment

and ideas has been critical in encouraging

domestic producers to cut costs by introducing

new technologies and to develop new and better

products in East Asian miracle economies.

Role of the state

A major lesson which emerges from the rich

mosaic of successes and failures on the

development front, is about the role of the state.

This role is crucial, but it must be kept within the

January - March 2007 Issue2


limits of the scarcest resource in the developing

world, that is the supply of competent and honest

administrative talent. A large public sector

especially exhausts this with strongly negative

consequences.

The dominant development paradigm in the

quarter century after World War II assigned a

major role to the state in the poor lands by

assuming the state to have certain characteristics

which it turned out not to have. In the name of

planning, a regulatory framework and mechanism

for allocating resources were created to control

private decisions. In exercising such control,

quantitative restrictions rather than price based

measures mediated through the market were most

often used. A chaotic incentive structure and an

unleashing of rapacious rent seeking were the

outcomes.

It is now quite clear that incentive system

matters and competition, domestic and

international, is the most effective way for ensuring

efficient resource allocation.

At present there is a broad consensus that the

state’s emphasis should not be on the production

of commodities and services which the private

sector can provide efficiently. It should rather be

on education, health, protection of the poor,

infrastructure and providing the right environment

for entrepreneurial activity to flourish.

State interventions in the economy, where

necessary, should be market friendly in that these

work with the market and do not become

entitlements of particular groups that cannot be

withdrawn once the need for intervention

disappears. Interventions should be transparent,

rule based rather than discretionary, price based

rather than through quantitative restrictions.

Poverty alleviation

Poverty has now become the hot favourite of

development economists and considerable

research inputs are being made into the

investigation of this theme. These endeavours

have thrown up some useful insights, but much of

the tangled skein of poverty remains unravelled.

This is not only a subject of endless research–

it also calls for action. On the economic side the

problem is now beyond charity and state

welfarism. The productivity of the poor has to be

raised and a more equitable distribution of

incomes brought about. This will have socially

wholesome and economically beneficial results.

Productivity and development will pick-up if

poverty is eradicated.

Recognition of environmental issues

The recognition of environmental issues in

developing countries is an aspect of the widening

of development concept. It is a part of a more

unified or integrated approach to development.

Which developing countries have to

industrialise and grow they also, at the same time,

need to be aware of the ecological limits to growth

and conserve the environment and control

environmental hazards through appropriate

domestic legislation which should be adequately

enforced. Adequate attention to environmental

concerns would obviously facilitate high growth by

sustaining the resource base of the biosphere.

Careful identification of priorities

Most developing countries are resource

constrained and some things are more important

than others. It is the planner’s first task to identify

them and devise an appropriate strategy to achieve

the priority goals in the most cost effective manner.

In this behalf, it is essential to concentrate resources

on priority tasks and not to diffuse them by spreading

these thinly over a broad spectrum of activities.

Peaceful resolution of conflicts

In many countries of the Third World,

development progress has been seriously retarded

by internal as well as international conflicts.

Millions have been killed or impoverished in the

developing world on account of national, ethnic or

religious conflicts. Peace and tolerance must be a

prime goal for the people of the Third World.

Conflicts must be resolved through negotiations,

mediation and, if necessary, through international

arbitration.




SBP First Quarterly Report:Overview and Executive Summary

The State Bank of Pakistan issued First

Quarterly Report for FY07. Following is an

overview and executive summary of the report:

Overview

Likelihood of achieving 7 percent growth

target for FY07 remains strong despite visible

challenges in meeting growth target of industry

and agriculture. While an anticipated recovery in

large scale manufacturing is likely to be realized, it

seems that achieving the 13 percent growth target

may prove difficult. Similarly, the weak

performance by the three major kharif crops

(cotton, rice and maize) had reduced the

probability of a sharp rebound by agriculture,

though even here, the value-addition is likely to be

an improvement over the preceding year if the

contribution from livestock and the wheat crop

remains strong. This suggests that achievement of

the annual growth target will require the services

sector to turn in an above-target growth.

Encouragingly, although real growth remained

strong and seems likely to exceed the FY06 levels,

inflationary pressures eased somewhat during

FY07, suggesting that tight monetary policy is

striking an appropriate balance, i.e., gradually

removing excess stimulus from the economy,

without dampening the growth momentum.

However, this should not lead to complacency; on

the one hand, the downtrend in the inflation over

the past 12 months clearly shows a degree of

instability, and on the other, reducing domestic

inflation further is essential to improving the

competitiveness of Pakistan's exports, and

ensuring a better return to domestic savers.

It is also important to note that not all of the

instability in inflation can be addressed through

monetary policy. Core inflation has already dipped

significantly and the present high levels of inflation

and its greater variability are both principally

driven by food inflation, which is largely

determined by factors other than monetary policy.

This does not imply that monetary policy cannot

play any role in containing food inflation, but

rather that the cost of monetary policy actions to

contain it should be weighed cautiously. The food

inflation pressures in Pakistan could be better

controlled through by (1) improvement in supply

of key staples, and (2) administrative measures as

were taken in the month of Ramadan.

Another challenge to containing inflationary

pressures is from the divergence between the

expansionary fiscal policy and tight monetary

policy, and the volatility in the government

borrowings from the banking system (and

particularly from SBP). The need to catalyze

improvements in infrastructure and boost

development (and particularly to reconstruct areas

devasted by the October 2005 earthquake) means

that it will be difficult to substantially reduce the

fiscal stimulus in the near term. Unfortunately, the

resulting added burden on monetary policy means

that the offsetting monetary tightening will need to

continue for a longer period.

Fiscal pressures have primarily originated from

higher growth in development expenditure,

although slowdown in revenue growth has also

added to the stress. While weakness in non-tax

receipts is not unexpected (and could potentially

be reversed in H2-FY07), the slowdown in key

CBR taxes is more of a concern. Specifically, the

sharp deceleration in imports during FY07 appears

to have impacted indirect tax collections, which

have remained below target through the initial

months of FY07.

It is noteworthy that aggregate collections have

nonetheless been strong due to a welcome, but

unexpected surge in direct tax receipts. It is hoped

that CBR will be able to recoup the shortfall in

indirect taxes from this recovery in direct taxes.


However, if any revenue shortfalls do emerge, the

impact on fiscal accounts should be sterilized

through curtailing expenditure (particularly

discretionary non-development spending). Such a

clear demonstration of commitment to fiscal

discipline would likely be crucial in reassuring

international investors, thereby supporting a

further improvement in the country's credit ratings,

and helping domestic companies access

international capital markets on more favorable

terms.

Moreover, in order to reduce the impact of

fiscal developments on monetary policy, it is

important that government reduce the uncertainty

associated with its borrowings (e.g., a start could

be made by publishing its quarterly borrowing

targets at the beginning of the period) and reduce

its dependence on borrowings from the central

bank. The government has indeed sought to do

the latter by reversing its ban on institutional

investments in NSS, but this mode of increasing

non-bank borrowings has significant drawbacks,

and it is important that the government focus

instead on raising funds through issuance of

tradable long-term paper, i.e., PIBs.

Finally, while import growth has decelerated

sharply in recent months, this has not relieved

pressures on monetary policy given the puzzling

decline also visible in export growth that has led to

a further widening of the trade deficit. While some

weakness in exports was not surprising given the

increasingly competitive international markets, the

reported slowdown was quite unexpected.

Moreover, it is not entirely consistent with trends in

associated variables, such as the US and EU

statistics on textile imports from Pakistan, as well as

the exchange record data of SBP (all of which

show stronger export growth than given by FBS

data). This raises hopes that at least a part of the

strong deceleration in exports growth may be a

statistical artifact due to unusual leads and lags in

reporting (this view seems to be supported by the

exceptional 23.9 percent YoY rise in November

2006 exports).

However, even if a part of deceleration is a

statistical phenomenon, there is no denying that

exports growth has been adversely impacted by

competitive pressures, which, in turn, is a major

contributor to the widening of the current account

deficit in FY07. This is in sharp contrast to the

import-led deterioration in the deficit over the

preceding two years. It is in this context that the

SBP seeks to support the government and

exporters by focusing on reducing domestic

inflation in order to help curtail increases in the

cost of business and to reduce any appreciation of

the rupee's real effective exchange rate.

In the meantime, while persistent large current

account deficits are clearly undesirable in the

medium term, Pakistan's current account deficit is

not yet a serious problem, as (1) the current

account deficit is forecast at 4.5 percent of GDP,

which is not unmanageable; (2) the country is in a

position to comfortably finance the deficit through

strong non-debt flows as well as by taking on debt

at relatively favorable terms; (3) and given that this

is without significantly increasing country risk, as

the external debt to GDP ratio will continue to

decline despite the rise in absolute debt levels. The

latter view is supported by the continuing upgrades

to Pakistan's sovereign credit rating by leading

international credit rating agencies.

Looking Ahead

SBP forecasts based on initial data indicate

that the FY07 annual growth target remains

achievable, although risks to the downside have

increased following the below target harvests of

key kharif crops (cotton, rice and maize), and the

possibility of growth in large-scale manufacturing

slowing a little in the months ahead as a result of

power shortages, capacity issues (e.g., fertilizer

production may drop as major units close

temporarily to implement expansions), and a

relative easing of demand due to the tight

monetary policy, etc.

However, M2 growth is forecast to be stronger

than estimated earlier as the contractionary impact

of net foreign assets of the banking system during

Jul-Nov FY07 has been lower than anticipated,

due to the unexpectedly robust net receipts in the

external account. The latter is likely to overshadow

the impact of the deceleration in private sector

credit. The continued strength of aggregate



demand, the unexpected strength in broad money

and, most importantly, the recent uptrend in food

prices reinforces the view that the inflation

outcome for FY07 is likely to be higher than the

annual target.

It is in this context that the SBP continues to

stress the importance of retaining a tight monetary

posture, in order to reduce the excessive monetary

stimulus in the economy. The direction of

monetary policy will need to be supported by the

fiscal policy by avoiding any expansion in the

targeted fiscal deficit (the target looks achievable;

however some risks have emerged as a result of

the slowdown in import-based taxes), improving

predictability in borrowings from banking system

and raising non-bank borrowings through PIBs

rather than NSS. The greater liquidity in larger

market-based issues would also improve price

discovery leading to improved long-term debt

benchmarks, helping develop domestic debt

markets. It should be kept in mind that healthy,

liquid domestic debt markets are not only essential

to long-term international investment in

infrastructure projects etc, but can lead to an

improvement in the balance of payments. To put

this in perspective, it is important to realize that in

order to remain competitive in the international

markets and sustain economic growth, the country

desperately needs to considerably augment and

improve its infrastructure. This will only be possible

by attracting significant private sector participation

in these projects. This will be difficult without long-

term debt markets.

Executive Summary

Agriculture

Hopes of a strong recovery in agricultural

growth during FY07 on the back of improved

water availability, continued access to credit, and

ease in the prices of fertilizers have decreased

following the lackluster performance of key major

kharif crops. The initial production estimates of

cotton, rice and maize posted a weak growth,

which overshadowed the impact of the strong

growth in sugarcane production during FY07

relative to the preceding year. As a result,

realisation of the FY07 agricultural growth target

will be possible if the livestock sub-sector

performance is well above target.

Large Scale Manufacturing

Growth in large scale manufacturing (LSM)

accelerated in Q1-FY07, rising to 9.7 percent as

compared with the 8.8 percent growth seen in Q1-

FY06. This was primarily due to acceleration in the

production in the textile, electronics, chemicals

and metal industries. However, LSM growth

acceleration is not broad-based.

The electronics sub-sector recorded an

extraordinary 41.6 percent YoY growth during Q1-

FY07 as against 9.2 percent YoY growth in the

same period of previous year. Strong income

growth, better access to credit, and the efforts of

power utilities to modernize and extension in their

distribution networks are the main factors behind

the extraordinary performance of the electronics

sub-sector.

As with electronics, the growth in the textiles

sub-group also rose to 12.4 percent during Q1-

FY07 as against a decline of 0.9 percent in the

same period last year. This growth is the second

highest for any first quarter during the last six

years. The growth recorded in textile production

appears to be supported by the acceleration in the

growth of the chemicals sub-sector to 10.1 percent

during Q1-FY07 as compared with 8.2 percent

growth during Q1-FY06.

Metals sub-sector also grew by 14.5 percent

during Q1-FY07 against the decline in the

production by 4.1 percent during the same period

last year. The improvement can be attributed to

the streamlining of production by Pakistan Steel

after completion of repairs of its coke oven

batteries in the last quarter of FY06.

The automobiles sector registered a growth of

only 11.1 percent during Q1-FY07, which is not

only lower than the strong growth of 33.1 percent

in the same period of the preceding year but also

the lowest during the last six years.

The production of fertilizer also fell in Jul-Oct

FY07, dropping by 1.7 percent as against a rise of



3.7 percent growth during the same period of the

preceding year. This decline was mainly due to

capacity constraints as well as lower demand on

the back of untimely rain and an anticipated

subsidy announcement by the government.

Prices

Although, on average, inflationary pressures

appear to be weakening in the economy, the

downtrend is unstable. This is evident in the

benchmark Consumer Price Index (CPI) inflation,

which jumped to 8.9 percent in August 2006

before dipping to 8.1 percent YoY during October

2006 and remained at the same level in November

2006, slightly higher than the 7.9 percent YoY in

November 2005. The instability emerged

essentially due to the volatility in food prices,

particularly stemming from (1) supply-side

disturbances on account of rains and floods, and

(2) the impact of increases in international prices of

some key food items.

A welcome development, from the monetary

policy perspective, however, is that non-food

inflation now appears to be trending downwards.

This deceleration in non-food inflation is clearly

mirrored in the easing of core inflation. The non-

food non-energy (NFNE) measure of core inflation

dipped to 5.6 percent YoY in November 2006

compared with 7.6 percent YoY for the

corresponding month of 2005, suggesting that

demand pressures in the economy are being

reined-in by the continued tight monetary policy.

As with the core inflation, the Wholesale Price

Index (WPI) inflation exhibited a steady

downtrend, with the overall WPI inflation coming

down to 7.5 percent YoY in November 2006

compared with 10.9 percent in November 2005.

The major contribution to the decline in WPI is

from the non-food group, which outweighed the

acceleration in the food group prices.

Unfortunately, despite the moderation in

inflationary pressures, CPI inflation is still close to

the 8 percent levels by November 2006, which is

significantly higher than the annual average

inflation target of 6.5 percent for FY07. Given that

core inflation is likely to remain contained through

the remaining months of FY07 as a result of a tight

monetary policy, it is important that its impact is

supplemented by measures to address food

inflation and high energy prices. Volatile, double-

digit food inflation is particularly undesirable in

view of its greater adverse impact on low-income

groups. Moreover, it is a source of disquiet for

monetary policy as well since inflationary

expectations are based on overall inflationary

trend. There is a need for effective administrative

measures (as exercised in the month of Ramadan)

to discourage profiteering on food items.

Money and Banking

The impact of monetary tightening pursued in

FY06 as well as the policy signals through the

FY07 changes, is already evident in the slowdown

in private sector credit growth, which has dropped

to 5.9 percent during Jul-Nov FY07 against the

10.9 percent growth witnessed in the

corresponding period of FY06. Moreover, core

inflation, as measured by non-food non energy

inflation has slowed to 5.6 percent (YoY) in

November 2006 from 7.6 percent (YoY) in

November 2005.

However, the growth in monetary aggregates

during Jul-Nov FY07 remained strong. This is

because: (1) the deceleration in private sector

credit has not been matched by an equally strong

decline in government borrowings, which have

remained significant; and (2) the contraction in

NFA during Jul-Nov FY07 has been much lower

than that in FY06.

The impact of continuing pressures on the

external account was evident on the NFA of the

banking system that showed a contraction of

Rs41.1 billion during Jul-Nov FY07, almost

equally distributed between SBP and all

commercial banks. However, it is important to

note that the contraction in the NFA of the banking

system during Jul-Nov FY07 was considerably

lower than the sizeable reduction of Rs90.5 billion

witnessed during Jul-Nov FY06. This is largely

because the NFA of commercial banks did not

decline as sharply as in FY06.

The government borrowings from the banking



system are higher and volatile. Although the

government may be able to remain within the

budgetary borrowing target of Rs120 billion from

the banking system for FY07, excessive borrowing

during the course of the year is a source of concern

for monetary policy, particularly because the

government borrowing is entirely from the central

bank, which is the most inflationary in nature as it

contributes to reserve money growth.

The high government borrowings and the

resulting rise in reserve money, has the potential of

re-igniting inflationary pressures in the economy. If

this happens, the time path for achieving a stable

low inflation could be extended, as in the absence

of low stable inflation, the central bank would have

to keep interest rates high for a longer duration.

The government has however sought to

increase its non-bank borrowings. Unfortunately,

instead of raising these incremental funds entirely

through PIB issues, the government has also re-

allowed institutional investment in NSS. While the

latter decision would, in theory, allow institutional

investors to rollover large NSS maturities, this

major policy reversal is likely to have significant

negative implications for the development of the

domestic debt market, and raise interest rate risk

for the government.

In contrast to government borrowings, the

private sector credit seems to be responding to

interest rate signals from the central bank.

Specifically, the growth in private sector credit

during Jul-Nov FY07 has slowed down to 5.9

percent compared to 10.9 percent rise witnessed

during the corresponding period of the previous

year. However, so far, this slowdown in private

sector credit growth is not a source of disquiet for

SBP for the following reasons:

* The YoY growth in private sector credit

remains very strong at 18.0 percent by 25th

Nov 2006, although down from 31.9 percent

last year.

* A review of monthly trends in private sector

credit shows that the slowdown is largely

concentrated in the month of September 2006.

In fact, trends during October and November

2006 indicate presence of strong demand for

private sector credit in the economy.

* The available evidence suggests that the

slowdown in private sector credit is not broad-

based as (1) the increased net retirement,

particularly by the sugar manufacturers during

Jul-Nov FY07 contained the growth in private

sector credit; and (2) deceleration in bank

credit against equities.

* More importantly, while the nominal lending

rates are rising, the real lending rates are still

very low. The real lending rates under export

finance facility are even negative.

In sum, though the overall demand for credit

by the private sector has decelerated, the

slowdown is not broad-based. This suggests that

monetary policy needs to remain tight.

However, while the transmission of the

monetary policy on lending rates has improved

over the last year, the impact on deposit rates has

been less than desired, contributing to an

unhealthy high banking spread. The available

evidence shows that banks are mobilising deposits

at higher returns and the share of such deposits

has been rising. Since the long-term deposits lower

the maturity mismatch for banks and reduce

liquidity risks, it was expected that the banking

spread would decline. But in the meanwhile,

lending rates have also risen thereby leading to a

sharp rise in the banking spread (calculated on the

basis of incremental loans and deposits) in recent

months. Such a large spread can have a

dampening effect on economic growth by

discouraging savings.

Fiscal Developments

Developments in public finance during Q1-

FY07 present a deterioration in the fiscal accounts.

Fiscal deficit widened by 0.5 percent of GDP to 1.0

percent of GDP in Q1-FY07. The Q1-FY07 fiscal

deficit (as percent of GDP) is not yet inconsistent

with meeting the annual target of 4.2 percent of

GDP. For example, the Q1-FY03 fiscal deficit had

been 0.8 percent of GDP, but full year outcome

was 3.7 percent of GDP. However, in that year the



growth in CBR taxes had been exceptionally

strong at 9.6 percent of GDP (a level achieved in

FY97 but never since). The FY07 tax target is close

to this level, at 9.5 percent of GDP, and attaining

it will be important to meeting the overall fiscal

deficit target for the year. Unfortunately, given the

recent moderation in import growth, and the high

dependence of tax receipts on import-based taxes,

achievement of the CBR tax target may prove

challenging.

This fiscal squeeze is attributable to both the

lower revenue growth, as the total revenue to GDP

fell from 3.1 percent in Q1-FY06 to 2.9 percent in

Q1-FY07 and the rising expenditure. It is note

worthy that the rise in expenditure to GDP ratio is

only due to the unidentified expenditure that rose

from 0.1 percent of GDP in Q1-FY06 to 0.4

percent of GDP in Q1-FY07. CBR though met its

revenue target of Rs236.2 billion with an actual

collection of Rs237.3 billion during Jul-Oct FY07

yet all the indirect taxes could not meet their

respective targets. A moderate growth in imports

and the large-scale manufacturing resulting in

lower growth in tax collection by the CBR during

first quarter, may keep the growth in indirect tax

revenues relatively weak during FY07. Provincial

governments, however, improved their position

during first quarter. This better fiscal position

stemmed from new formula of revenue sharing

from federal divisible pool of tax revenue, except

Balochistan, all the other provinces seem to be in

a comfortable position.

Balance of Payments

Pakistan's overall external account position

improved during Jul-Nov FY07 compared to the

same period last year despite a worsening of the

current account deficit. Specifically, while the

current account deficit increased from US$3.1

billion to US$4 billion, an increase of 29.1 percent,

the overall external account deficit shrank to US$

0.73 billion in Jul-Nov FY07 compared to US$

0.88 billion in Jul-Nov FY06.

As in the previous year, it was the surpluses in

the capital and financial accounts that offset most

of the deficit in the current account. The bulk of the

35.4 percent YoY increase in the aggregate surplus

in the capital and financial accounts during Jul-

Nov FY07 was contributed by foreign investment.

Although Pakistan was able to finance the Jul-

Nov FY07 current account deficit relatively easily,

the rise in the deficit nonetheless remains a source

of some concern, particularly because unlike the

previous years, it owed more to a substantial

slowdown in the countryís exports rather than an

extraordinary rise in imports. Specifically, while the

imports growth during Jul-Nov FY07 slowed

substantially to 13.9 percent compared to 33.2

percent in the corresponding period last year, it

was the unusual decline in the exports growth (that

dropped to a mere 7.3 percent compared to 13.8

percent in the corresponding period last year), that

drove the trade deficit up by 25.5 percent to US$

4.5 billion.

In addition, the current account deficit was also

adversely affected by an unusual rise in the income

account deficit arising from a higher direct

investment income outflows. The rise in the trade,

services, and income account deficit was, however,

mitigated to an extent by the increase in the

current transfers, which increased by 13.4 percent

during Jul-Nov FY07.

Due to substantial inflows, both on account of

current transfers and foreign investment during

Jul-Nov FY07, the impact of the widening current

account on the country's reserves was relatively

low. Pakistan's overall foreign exchange reserve

declined by US$ 799.4 million during Jul-Nov

FY07 compared to decline of US$ 1,321.6 million

in the same period last year. Nevertheless, a result

of the continuous pressures on the external sector,

Pakistanís currency vis-a-vis US Dollar,

depreciated by 1.1 percent during Jul-Nov FY07

as compared to the 0.1 percent in the

corresponding period last year.

Foreign Trade

The trade deficit continued to rise during Jul-

Nov FY07, although the growth slowed

substantially to 17.8 percent from the 147.5

percent YoY increase recorded during the

corresponding period last year. This welcome

deceleration in the growth of the trade deficit



during Jul-Nov FY07 is principally due to the

slowdown in the import growth.

Specifically, the moderation in import growth,

which has been apparent since H2-FY06 further

strengthened during Jul-Nov FY07 as all major

imports categories other than petroleum,

machinery and other products, recorded negative

growth rates. As a result, the overall growth in

imports fell to 10.4 percent during Jul-Nov FY07

against 54.3 percent rise in the corresponding

period last year. Indeed, the trade deficit would

have been even lower, had it not been for the

unexpected sharp deceleration in export growth to

5.2 percent YoY during Jul-Nov FY07 compared

to 22.3 percent YoY in Jul-Nov FY06.

A part of the decline in the exports growth is

understandable given the more challenging

economic environment as compared to a year

earlier, both domestically and externally.

Nevertheless, the magnitude of the slowdown in

exports is still puzzling.

Specifically, while the FBS data shows a 3.3

percent decline in the textiles exports during Jul-

Nov FY07, exchange records depict a growth of

11.0 percent. Furthermore, EU textiles and

clothing imports from Pakistan also show a rise of

3.2 percent during Jul-Sep FY07,2 and similarly,

the US imports data show a rise of 8.8 percent in

textile and clothing imports from Pakistan.3

However, the November trade figures are some

consolation; although detailed data is not yet

available, the increase of 23.9 percent YoY in

overall exports is nevertheless quite encouraging.

The analysis is based on the provisional data

provided by Federal Bureau of Statistics, which is

subject to revisions. This data may not tally with

the exchange record numbers reported in the

section on Balance of Payments.




IBP Knowledge Endeavours(October-December 2006)

Training and Development of Human

Resources

During the quarter October - December

2006, IBP continued to follow its critical role

of training and professional development of

human resource of banks and financial

services sector. Overall, the Institute held 23

courses -, 13 in Karachi, 8 at its local centers

and 2 at small centres under mobile training

program. Over 500 participants from banks

and financial institutions received training

under these programs. Details of the courses

held at Karachi and other centres are given

below:

EVENTS AT KARACHI

S. No. Courses Title Speaker

1. KYC & Anti-Money Laundering Mr. Muhammad Ilyas

2. Working Capital Financing Mr. Murtaza Y. Rizvi

3. Basel - II Accord Mr. Jameel Ahmad

4. Customer Relationship Management Mr. Murtaza Y. Rizvi

5. Cash Flow Based Lending Mr. Murtaza Y. Rizvi

6. Branch Banking Operations Mr. Razi Mujtaba

Mr. Muhammad Ilyas

7. Demystifying UCP - 600 (2 courses) Mr. Abid Aziz Merchant

8. SBP Export Refinance - A Detailed Workshop Mr. Ishtiaq Ali

9. Prudential Regulations for Corporate

& Commercial Banking Mr. Muhammad Ilyas

10. The Art of Negotiation for

Achieving Positive Results Mr. M. Afzal Janjua

11. Fraud & Forgery: How to Detect and

Protect the Banks Mr. Muhammad Ilyas

12. Banker-Customer Relationship:

Laws Impacting Banks Operations Mr. Muhammad Ilyas




EVENTS AT LOCAL CENTRES

The Institute has 11 Local Centres in different

parts of the country. They also hold courses on

topical subjects. During October - December 2006,

following programs were held by the Local

Centres:

EVENTS AT LOCAL CENTRE

S. No. Courses Title Resource Persons

Lahore.

1. Assets & Liability Management Mr. Kh. Waheed Raza

Rawalpindi

1. Cash Flow Based Lending Mr. Malik Dilawar

2. UCP - 600 Mr. Mudassar Hussain

Islamabad

1. How to Spot and Encounter Counterfeit

Bank Notes and Tampered Prize Bonds Mr. Muhammad Arif Azam

2. Time & Stress Management Prof. Dr. Rafiq Ahmed Ghuncha

Quetta

1. Export Refinance Scheme Mr. Ishtiaq Ali

Hyderabad

1. Branch Banking Operations Mr. Muhammad Ilyas

Multan

1. Know Your Customer & AML Mr. Kh. Waheed Raza

MOBILE COURSE

Mirpur A.K.

1. Auditing Financing Operations:

Onsite Inspection by SBP Audit Team Mr. Taslim Kazi

Sargodha

1. Auditing Financing Operations:

Onsite Inspection by SBP Audit Team Mr. Taslim Kazi



Besides the courses mentioned above, the

following knowledge events were also held during

the quarter under report:

1. Effective Branch Management

The fourth of the series of 120-hours high-

value certificate course on "Effective Branch

Management" is in progress w.e.f. November

21, 2006 at Karachi, Lahore, Rawalpindi and

Peshawar. The program covers core banking

as well as soft skills needed by the Branch

Managers. 93 Managers - , 24 at Karachi, 20 at

Lahore, 29 at Rawalpindi and 20 at Peshawar

are attending this program.

2. Effective Credit Management

Effective Credit Management (ECM) is one of

the critical factors of a bank's overall

management strategy and is vital to the long

term success of a banking organization.

Considering the fact that banks' loan portfolio

is rising and consequently the quantum of risk,

the Institute held a week long workshop on

"Effective Credit Management" from December

4 - 9, 2006. The workshop targeted at middle

management executives who have basic

understanding of credit functions. 28

executives and officers attended the workshop.

Ms. Tahira Raza, EVP/Head of Loan Examiner

Wing, NBP, Mr. Altaf Hussain Saqib, AVP,

Risk Management Division, NBP, Mr.

Azizuddin Khan, Advocate, Mr. Asadullah

Saleem, SVP & Head of Risk Management

Division, PICIC, and Mr. Anjum Noaman

Mirza, Branch Manager, Bank Alfalah Limited

shared their rich knowledge and experience at

the above workshop.

3. Customized Courses

Besides regular programs, IBP also holds

customized training courses tailored to meet

specific needs of banks. During October -

December 2006, the Institute held courses for

the following banks:

a) Arif Habib Rupali Bank Ltd.

6-week course on "Branch Banking

Operations" for the Trainee Officers from

October 2 - November 21, 2006 at

Karachi. 20 Officers attended the program.

b) Emirates Global Islamic Bank

5-day course on "Islamic Banking:

Principles & Products" from October 30-

November 03, 2006 at Karachi. 20 officers

attended the course.

c) First Women Bank Limited

5-day course on "Basel-II, Treasury &

Foreign Exchange" from October 30-

November 03, 2006 at Karachi. 10

executives/ officers attended the course.

d) Crescent Commercial Bank Ltd.

5-week course on "Commercial Banking"

for Operations Management Trainees

from November 06 - December 14, 2006

at Karachi & Lahore. 24 trainees - , 14 at

Karachi and 10 at Lahore attended the

program

e) National Bank of Pakistan

6-week course on "Commercial Banking"

for HR Management Trainees from

November 21 - December 30, 2006 at

Karachi. 19 Management Trainees

attended the program.

f) Habib Bank Limited

1-day course on "SBP Prudential

Regulations for Consumer & SME

Financing" on December 28, 2006 at

Karachi. 22 officers attended the program.

4. Talks/Events by Foreign Speakers

From time to time the Institute invites eminent

personalities from within the country and

abroad for sharing of knowledge and

experience with executives and officers of

banks and financial institutions in Pakistan.

During the quarter under reference, following

knowledge sharing events were held:

a) Basel - II: Issues & Challenges

Considering heavy operational duties of

the bank executives, IBP arranged a

Business Breakfast meeting with Mr.

Bambang Moerwanto, a senior specialist of

SAP Malaysia on the subject of "BASEL -II:

ISSUES & CHALLENGES" on November

23, 2006. Over 70 senior executives and



officers from banks, financial institutions

and the corporates attended the forum.

b) Powerful Presentation Skills

It was an interactive learning session on

November 06, 2006 steered by Dr. Aamir

Shamim, Senior Consultant, Life Skills

Studio, which is a public speaking and

presentation skills consultancy with its

head office in Vancouver, Canada. A

good number of account managers, sales

and marketing professionals, financial

experts, public relations executives,

instructors, trainers and others who deliver

business presentations attended this

session.

c) IBP - MIGA Knowledge Sharing Event

In association with MIGA - Multilateral

Investment Guarantee Agency of World

Bank, IBP organized a high value

knowledge sharing event on "Political Risk

Insurance Coverage" on November 11,

2006. Mr. Azhar Kureshi, Advisor to

Governor on Development Finance, State

Bank of Pakistan was the key-note

speaker. Mr. Arif Elahi, Director General,

Board of Investment who represented

Government of Pakistan. MIGA's team

comprising Mr. Srilal M. Perera, Chief

Counsel, and Mr. Hal G. Bosher,

Investment Officer, Small Investment

Program, MIGA gave presentations at the

program. The presentations were made

covering the following topics:

1. The role of MIGA's political risk

instruments to manage non-commercial

risk and facilitate project financing;

2. Case studies to show how MIGA's risk

mitigation tools have played an important

role in securing foreign direct investment in

Pakistan and other countries;

3. MIGA's new Small Investment Program

targeting smaller investors and businesses;

4. How Pakistani investors can protect

investments in Afghanistan with MIGA's

risk mitigation tools.

This was a senior level forum for

understanding the risk mitigation tools in

promoting foreign direct investment in

Pakistan and other countries as also to

explore the opportunities for taping on the

MIGA's resource. Senior level executives

from SBP and other banks attended the

event.

d) Visit of foreign delegates

During the quarter, Mr. Hans-Joachim

Kiderlen, Consul General, Consulate of the

Federal Republic of Germany visited IBP

on November 28, 2006 and had

discussions on different knowledge

endeavors. He appreciated the role of IBP

in dissemination of knowledge and

expressed the hope that partnership

between IBP and its counterpart

organizations in Germany would

materialize to serve the cause of

knowledge and friendship.

He also delivered an enlightening lecture

to the young bankers who were under

6-week training at the IBP.

5. Recruitment & Selection Process

To meet their continuous need for qualified

professionals in the fast changing and

expanding financial sector, growing number of

banks and DFI's are outsourcing their

recruitment and selection assignments to IBP

for accuracy, impartiality and swiftness of

results. IBP is presently an active partner in the

recruitment and selection of 16 banks and

other financial institutions. During the quarter

under review, recruitment tests and interviews

were conducted for the following banks:

6. IBP Website

Ever since IBP website was given a new look in

July 2006, it is becoming increasing popular

among the users worldwide. During October -

December 2006, it surpassed all time high

record of close to 9.5 million hits. Those who

visited IBP website during the quarter under

report include US Commercial, UAE, Canada,

U.K., Saudi Arabia, France, Ireland,



Singapore, Egypt, Switzerland, Italy, Jordan,

Netherlands, Sri Lanka, Norway, Thailand,

Belgium, Russian Federation, Japan, Sweden,

Denmark, Australia and India besides the users

in Pakistan. The Institute updates information

on its website continuously on day-to-day

basis. Stakeholders are invited to visit our

website and favor us with their valuable

suggestions for further improvements.

7. Research & Publications

Besides its quarterly Journal and weekly

Economic Letter, IBP published the following

books during the quarter under report:

IBP is committed to improve its services which

meet the human resource and training needs of its

stakeholders. Comments and suggestions from the

stakeholders would be welcome with gratitude.

No. of Total

S. No. Banks Centers Enrolled

1. National Bank of Pakistan -

HR Management Trainees (Interviews) 1 53


Management Trainees(Recruitment) 5 2977


Management Trainees (Group Discussions) 3 309


Operations Management Trainees (Interviews) 3 103

5. State Bank of Pakistan - Economic Analyst (Test) 6 366

Bank-wise, qualification-wise and distinction-wise results are given below:

Bank Wise Position of Successful Candidates

Junior Associateship of IBP (JAIBP)


ISQ Examination (Winter) 2006 Result

Alhamdolilah, the second IBP Superior

Qualification (ISQ) examinations were held

from November 13 to 18, 2006 at 23 different

centres in Pakistan and abroad. The registration

received for ISQ was encouraging, both in terms

of number and qualifications. Most of the

participants were either MBAs, M. Coms, MAs,

CAs, ICMAs, or even B.E.s. Thus ISQ has been

professed as a professional qualification

equivalent to or even to some extent above the

Masters degree.

Since its launching in January 2006, IBP

Superior Qualification (ISQ) has received

greater acceptability among the professionals

from banks, financial institutions and the

corporates. Based on ideally designed syllabi,

the qualification is being recognized and

appreciated and rightly termed as a true value-

based knowledge endeavor.

Over 2566 candidates were listed in fifteen

subjects of Junior Associateship of IBP (JAIBP)

and five subjects of Special Certificate. The

aggregate pass percentage was 16%. Forty-

Sixty professionals completed all the requisite

subjects of JAIBP and are eligible to join the

celebrated family of JAIBP/DAIBP.

Sl.# Name Sl.# Name

State Bank of Pakistan

1. Ms. Quratul Ain Javid 2. Mr. Sher Afgan Malik

3. Mr. Shaukat Ali -

National Bank of Pakistan

4. Mr. Imtiaz Ahmed Shaikh 5. Mr. Farhan Abbas Zaidi

6. Mr. Wasim Ahmad 7. Ms. Fareeha Khalil

8. Mr. Shahzad Iqbal 9. Ms. Razia Nazir

10. Mr. Rana Masood Ahmed 11. Mr. Muhammad Ali Qamar

12. Mr. Rashid Ata 13. Mr. Adnan Manzoor

14. Mr. Nadeem Rashid 15. Mr. Jawaid Ahmed Shaikh

16. Mr. Salman Rafiq 17. Ms. Iram Saeed

18. Mr. Muhammad Iqbal 19. Mr. Abid Umar Farooq

MCB Bank Limited

20. Mr. Javeed Ahmed 21. Mr. Najabat Ali

22. Mr. Talat Ejaz 23. Mr. Syed Zafar Hasan Naqvi

24. Mr. Abdul Hafeez 25. Ms. Hira Rasheed

26. Mr. Adil Waheed




Sl.# Name Sl.# Name

Bank Al Habib Limited Bank Alfalah Limited

27. Mr. Sultan Muhammad 30. Mr. Noman Khalid

28. Mr. Sajid Riaz 31. Mr. Muhammad Kashif

29. Mr. Ali Raza Abidi 32. Mr. Zeeshan Ghani

Habib Bank Limited Other Professionals

33. Mr. Muhammad Masood Hasan 36. Mr. Kashif Adeel

34. Mr. Angelo Thomas John Gomes 37. Mr. Sheikh Bilal Shams

35. Mr. Nawaz Meraj 38. Ms. Farhana Rasheed

- 39. Ms. Sadia Asghar

Saudi Pak Commercial Bank Limited Soneri Bank Limited

40. Mr. Salman Ali 41. Mr. Naveed Kamran

The Bank of Khyber Meezan Bank Limited

42. Mr. Muhammad Sultan 43. Mr. Rizwan Ghulam Hussain

First Gulf Bank Limited Zarai Taraqiati Bank Limited

44. Mr. Sikander Ali Karim 45. Mr. Rashid Ali

Askari Commercial Bank Limited

46. Ms. Shabana Batool

Special Certificate

Habib Bank Limited Askari Commercial Bank Ltd.

1. Mr. Muhammad Khalid 2. Mr. Maqbool Ahmad Soomro

Qualification-wise Position and Pass Perventage

STAGES SPECIAL CERTIFICATE TOTAL of STAGES &

SPECIAL CERTIFICATE

S No Qualification Enrolled Appeared Passed Pass% Enrolled Appeared Passed Pass% Enrolled Appeared Passed

1 M.B.A. 1000 776 180 23 21 16 2 13 1021 792 182

2 CA/ACMA 36 26 5 19 1 0 0 0 37 26 5

3 M.COM. 232 179 30 17 1 0 0 0 233 179 30

4 MASTERS 427 332 40 12 22 14 0 0 449 346 40

5 BE 5 5 0 0 0 0 0 0 5 5 0

6 BACHELORS 806 611 45 7 16 11 0 0 822 622 45

Grand Total 2506 1929 300 16 61 41 2 5 2567 1970 302



Distinctions

Sl. No. Name Organization Subject

1. Ms. Syeda Erum Fatima Non Banker Business Comm. for FS

2. Mr. Assad Khan National Bank of Pakistan Accounting for FS

3. Mr. Tariq Nisar Allied Bank Limited Accounting for FS

4. Mr. Junaid Murtaza Non Banker Accounting for FS

5. Ms. Zahid Siddique Non Banker Accounting for FS

6. Mr. M. Umar Munir Non Banker Accounting for FS

7. Ms. Syeda Erum Fatima Non Banker Accounting for FS

8. Mr. M. Usman Shakir Bank Alfalah Limited Accounting for FS

9. Mr. Abdul Salam Bank Alfalah Limited Accounting for FS

10. Mr. Basit Younus Bank Alfalah Limited Accounting for FS

11. Mr. Rizwan Jamil Bank Albaraka Islami Accounting for FS

12. Mr. Adil Saleem Bank Albaraka Islami Accounting for FS

13. Mr. M. Aurangzeb The Bank of Punjab Accounting for FS

14. Mr. M. Hamad Usmani Askari Commercial Bank Accounting for FS

15. Mr. Atif Iqbal MCB Bank Limited Accounting for FS

16. Mr. Ali Asad United Bank Limited Macro Economics &

Financial System of Pakistan

Associateship

Five candidates appeared for the Associateship

examination in Winter 2006. Such a small

number of examinees was due to minimum

entry requirement of three years post

DAIBP/JAIBP experience and a record of

Continual Professional Development (CPD)

during 3-years' period either by receiving or

imparting training or engaging in other

knowledge related activities. A minimum of 20

hours CPD per year is mandatory.

Conclusion

ISQ is a continuous route towards professional

excellence, which is open to every knowledge

seeker holding Bachelor degree with a minimum

second division. We have to guide the

youngsters and in-service bankers to enter into

this high value path.

S.No. TITLE

01 Fundamentals of Financial Management

by Chandra Prasanna.

02 Futures & Options Introduction to Equity

Derivatives by Mahajan .R.

03 Human Resource Development in

Financial Sector by Gupta K.C.

04 Investment Analysis and Portfolio

Management by Chandra Prasanna.

05 State Bank Probationary Officer's Guide

by Chopra Ravi.

06 Treasury Risk Management by Bagchi S.K.

07 An Introduction To Islamic Finance by

Usmani Muhammad Taqi.

08 Pakistan the Economy of an Elitist State by

Dr. Ishrat Hussain.

09 Issues in Pakistan's Economy by Zaidi

Akbar .S.

10 Money and Banking in Pakistan by S.A.

Meenai.

11 The Financial Services Marketing

Handbook by Ehrlich Evelyn.

12 Credit Risk Management in Banks By Jain

Arvind.

13 Practice and Law of Banking in Pakistan

by Siddiqui Asrar .H.

14 Accounting and Finance for Banks by N.P.

Agarwal.

15 Introduction to Computer by Peter Norton.

16 Services Marketing by Zeithaml .A. Valarie.

17 Interest Free Banking by Dr. Uzair

Muhammad.

18 Business Data Communication by Stallings

William.

19 Management Information Systems by

Laudon .C. Kenneth.

20 Computer Networks by Tanenbaum.

S.No. TITLE

21 Managing Human Resources by Cascio .F.

Wayne.

22 Macro Economics 9th ed by Dornbusch

Rudiger.

23 Bank Marketing by Patnaik.

24 Banking Sector Efficiency in Globalised

Economy by Kumar Parmod.

25 Credit Risk Management by Bagchi S.K.

26 Microfinance Challenges and

Opportunities by Rajagopalan .S.

27 U$ Banking Strategic Issues by Rao

Nageswara.

28 Agricultural Economics 2nd ed by

Drummond.

29 Business Communication Concepts and

Cases by Chaturvedi.

30 Marketing Management A South Asian

Perspective by Kotler Philip.

31 Total Quality Management by

Charantimath.



33 Management Information Systems 2nd ed

by Davis .B. Gordon.

34 Introduction to Computers by Norton

Peter.



36 Model Business Letters E-mails & Other

Business Documents by Taylor Shirley.

37 Principles of Marketing by Kotler Philip.

38 Accounting & Finance for Bankers by

Indian Institute of Banking & Finance.

39 Principles of Bankingby Indian Institute of

Banking & Finance.

40 Treasury Risk Management by Bagchi S.K.

IBP Publications - New Arrivals




Basel II Framework:The IRB Use TestImplementation

Shakil Akhtar QureshiProject ManagerFaysal Bank Ltd.

The new capital adequacy framework

commonly known as “Basel II” was finalized by

Basel Committee on Banking Supervision on June

26, 2004. The new capital allocation framework is

more risk sensitive as compared to Basel I. The

banks are required to establish a strong and

comprehensive risk management framework.

Basel II has also prescribed a strong and vigilant

role of the regulatory authorities. Further, the

accord envisages a detailed disclosure requirement

depending upon the specific approach adopted by

the institution for capital allocation to enhance

transparency and market discipline. This new

capital adequacy regime has been adopted by

State Bank of Pakistan and is applicable to all

banks and Development Financial Institutions

(DFIs) that fall under its regulatory purview.

The new framework offers Standardized

Approach (SA) and Internal Ratings Based (IRB)

Approach for assessment of capital requirements

for credit risk. The timeframe for adoption of IRB

approach is 1st January 2010 with parallel run of

two years starting from 1st January 2008. Banks /

DFIs are required to submit a quarterly statement

on the calculation of their capital adequacy ratio

based on revised regulatory capital framework

under Basel II within 30 days of the end of each

calendar quarter. During the parallel run period

banks will also calculate their Capital Adequacy

Ratio (CAR) on the basis of guidelines issued vide

BSD Circular No. 12 dated 25th August, 2004 and

submit the results of both the calculations on

quarterly basis.

Basel II Framework emphasizes that “Internal

ratings and default and loss estimates must play an

essential role in the credit approval, risk

management, internal capital allocation and

corporate governance functions of banks using the

IRB approach. Rating systems and estimates

designed and implemented exclusively for the

purpose of qualifying for the IRB approach and

used only to provide IRB inputs are not

acceptable. It is recognized that banks will not

necessarily be using exactly the same estimates for

both IRB and all internal purposes. For example,

pricing models are likely to use PDs and LGDs

relevant to the life of the asset. Where there are

such differences, a bank must document them and

demonstrate their reasonableness to their

regulator.”

This paper attempts to clarify expectations for

the use of IRB components and risk estimates for

internal purposes. It expounds a number of

principles that are anticipated to support banks

and regulators in interpreting the key use test

provisions of the Basel II Framework.

Background of the Use Test

The use test pertains to the internal

employment by a bank of the borrower and/or

facility ratings, retail segmentation and estimates of

PD, EAD and LGD that the Basel II Framework

expects banks to use for the calculation of

regulatory capital, hereinafter collectively referred

to as “IRB components”. While the second

consultative paper on the new framework

contained detailed and prescriptive language on

the internal use of IRB components, the Basel II

text (paragraph 444) is more principle based.

The IRB use test is based on the perception

that regulators can take additional comfort in the

IRB components where such components “play a

vital role” in how banks measure and manage risk

in their businesses. If the IRB components are

exclusively used for regulatory capital purposes,

there could be incentives to minimize capital

requirements rather than generate accurate

measurement of the IRB components and the


resultant capital requirement. Moreover, if IRB

components were used for regulatory purposes

only, banks would have fewer internal incentives

to keep them accurate and up-to-date, whereas the

employment of IRB components in internal

decision-making creates an automatic incentive to

ensure sufficient quality and adequate robustness

of the systems that produce such data.

Use of IRB Components

In general, there are three main areas where

the use of IRB components for internal risk

management purposes should be observable:

strategy and planning processes, credit exposure

management, and reporting. Uses in any of these

areas provide evidence of internal use of IRB

components. If IRB components are not used in

any of these areas, the regulator may require an

explanation for such non-use, or may raise

concerns about the quality of the IRB components.

In many instances, regulators will need to exercise

considerable judgment in assessing the use of IRB

components.

Strategy and planning processes cover all

activities related to a bank specifying its objectives;

developing its policies and the plans to achieve

these objectives; and allocating resources to

implement these plans. IRB components may be

used in assessment and allocation of economic

capital; credit risk strategy; and decisions about

acquisitions, new business lines/products, capacity

and expansions.

Credit exposure measurement and

management covers all activities related to

management and control of the credit risk that a

bank takes as a consequence of implementing its

strategies. IRB components may be used in credit

portfolio management; credit approval, review and

monitoring; performance assessment /

remuneration; pricing; individual / portfolio limit

setting; provisioning; and retail segmentation.

Reporting refers to the information flow from

credit exposure measurement and management to

other functions of the organization. Reporting is a

necessary component of defining a bank's strategic

goals. IRB components may be used in credit

portfolio reporting; credit portfolio analysis; and

other credit risk information.

Principles

The following principles are designed with the

objective of supporting banks and regulators in

interpreting stipulations of the Basel II Framework.

1. Banks are responsible for demonstrating

their compliance with the use test

AIG validation principle 2, as set forth in

“Update on work of the Accord Implementation

Group (AIG) related to validation under the Basel

II Framework”, emphasizes that banks have the

responsibility for validating their rating system and

associated IRB parameter estimates. The use test is

no exception to this principle. Banks are

responsible for complying with the use test

requirement and for demonstrating compliance by

providing relevant documentation and evidence of

use of IRB components.

Banks should demonstrate to their regulators

the processes where IRB components play an

essential role and provide the relevant supporting

evidence for compliance with the use test. Banks

should illustrate how these internal uses confirm

management's belief in the validity of the IRB

components and contribute towards meeting the

use test objectives. Banks should clarify whether

the IRB components are used directly in risk

management processes, or whether they are used

in a derived form or in a partial way. Banks should

also demonstrate how risk management processes

support the accuracy, robustness and timeliness of

the IRB components.

Banks and regulators may rely on existing

internal documentation for the purpose of

demonstrating use test compliance. To a large

extent, the obligations implied by this principle will

be met through normal documentation of the

banks' overall validation and governance

frameworks and internal operating processes.



2. Internal use of IRB components should

be sufficiently material to result in

continuous pressure on the quality of

IRB components.

To make the use of the IRB approach credible,

IRB components should be entrenched in the

bank's internal risk management processes. While

IRB components should play an essential role in

risk management and decision-making, this does

not necessarily mean an exclusive or primary role

in all relevant processes. In addition, as elaborated

upon in principle 3, there may be differences

between the internal risk measures used for risk

management and the IRB components.

One of the aims of the use test is to promote

adequate and appropriate incentives internal to

banks so that the banks have a strong belief and

interest in the accuracy of their IRB components

and the quality of the processes that generate

those components. The following are examples of

situations where a lack of quality in the IRB

components or their underlying processes may

give rise to regulatory concern:

* the IRB components are calculated solely for

regulatory purposes with little or no internal

incentives for ensuring the quality of those

components;

* a deterioration in the accuracy, robustness,

and timeliness of the IRB components is

unlikely to be picked up by the bank's internal

processes;

* the IRB components are based on insufficient

or lower quality data relative to what is used to

estimate internal parameters;

* the bank lacks a process for continuous

improvement of the IRB components; and

* the bank has used the Framework's flexibility

for designing an IRB rating system in a way

that produces artificially low capital

requirements inconsistent with their internal

approach to measuring credit risk.

In a bank that meets the use test, regulators

would expect to see evidence of the occurrence of

internal challenges to the accuracy, robustness,

and timeliness of IRB components resulting from

any direct or indirect employment of IRB

components along the lines stated earlier, i.e.

strategy and planning processes, credit exposure

management, and reporting.

Thus as a quality check of IRB components

and underlying processes, the use test is a

necessary supplement to the overall validation

process. It represents a very important regulatory

tool and a fundamental component of the case

that banks must put to their regulators to

demonstrate that they initially meet the IRB

minimum requirements and will continue to do so,

on an ongoing basis.

As such, the use test plays a key role in

ensuring and encouraging the accuracy,

robustness, and timeliness of a bank's IRB

components, confirms the bank's trust in those

components and allows regulators to place more

reliance on their robustness and thus on the

adequacy of regulatory capital. The evaluation of

the use test in banks' risk management processes

and the focus on continuous quality assurance for

risk estimates may also encourage improved risk

management, which is an overarching objective of

the Basel II Framework.

3. Demonstrating consistency and explaining

differences between IRB components

and internal measures.

Measures used for internal processes may

reasonably differ from IRB components in some

instances. Such differences may arise from

legitimate mismatches between the prudential

requirements of the IRB framework and a bank's

own risk management practices. Where such

differences exist, banks should demonstrate good

reasons for use of parameters that do not match

IRB components. The regulatory objectives of the

use test could be met if banks demonstrate that the

degree of consistency between the IRB

components and the internal estimates is

sufficiently high as to contribute to continuous

quality pressure on the IRB components. In this

context, consistency might be demonstrated by



establishing clear linkages between the internal

inputs and the IRB components, showing that any

differences reflect legitimate risk management

needs.

A combination of multiple features could

provide comfort to regulators that sufficient linkage

exists. Such features could include use of the same

underlying data for computations, reliance on the

same IT systems, application of similar quality

checks and similar validation techniques, or use of

common methodologies or similar models.

4. The importance of an internal process to

the bank's decision making influences

and the extent to which that process

contributes to an assessment of use test

compliance. Banks should take a holistic

approach when assessing overall

compliance of their institution with the

use test requirements.

Any processes in which significant use is made

of IRB components or where incentives to ensure

the quality of IRB components are sufficiently

strong can contribute to a bank's overall self-

assessment of use test compliance. Certain uses in

certain processes could potentially provide higher

comfort than others. Generally speaking, the more

important, pervasive and granular the use of the

IRB components in a bank's decision making

processes, the greater is the likelihood of

meaningful internal challenge and the stronger are

the incentives to ensure the accuracy and

robustness of IRB components, giving greater

confidence that management is committed to the

validity of the IRB components. Regulators should

adopt a similar approach when assessing factors

supporting a bank's compliance with the use test.

If, on the other hand, ratings, retail

segmentation and estimates used in internal

processes differ from respective IRB components

without convincing explanation as to the reasons

for the lack of consistency, bank management's

commitment to the importance of the IRB

components and thus compliance with the use test

may be in doubt. However, shortfalls in use test

compliance in individual processes do not in and

of themselves imply a negative overall evaluation

of an institution's compliance with the use test.

It should be recognized that a group with

subsidiaries in more than one country may

conduct much of its risk management and business

management activities on a group basis using

processes, procedures and IRB and internal

components defined at the group level. In such

cases both home and host regulators may need to

be flexible in determining whether the purposes of

the use test are met on a holistic basis, generally

with reference to such group policies, procedures

and components.

Reference: Publications of Basel Committee and

State Bank of Pakistan.




Collateralization,Risk Management and SME Financing

SYED ALAMDAR ALIStudent of MBA (Banking & Finance)University of the Punjab,Lahore.

The words collateral and risk management

have diversified meanings according to their uses

in different fields like sociology, economics,

medicine, etc. These terms camouflage themselves

in different studies in such a way that it becomes

difficult for a reader to identify the limits of these

terms. We first look into the definition of Collateral.

Collateral has been defined in various ways. It can

be used as a noun as well as an adjective. We start

from its basic dictionary meaning which shall then

be widened to the existing parameters of

collateralization.

As a noun it means:

1. Property acceptable as security for a loan or

other obligation.

2. A collateral relative.

As an adjective it means:

1. Situated or running side by side; parallel.

2. Coinciding in tendency or effect; concomitant

or accompanying.

3. Serving to support or corroborate: collateral

evidence.

4. Of a secondary nature; subordinate: collateral

target damage from a bombing run.

5. Of, relating to, or guaranteed by a security

pledged against the performance of an

obligation: a collateral loan.

6. Having an ancestor in common but descended

from a different line.

In legal terminology it means:

“Related; indirect; not bearing immediately

upon an issue. The property pledged or given as a

security interest, or a guarantee for payment of a

debt, that will be taken or kept by the creditor in

case of a default on the original debt”.

In finance, from a legal point of view it means

in a form of security.

Barron's Dictionary of Banking explains a form

of security as:

“Asset pledged as security to ensure payment

or performance of an obligation. In bank lending,

it is generally something of value owned by the

borrower. If the borrower defaults, the asset

pledged may be taken and sold by sold by the

lender to fulfill completion of the original contract.

Four types of collateral, as recognized by the

Uniform Commercial Code, are commonly used in

secured lending: (1) trade goods, (2) paper

(negotiable instruments and title documents), (3)

intangibles, and (4) business proceeds (cash).

Collateral assigned to the lender can even be the

asset being financed, as in Asset-Based Lending

where a loan might be secured by business

inventory or accounts receivable. In a home

mortgage loan, the borrower gives the lender a

mortgage on the house being purchased.”

The above definition also gives a clue to the

function that collateral plays when the borrower

commits default in the performance of his

obligations under the terms of the “Original

Contract”. The form of collateral described as

“Even the assets being financed” is also sometimes

referred to as “Prime Security” specifying the

assets for which the finance has been utilized

compared with those assets for which the finance

has not been utilized. Such assets are held as

security in a borrowing transaction only in order to

facilitate those borrowers who have a feasible

investing plan and limited amount of funds, but

cannot reap the benefits of the opportunity due to

shortage of funds with them. In such situations the

financial institutions come forward and after

careful analysis decide to participate with the


borrower in that investment opportunity.

However, for managing the risk between the

lender and the borrower, the financial institutions

sometimes also require such immoveable assets

from the borrower in which the borrower is the

sole investor.

On the basis of the above discussion it can be

said that collateral means assets that secure a debt

obligation. For example, in the case of a mortgage,

the house serves as the collateral for the mortgage

loan. This way, the bank is secured against the

default risk of the borrower not being able to meet

the interest payments. In case of default, the bank

can sell the house and get its money (or at least a

part of it) back.

From this statement the definition of collateral

can be expanded with some help of risk

management:

Collateralization is a method of managing the

risk between the lender and the borrower. In a

lending transaction, amongst other risks, the lender

is primarily faced with the risk of default of the

borrower. As the borrower controls the funds of the

lender, the latter faces the risk of loss of his funds if

the borrower takes any wrong decision about the

application of funds. Further, it is always possible

that the borrower will assume higher business risk

while taking any investment decision involving

borrowed amount, than if it was his own

investment. Keeping in view the possibility of

assuming higher risk in any investment decision by

the borrower, the sender often designs and

implements its decision of financing the borrower

in such a way that it requires the borrower to also

arrange funds to involve his own risk in the lending

transaction in order to diversify the risk between

themselves. This arrangement between the lender

and borrower is called the collateralization of

finance. This is usually done by the borrower by

bringing some of his assets under the control of the

lender.

TYPES OF COLLATERAL: Many different

types of collateral arrangements can be made by

companies, whether they are experiencing a

financial crunch or making plans for expansion.

Some common types of collateral include the

following:

Purchase Money Security Interest (PMSI).

Also known as a chattel mortgage, this option

allows the borrower to secure a loan by borrowing

against the value of the equipment being

purchased.

Real Estate. Businesses that utilize real estate __

usually a personal residence __ as collateral are

generally requesting long-term loans of significant

size (the borrower has plenty of other collateral

options for smaller loans). The size of the loan

under this arrangement depends mainly on the

market and foreclosure value of the property, as

well as the amount of insurance coverage that the

borrower has taken out on it.

Endorser. Under this form of collateral, the

borrower secures a loan by convincing another

person to sign a note that backs up the promises of

the borrower. “This endorser is then liable for the

note,” stated Mark Van Note in ABCs of

Borrowing. “If the borrower fails to pay, the bank

expects the endorser to pay. Sometimes, the

endorser may also be asked to pledge assets.” A

guarantor loan security is similar to the endorser

arrangement, except that the guarantor is not

required to post collateral.

Warehouse Receipts. Another option for

borrowers is to put a portion of their warehouse

commodities as collateral. Van Note explained that

with warehouse receipts, “the receipt is usually

delivered directly to the bank and shows that the

merchandise has either been placed in a public

warehouse or has been left on your premises

under the control of one of your employees who is

bonded. Such loans are generally made on staple

or standard merchandise that can be readily

marketed. The typical loan is for a percentage of

the cost of the merchandise.”

Display Merchandise. This method of

borrowing, which is also sometimes referred to as

“floor planning,” is similar to warehouse inventory.

Under this plan display merchandise such as

furniture, automobiles, boats, large appliances,



and electronic equipment can be used as collateral

to secure loans.

Inventory. This encompasses all the various

assets (merchandise, property, equipment, etc.)

owned by the borrowing business that could be

liquidated to repay the loan.

Accounts receivable. “Many banks lend money

against accounts receivable; in effect, counting on

your customers to pay your loan,” explained Van

Note. “The bank may take accounts receivable on

a notification or non-notification plan. Under the

notification plan, the purchaser of the goods is

informed by the bank that the account has been

assigned and is asked to make payments directly to

the bank. Under the non-notification plan,

customers continue to pay you and you pay the

bank.” Under this collateral agreement, lenders

sometimes advance up to 80 percent of the value

of the receivables once the goods are shipped.

Savings accounts and certificates of deposit.

These accounts can also be used as collateral.

Stocks and bonds. Publicly held companies

have the option of offering stocks and bonds

within the company as security.

Life insurance. Some lenders are willing to

accept the cash value of a life insurance policy as

collateral on a loan.

As collateral is a form of risk management

between the lender and the borrower it is

discussed in more detail.

The term risk management is a relatively recent

(within the last 20 years) evolution of the term

“insurance management.” The concept of risk

management encompasses a much broader scope

of activities and responsibilities than does

insurance management. Risk management is now

a widely accepted description of a discipline within

most large organizations. Basic risks such as fire,

windstorm, employee injuries, and automobile

accidents, as well as more sophisticated exposures

such as product liability, environmental

impairment, and employment practices, are the

province of the risk management department in a

typical corporation. Although risk management

has usually pertained to property and casualty

exposures to loss, it has recently been expanded to

include financial risk management - such as

interest rates, foreign exchange rates, and

derivatives - as well as the unique threats to

businesses engaged in E-commerce. As the role of

risk management has increased, some large

companies have begun implementing large-scale,

organization-wide programs known as enterprise

risk management.

Risk Management is a two-way process

determining what risks exist in an investment and

then handling those risks in a way best suited to

the investment objectives. Risk management

occurs everywhere in the financial world. It occurs

when an investor buys low-risk government bonds

over more risky corporate debt; when a fund

manager hedges his currency exposure with

currency derivatives; and when a bank performs a

credit check on an individual before issuing him a

personal line of credit. Risk management is also

done through a combination of internal policies

and contractual arrangements with various

companies in order to safeguard the interests of

the bank. It is a set of services, rather than a

specific product, aimed at controlling financing

risk, including credit risk, and interest rate risk,

through hedging devices, financial futures, and

interest rate caps. The aim is to control corporate

funding costs, budget interest rate expense, and

limit exposure to interest rate fluctuations.

Every business encounters risks, some of which

are predictable and under management's control,

and others are unpredictable and uncontrollable.

Risk management is particularly vital for small

businesses since some common types of losses -

such as theft, fire, flood, legal liability, injury, or

disability - can destroy in a few minutes what may

have taken an entrepreneur years to build. Such

losses and liabilities can affect day-to-day

operations, reduce profits, and cause financial

hardship severe enough to cripple or bankrupt a

small business. But while many large companies

employ a full-time risk manager to identify risk and

take the necessary steps to protect the firm against



them, small companies rarely have that luxury.

Instead, the responsibility for risk management is

likely to fall on the small business owner.

Steps in the Risk Management Process

According to C. Arthur Williams Jr. and

Richard. M. Heins in their book Risk Management

and Insurance, the risk management process

typically includes six steps:

1) Determining the objectives of the organization;

2) Identifying exposures to loss;

3) Measuring those same exposures;

4) Selecting alternatives;

5) Implementing a solution; and

6) Monitoring the results.

The primary objective of an organization–

growth, for example–will determine its strategy for

managing various risks. Identification and

measurement of risks are relatively straightforward

concepts. Earthquake may be identified as a

potential exposure to loss, for example, but if the

exposed facility is in New York the probability of

earthquake is slight and it will have a low priority

as a risk to be managed.

Businesses have several alternatives for the

management of risk, including avoiding, assuming,

reducing, or transferring the risks. Avoiding risks,

or loss prevention, involves taking steps to prevent

a loss from occurring, via such methods as

employee safety training. As another example, a

pharmaceutical company may decide not to

market a drug because of the potential liability.

Assuming risks simply means accepting the

possibility that a loss may occur and being

prepared to pay the consequences. Reducing risks,

or loss reduction, involves taking steps to reduce

the probability or the severity of a loss, for example

by installing fire sprinklers.

Transferring risk refers to the practice of

placing responsibility for a loss on another party

via a contract. The most common example of risk

transference is insurance, which allows a company

to pay a small amount as monthly premium in

exchange for protection against automobile

accidents, theft or destruction of property,

employee disability, or a variety of other risks.

Because of its costs, the insurance option is usually

chosen when the other options for managing risk

do not provide sufficient protection. Awareness of,

and familiarity with, various types of insurance

policies is a necessary part of the risk management

process. A final risk management tool is self

retention of risks sometimes referred to as “self-

insurance.” Companies that choose this option set

up a special account or fund to be used in the

event of a loss.

Any combination of these risk management

tools may be applied in the fifth step of the process

i.e. implementation. The final step, i.e. monitoring,

involves a regular review of the company's risk

management tools to determine if they have

obtained the desired result or if they require

modification. Some easy risk management tools

for small businesses are: Maintain a high quality of

work; Train employees well and maintain

equipment properly; Install strong locks, smoke

detectors, and fire extinguishers; Keep the office

clean and free of hazards; Maintain back up of

computer data and ; Store records securely offsite.

Risk Management in the Internet Age

Small businesses encounter a number of risks

when they use the internet to establish and

maintain relationships with their customers or

suppliers. Increased reliance on the internet

demands that small business owners decide how

much risk to accept and implement security

systems to manage the risk associated with online

business activities. “The advent of the internet has

provided for a totally changed communications

landscape. We communicate faster, more

efficiently, and to a larger number of people,”

Gary Griffith wrote in the Dallas Business Journal.

“Shifting to web sites and e-mails as forms of

communication changes the scope, speed, and

cost of advertising, customer/vendor

communication, and employee-to-employee

communication. Along with the advantages are



liabilities issues which should not be ignored.”

Conducting business online exposes a

company to a wide range of potential risks,

including Liability due to infringement on

copyrights, patents, or trademarks; Charges of

defamation due to statements made on a web site

or via e-mail; Charges of invasion of privacy due to

unauthorized use of personal information or

excessive monitoring of employee

communications; Liability for harassment due to

employee behavior online and; Legal issues due to

accidental noncompliance with foreign laws. In

addition, businesses connected to the internet also

face a number of potential threats from computer

hackers and viruses, including loss of business and

productivity due to computer system damage, and

the theft of customer information or intellectual

property.

As of the early 2000s, the insurance industry

had not made policies widely available to protect

businesses against the risks of e-commerce. As a

result, business owners had to include Internet

security in their risk analysis and management

activities. As a minimum level of protection,

experts recommend that companies conduct a

legal review of their web site content, establish

policies on employees' internet and e-mail usage,

and install virus protection and security systems on

all computers used to access the internet.

Enterprise Risk Management

In the 1990s, the field of risk management

expanded to include managing financial risks as

well as those associated with changing technology

and internet commerce. As of 2000, the role of risk

management had begun to expand even further to

protect entire companies during periods of change

and growth. As businesses grow, they experience

rapid changes in nearly every aspect of their

operations, including production, marketing,

distribution, and human resources. Such rapid

change also exposes the business to increased risk.

In response, risk management professionals

created the concept of enterprise risk

management, which was intended to implement

risk awareness and prevention programs on a

company-wide basis. “Enterprise risk

management…seeks to identify, assess, and

control - sometimes through insurance, more often

through other means - all of the risks faced by the

business enterprise, especially those created by

growth,” Griffith explained.

The main focus of enterprise risk management

is to establish a culture of risk management

throughout a company to handle the risks

associated with growth and a rapidly changing

business environment. Writing in Best's Review,

Tim Tongson observes that business owners take

the following steps in implementing an enterprise-

wide risk management program:

1) Incorporate risk management into the core

values of the company;

2) Support those values with actions;

3) Conduct a risk analysis;

4) Implement specific strategies to reduce risk;

5) Develop monitoring systems to provide early

warnings about potential risks and;

6) Perform periodic reviews of the program.

Finally, it is important that the small business

owners and top managers show their support for

employee efforts at managing risk. “To bring

together the various disciplines and implement

integrated risk management, ensuring the buy-in

of top-level executives is vital,” Luis Ramiro

Hernandez wrote in Risk Management. “These

executives can institute the processes that enable

people and resources across the company to

participate in identifying and assessing risks, and

tracking the actions taken to mitigate or eliminate

those risks.”

Traditional risk management focuses on risks

stemming from physical or legal causes (e.g.

natural disasters or fires, accidents, death, and

lawsuits). Financial risk management, on the other

hand, focuses risks that can be managed using

traded financial instruments. Regardless of the type

of risk management, all large corporations have

risk management teams and small groups and

corporations practice informal, if not formal, risk



management.

In ideal risk management, a prioritization

process is followed whereby the risks with the

greatest loss and the greatest probability of

occurring are handled first, and risks with lower

probability of occurrence and lower loss are

handled later. In practice the process can be very

difficult, and balancing between risks with a high

probability of occurrence but lower loss vs. a risk

with high loss but lower probability of occurrence

can often be mishandled.

Intangible risk management identifies a new

type of risk - a risk that has a probability of

occurring but is ignored by the organization due to

a lack of identification ability. For example,

knowledge risk occurs when deficient knowledge

is applied. Relationship risk occurs when

collaboration ineffectiveness occurs. Process

engagement risk occurs when operational

ineffectiveness occurs. These risks directly reduce

the productivity of knowledge workers, decrease

cost effectiveness, profitability, service, quality,

reputation, brand value, and earnings quality.

Intangible risk management allows risk

management to create immediate value from the

identification and reduction of risks that reduce

productivity.

Risk management also faces difficulties in

allocating resources. This is the idea of opportunity

cost. Resources spent on risk management could

have been spent on more profitable activities.

Again, ideal risk management minimizes spending

while maximizing the reduction of the negative

effects of risks.

Another approach to risk

management process

Establish the context

Establishing the context includes planning the

remainder of the process and mapping out the

scope of the exercise, the identity and objectives of

stakeholders, the basis upon which risks will be

evaluated and defining a framework for the

process, and agenda for identification and

analysis.

Identification

After establishing the context, the next step in

the process of managing risk is to identify potential

risks. Risks are about events that, when triggered,

cause problems. Hence, risk identification can start

with the source of problems, or with the problem

itself.

* Source analysis: Risk sources may be

internal or external to the system that is the

target of risk management. Examples of risk

sources are: stakeholders of a project,

employees of a company or the weather over

an airport.

* Problem analysis: Risks are related to

identified threats. For example: the threat of

losing money, the threat of abuse of privacy

information, or the threat of accidents and

casualties. The threats may exist with various

entities, most important with shareholder,

customers and legislative bodies such as the

government.

When either source or problem is known, the

events that a source may trigger or the events

that can lead to a problem can be investigated.

For example: stakeholders withdrawing

during a project may endanger funding of the

project; privacy information may be stolen by

employees even within a closed network;

lightning striking a Boeing 747 during takeoff

may expose all people on board to immediate

casualties.

The chosen method of identifying risks may

depend on culture, industry practice and

compliance. The identification is formed by

templates or the development of templates for

identifying source, problem or event. Common

risk identification methods are:

* Objectives-based Risk Identification:

Organizations and project teams have

objectives. Any event that may endanger

achieving an objective partly or completely is

identified as risk.



* Scenario-based Risk Identification. In

scenario analysis different scenarios are

created. The scenarios may be the alternative

ways to achieve an objective, or an analysis of

the interaction of forces in, for example, a

market or battle. Any event that triggers an

undesired alternative is identified as risk.

* Taxonomy-based Risk Identification. The

taxonomy in taxonomy-based risk

identification is a breakdown of possible risk

sources. Based on the taxonomy and knowledge

of best practices, a questionnaire is compiled.

The answers to the questions reveal risks.

* Common-risk Checking. In several

industries lists with known risks are available.

Each risk in the list can be checked for

application to a particular situation.

Assessment

Once risks have been identified, they must

then be assessed as to their potential severity of

loss and to the probability of occurrence. These

quantities can be either simple to measure, in the

case of the value of a last building, or impossible to

know for sure in the case of the probability of an

unlikely event occurrence. Therefore, in the

assessment process it is critical to make the best

educated guesses possible in order to properly

prioritize the implementation of the risk

management plan.

The fundamental difficulty in risk assessment is

determining the rate of occurrence since statistical

information is not available on all kinds of past

incidents. Furthermore, evaluation of the severity

of the consequences (impact) is often quite difficult

for immaterial assets. Asset valuation is another

question that needs to be addressed. Thus, best

educated opinions and available statistics are the

primary sources of information. Nevertheless, risk

assessment should produce such information for

the management of the organization that the

primary risks are easy to understand and that the

risk management decisions may be prioritized.

Thus, there have been several theories and

attempts to quantify risks. Numerous different risk

formulae exist, but perhaps the most widely

accepted formula for risk quantification is:

Rate of occurrence multiplied by the

impact of the event equals risk

Later research has shown that the financial

benefits of risk management are less dependent on

the formulae used, are more dependent on the

frequency and how risk assessment is performed.

Potential Risk Treatments

Once risks have been identified and assessed,

the various techniques to manage the risk fall into

one or more of these four major categories:

(Dorfman, 1997)

* Transfer

* Avoidance

* R5eduction (aka Mitigation)

* Acceptance (aka Retention)

Some ways of managing risk fall into multiple

categories. Risk retention pools are technically

retaining the risk for the group, but spreading it

over the whole group involves transfer among

individual members of the group. This is different

from traditional insurance, in that no premium is

exchanged between members of the group up

front, but instead losses are assessed to all

members of the group.

Create the plan

Decide on the combination of methods to be

used for each risk. Each risk management decision

should be recorded and approved by the

appropriate level of management. For example, a

risk concerning the image of the organization

should have top management decision behind it

whereas IT management would have the authority

to decide on computer virus risks.

The risk management plan should propose

applicable and effective security controls for

managing the risks. For example, an observed

high risk of computer viruses could be mitigated by

acquiring and implementing anti-virus software. A



good risk management plan should contain a

schedule for control implementation and

responsible persons for those actions. The risk

management concept is old but is still not very

effectively measured.

Implementation

Follow all of the planned methods for

mitigating the effect of the risks. Purchase

insurance policies for the risks that have been

decided to be transferred to an insurer, avoid all

risks that can be avoided without sacrificing the

entity's goals, reduce others, and retain the rest.

Review and evaluation of the plan

Initial risk management plans will never be

perfect. Practice, experience, and actual loss

results will necessitate changes in the plan and

contribute information to allow possible different

decisions to be made in dealing with the risks

being faced.

Risk analysis results and management plans

should be updated periodically. There are two

primary reasons for this:

l. To evaluate whether the previously selected

security controls are still applicable and

effective, and

2. To evaluate the possible risk level changes in

the business environment. Information risks

are a good example of rapidly changing

business environment.

Limitations

If risks are improperly assessed and prioritized,

time can be wasted in dealing with risk of losses

that are not likely to occur. Spending too much

time in assessing and managing unlikely risks can

divert resources that could be used more

profitably. Unlikely events do occur but if the risk

is unlikely enough to occur it may be better to

simply retain the risk and deal with the result if the

loss does in fact occur.

Prioritizing too highly the risk management

processes could keep an organization from ever

completing a project or even getting started. This is

especially true if other work is suspended until the

risk management process is considered complete.

It is also important to keep in mind the

distinction between risk and uncertainty. Risk can

be measured by Impacts x Probability.

Areas of risk management

As applied to corporate finance, risk

management is a technique for measuring,

monitoring and controlling the financial or

operational risk on a firm's balance sheet.

The Basel II framework breaks risks into

market risk (price risk), credit risk and operational

risk and also specifies methods for calculating

capital requirements for each of these

components.

Enterprise Risk Management

In Enterprise Risk Management, a risk is

defined as a possible event or circumstance that

can have negative influences on the enterprise in

question. Its impact can be on the very existence,

the resources (human and capital), the products

and services, or the customers of the Enterprise, as

well as external impacts on Society, Markets or the

Environment.

In addition, every probable risk can have a

pre-formulated plan to deal with its possible

consequences (to ensure contingency if the risk

becomes a liability).

Having had some insights of collateralization

and risk management we can now look towards

applying the concepts towards forming new bases

in the SME Financing. We can now state that

collateralization is a risk management tool that

helps in managing the risk between the lender and

the user of finance. It is not particularly imperative

that risk management through collateralization can

only take place in physically involving any kind of



tangible assets. This may take any form because

the intention is to keep the user of the finance

interested in the business wherein he has either

least or negligible financial involvement.

Some forms of risk management while making

a financing decision for SME's that do not involve

pledging of any moveable asset or mortgaging of

titles of any immoveable assets are as follows:

The SME's opting for any specific kind of

financing should have a good internal control

system. The matter does not conclude only upon

asking the SME to opt for a specific kind of Internal

Control. Risk management also involves very close

monitoring of the fact that whether or not the

entity being financed is sticking to internal control

system provided to it. This kind of risk

management is really asking for the increased role

of lending authority in the control and

management of the entity. This seems to be out of

the sphere of the roles of the banks at present. But

at the same time it will definitely widen the ability

of the banks to monitor the lended funds

effectively. With the passage of time the

conventional methods of' monitoring funds are

technically and practically becoming obsolete. For

instance, in working capital financing the banks are

financing SME's in basically three ways. All three

of these modes of financing have been traditionally

based upon physically collateralizing the amount

of finance. These are:

* An Account Overdraft facility or Running

Finance facility with the condition that the

amount of finance will be secured in such a

way that the borrower will utilize the finance

for financing the stocks in such a way that only

a portion of the physical inventories shall be

financed by the bank and the remaining

finance shall be arranged by the borrower.

Here the inventories are left in the possession

of the borrower. The borrower is further asked

to mortgage the title of any immoveable

property in the form of land or building to

secure the finance of the bank.

* In a type of working capital financing the banks

do not specifically require from the borrower to

mortgage the title of any immoveable property.

Instead for collateralization, the stocks are at

least kept under effective control of the bank

called the pledging arrangement, the bank

releases a particular quantity of stocks as soon

as the borrower repays and proportionately

adjusts the amount of finance.

* In another type of financing recently

introduced, the banks have withdrawn the

condition that the borrower will also have to

finance a portion of inventories. Instead, the

borrower only mortgages the title of some

immoveable property and can utilize the whole

amount of finance for purchasing inventories.

Taking account of all these three kinds of

financing reveals that these are prequalification

type of financing for SME's. That is to say, they

first have to arrange the security in the form of

moveable or immoveable property in order to

secure the bank's finance. Particularly in the first

two kinds of finances the interest of the borrower

in the borrowing contract should be significantly

more than the amount of finance agreed to be

provided by the customer. In order to explain the

situation more clearly an example is given below:

Suppose a borrower approaches the bank in

order to secure some working capital finance say,

Rs. 10M from the bank. The security requirement

for the bank under the above three types of

facilities would be as follows:

Under the first arrangement the borrower shall

be asked to provide the immoveable collateral to

the bank that is at least 142% of the amount

financed or in other words the finance requested

should not be more than 70% of the value of

mortgaged immoveable collaterals. The borrower

shall also be asked to invest a significant portion in

the inventories that is also at least 40% of the

purchase value of inventories acquired. It means in

order to acquire a finance of Rs. 10M, under

present arrangement the financial involvement of

the borrower will be at least 20.87M. The borrower

can not sell any inventory on credit as well because

he has to maintain the margin requirement of the

bank. This makes this product very inflexible. If the



borrower decides to sell the stocks on credit he has

to invest Rs. 16.67M from his own resources in

order to bring the stocks to cover the bank's

security. This makes the total interest of the

borrower in the business more than Rs. 37.54M

making the total facility absolutely useless. This

very high securitization on his part is in effect an

adversity for the borrower and by no means any

facilitation to the SME sector. This also exposes the

bank primarily to the following types of risks:

* The risk that the inventories will become

obsolete due to long holding of inventories

while waiting for the cash sales customers that

can also deteriorate the value of stocks.

* Price Variation Risks, that is, the market value

of stocks may fall below its purchase value in

some cases, in which case the borrower shall

be required to provide the inventories equal to

the diminished amount of stocks entirely from

his own resources.

* The risk that the customer will lose the credit

sale customers and therefore a significant

market share. This will ultimately affect the

repayment ability of the customer.

The latest form of liberal working capital facility

introduced by some banks is based upon only the

collateral and the evenue generation ability of the

customer with no specific restriction for the

customers regarding financing the stocks. This

provides the customer with some liberty about the

usage of bank's finance and also initiating the

credit sales. However, this type of facility still

requires the borrower to furnish some sort of

immoveable property for mortgaging in favor of

the bank to secure the finance. This type of facility

also has a drawback that an SME that does not

have immoveable property in its name can not

secure working capital finance from the bank.

Some of the banks are also providing working

capital finance to some relatively bigger SME's

without mortgaging any of the immoveable

property of the borrower. Such type of financing is

made only against such commodities that are

readily marketable by keeping the required

inventories of such commodities under at least

effective possession of the bank. This type of

financing also requires the customer to sell of its

stocks on cash basis because he has to

immediately repay the proportionate amount of

finance in order to get the requisite quantity of

stocks from the banks. Therefore, under this type

of financing the bank has to face similar type of

risks as were mentioned in the first type of working

capital finance provided to the bank.

An analysis of all these three products reveals

that the banks while financing the working capital

of the SMEs do not take into account the accounts

receivable of the client as part of the working

capital. Furthermore, they also exclude their

average collection period from the cash operating

cycle of the borrower while making any financing

decision for them that is very unrealistic. In any

organization, there are a number of cash operating

cycles in operation at the same time. The

inventories and accounts receivables actually result

from multiple uncompleted cash operating cycles

at the end of the accounting period.

In the modern era of innovative and virtual

banking, much of the emphasis is being laid on the

customer service involving customer direct access

to the banking activities that were previously

considered under the control of the bank like

account statements, funds transfers etc. With these

innovations there is also a need to introduce SME

Financing Banking Products that are more realistic

and according to the need of the SME sector.

For the SME sector the financial institutions

need to further penetrate into their businesses in

order to provide them newer financing products.

For example, the banks need to take into account

the accounts receivables of the SME while making

the working capital finance decision. For

convincing the bank for making any such decision

there is need to consider why the banks are

reluctant to take into account the accounts

receivables of SME's

One of the major reasons seems to be the

conventions that form the bases of the creation of

accounts receivables in the trade market of SME's.

The accounts receivables on account of such trade



arise most of the time without any legally

enforceable documentary proof of any such credit

sale between the two SME's. The banks therefore

ignore any accounts receivables as part of the

working capital that has already been injected by

owner of the concern in the business activity.

Banks should also emphasize on the improved

internal control system within the SME while

making any financing decision.

Therefore, as part of the internal Control

system, the practice of initiating a bill of exchange

for any such credit sale transaction should be

initiated in the SME sector. This will enable any

SME to document its credit and bring its claim to

the debtor legally acceptable. This legally

acceptable claim is pledged to the bank, enabling

the SME's to encash a significant portion of their

working capital investment from the Financial

Institutions.

The financial institutions may provide liberal

finance to SMEs' through pledging the working

capital assets i.e., inventories or bills of exchange

by way of providing a multiple transaction facility

to the borrower instead of a single transaction

existing facility to the borrower. This facility along

with a more closer monitoring of the bank's

finance can also form a successful market oriented

product. This type of facility may be approved for

shorter periods like that of single transaction

finance so that the risks connected with the stocks

can be avoided.

This type of facility should be sanctioned

exactly in the pattern of single transaction of

finance facility with the only distinction that this is

a multiple transaction financing facility. In order to

finance the working capital finance of the borrower

completely, either the borrower is restricted to sell

any good on credit or the bank should make an

arrangement to finance the accounts receivables

after selling off the stocks.

Bibliography:

Books:

American Heritage Dictionary

Barron's Dictionary

Encyclopedia of Small Businesses

brealey, Richard A., and Stewart C. Myers.

Principles of Corporate Finance. McGraw-Hill,

1991.

financing for the Small Business. Small Business

Administration, n.a.

J acksack, Susan M., ed. Start, Run and Grow a

Successful Small Business. CCH, Inc., 1998.

Pickle, Hal B., and Royce L. Abrahamson. Small

Business Management. John Wiley & Sons, 1990.

Van Note, Mark. ABCs of Borrowing. Small

Business Administration, n.a.

Houghton Mifflin Company Thesaurus

Columbia University Press Encyclopedia

Thomson Gale Legal Encyclopedia

Wizcom Technologies Ltd Translation

Anastasio, Susan. Small Business Insurance and

Risk Management Guide. U.S. Small Business

Administration,

Blakely, Stephen. “Finding Coverage for Small

Offices.” Nation's Business. June 1997.

“The Face of Risk Management.” Internal Auditor.

October 1998.

Conley, John. “Waves of the Future.” Risk

Management. July 1999.

Griffith, Gary. “Net Increases Need for Risk

Management.” Dallas Business Journal.

September 22, 2000.

Head, George L_ and Stephen hen Horn 11.

Essentials of Risk Management. Insurance Institute

of America, 1991. p

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Management in the Internet Age.” Risk

Management. June 2000.



Tongson, Tim. “Turning Risk into Reward.” Best's

Review. December 2000.

Williams, C. Arthur, Jr., and Richard M. Heins.

Risk Management and Insurance. McGraw-Hill,

1989.

Dorfman, Mark S. (1997). Introduction to Risk

Management and Insurance (6th ed.) Prentice

Hall. ISBN 0-13-752106-5.

Stulz, Rend M. (2003). Risk Management &

Derivatives (1st ed.). Mason, Ohio: Thomson

South-Western. ISBN 0-538-86101-0.

Alijoyo, Antonius (2004). Focused Enterprise Risk

Management (1st ed.) PT Ray Indonesia, Jakarta.

ISBN 979-9891818-1-7.

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management. Upper Saddle River, NJ: Prentice

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Websites:

www.smeda.com

www.sbp.org.pk

www.investopedia.com

www. Business-Forms.big.com

www.allbusiness.com

www.cap-eng.com

www.ecreditriskmanagement.com

www. securityunleashed.leashed.com




Use of Derivatives inTreasury Management

C.E.S. AZARIAHDirector & Chief Executive OfficerFixed Income Money Market & Derivatives Association of IndiaMumbai - INDIA

Before delving into the world of Derivatives

and their use in the Treasury Management,

particularly of banks, we need to quickly skim

through the business of banking, as the price of

Derivatives depends upon the “underlying” items

which are found in the assets and liabilities of

banks.

The main business of banking involves:

* Accepting deposits from the public, for

purpose of lending or investment. (deposits,

advances, investments)

* Borrowing from other banks for funding of

advances or investments

* Transferring money from one place to another

within and outside the country (remittances

and foreign exchange)

* Keeping cash reserves with the Reserve Bank

of India (Cash Reserve Ratio)

* Maintaining minimum level of investments in

Government Bonds (Statutory Liquidity Ratio)

While banks are now into varied business,

opening subsidiaries for handling products like

insurance, Mutual Funds, helping corporates raise

funds through capital market issues, etc. the core

activities remain as shown in the bulleted points

above.

With competition increasing between banks for

increasingly better products and services to suit the

customers' palate, the inherent business risks

embedded in the products and activities that banks

are engaged in, are increasing.

The major risks faced in the above core

activities of the banks are:

* Interest rate risk on their deposits, loans, and

investments

* Foreign Exchange risk on their activities

involving conversion of rupees into foreign

currency and vice versa.

Where do Derivatives fit into this banking

scenario and how do banks use Derivatives in

management of their treasuries?

Definition of Derivatives:

A derivative is a financial instrument whose

characteristics and value depend upon the

characteristics and value of an “underlying” or

“underlier” typically a commodity, bond (interest

rate), currency (exchange rate), or equity.

Having mentioned that bank's balance sheet

has items which are sensitive to “interest rate

movements” and exchange rate fluctuations the

importance of Derivatives which have Interest

Rates or Exchange Rates as the “underlying”,

comes to the fore.

Broadly, Derivatives with Interest Rates as the

“ underlying” are used for management of interest

rate risks associated with deposits, advances and

investments, while Derivatives with Exchange

Rates as the “underlying” are used for

management of risks associated with foreign

exchange transactions.

Derivatives for managing Interest Rate Risks

Inherent in the Asset and Liabilities in the

Balance Sheet and Improving the Returns

With quoting of deposit rates for customers

having been freed, banks now compete fiercely,

for the funds available from the public in the

market. Each bank keeps a watchful eye on its

competitor bank, with regard to some large deposit

getting withdrawn and transferred to another bank,


just because the competitor is offering a higher rate

of interest. The Branch Manager leaves no stone

unturned to see that the bank management keeps

up with the higher rate of interest offered by the

competitors, so that further deposits may not go

past the branch of the bank in particular, and the

bank as a whole. While such a strategy of

garnering of deposits at higher and higher costs

may work well if interest rates are rising, or to put

it in “treasury” language, if the yield curve is

steepening or shifting upwards, in a scenario

where interest rates are failing, or the yield curve is

tending to flatten or invert, banks run the risk of

getting saddled with high cost deposits with no

avenues for deployment, at rates higher than the

rate at which the deposits were taken. In such an

event, the banks Treasuries have the task of

managing these funds in such a way, as to

maximize the yield from the funds on hand and

also reduce the impact of losses on account of

holding high cost funds in a falling interest rate

scenario. The Derivative instrument used for managing

interest rate risk is called Interest Rate Swap.

Use of Interest Rate Swaps:

Let us see how an Interest Rate Swap can be

used in a falling interest rate scenario, where banks

have been garnering term deposits. Assume that

the Term Deposit Rate for a 3-year deposit is 8%.

In a falling interest rate scenario, such as the one

that existed between October 2000 and October

2003, the borrowers did not want to lock in their

borrowing costs for 3 years, and preferred to ask

for a floating rate loan linked to the Call Money or

the Mumbai Inter-Bank Offered Rate (MIBOR). If

the Inter-Bank Call Money rate and the MIBOR is

at say, 6% and the borrower is willing to pay 2.5%

above MIBOR for a 3 year loan, if no other

avenues are available to the banks for deployment

of the deposit garnered at 8%, the choices

available to the Bank are:

a. Deploy the money in the Call Money Market

and daily earn 6% p.a., with the risk of the Call

Money Rate falling lower to 5% on account of

continued surplus liquidity in the system, and

borrowers looking for borrowing at lower and

lower rates.

b. Lend to the borrower at a floating rate of 2.5%

plus MIBOR which would work out to 8.5% if

MIBOR rules at 6%. The risk in this loan is that

as the MIBOR falls towards 5%, the return to

the bank would drop from 8.5% to 7.5%.

An Interest Rate Swap is a derivative

instrument in which two parties exchange two

streams of interest on a fixed notional amount.

Thus, a party A may enter into an agreement to

pay party B, a fixed rate of interest, say 8%, on a

notional sum of say, Rs. 100 Cr. (Rs. 1000 million)

in return of party B paying party A, a floating rate

(say MIBOR) plus a margin of say 2%. The Interest

Rate Swap transaction would look as follows:

In the above illustration, if MIBOR is 6 %, both

A and B would be paying each other Rs.8 Crore

(Rs. 80 million) per annum (@ 8 % p.a.) on a

notional amount of Rs. 100 Crore.

However if:

- MIBOR moves down from 6 % to 5 %, while B

would pay 5+2 =7% to A, A would have to

continue paying 8 % to B throughout the life of

the Swap.

- MIBOR moves up from 6 % to 7 %, B would

have to pay 7+ 2 = 9 % to A, while A would

continue paying only 8 % to B throughout the

life of the Swap.

Thus, it can be seen that the “Payer” of a fixed

rate in an Interest Rate Swap stands to gain when

the interest rates move up. Whereas, the

“Receiver” of a fixed rate in an interest rate swap

stands to gain when the interest rates come down.

Having established the above two “theorems”

let us examine the choices available to the bank A

which has taken a 1 year deposit at 8%, when



MIBOR is at 6%, and a borrower is looking for a

Floating Rate Loan linked to MIBOR. If the

market-quoted rate for a 3-year Interest Rate

Swap, called “Overnight Indexed Swap”, is 7.90%

- 8.0%, which means the bank can “Receive” fixed

7.90% and “Pay” floating MIBOR for 3 years. If

the bank A enters into a 3-Year OIS Interest Rate

Swap with bank B, it can lend to its borrower at

MIBOR + 2.5%, while receiving a fixed rate of

7.90 % from the bank B.

The cash flow chart would now look as follows:

The profitability for bank A, in the first year

would be as follows:

On Floating Leg

From Borrower RECEIVE: MIBOR+2.50%

To Swap Bank B PAY : MIBOR

INFLOW (MIBOR+2.50%-

MIBOR)=2.50%

On Fixed Leg

From Swap Bank B RECEIVE: 7.90% (Fixed)

To Depositor on TDR, PAY: 8.00% (Fixed)

Outflow: 0.10%

III NET RESULT : INFLOW-OUTFLOW

(2.50-0.10)=2.40%

The above Interest Rate Swap, fully protects

the bank's Interest Margin at 2.40 % whether

interest rates fall or rise, as long as the bank has a

full 3-year Term Deposit from its depositor.

However, if the bank takes only a One Year

Term Deposit and enters into the above IRS, the

bank would:

- Stand to gain if interest rates fall, as, on

the Fixed Leg, it would be paying lesser and

lesser as the one-year deposit gets renewed, or

a fresh deposit is taken at the lower rates.

- Stand to get its Interest Margin eroded if

interest rates rise, as it would be paying

higher and higher as the one-year deposit gets

renewed, or a fresh deposit is taken at higher

rates.

In such a scenario (funding a floating rate 3

year loan with a 1 year deposit in a rising interest

rate), the bank can unwind its Interest Rate Swap

and try to fund its floating rate loan from longer

tenor fixed rate deposits. In other words “Paying

Fixed on its TDR and Receive Floating on its

Loan”

Use of interest rate swaps in reducing the

cost of liabilities (cost reduction strategies)

In the current financial year 2006 -07, we have

seen banks scrambling over each other for deposits

for funding their loan assets. We have seen banks

offering 8% for 1 year or 360 days deposits, when

MIBOR has been ruling at 6% on account of

surplus liquidity in the system. Banks, which are

not into Derivatives, wonder how these high cost

funds can be deployed.

Let us see how the OIS Interest Rate Swap is

used in reducing the cost of deposit from 8% to

close to 7%.

The Call Money Rate and, hence, the MIBOR

trades in a band of 1 % which is the corridor for

the Liquidity Adjustment Facility (LAF) of RBI.

With the lower end of the corridor (Reverse Repo

Rate of RBI) currently at 6 % and the higher end

of the corridor (Repo rate of RBI) currently at 7%,

the MIBOR is expected to fluctuate between 6%

and 7%. This is so because banks can always park

their surplus funds with RBI at the Reverse Repo

Rate of 6% and hence would not like to lend in the

Call Money Market at a rate lower than 6%.

Similarly, if there is a shortage of funds with banks,

they can always borrow from RBI against excess

SLR securities at 7%, from the RBI's Repo



window. Hence, banks would not prefer to borrow

at a rate higher than 7% in the Call Money Market.

In a scenario where short-term interest rates

are likely to head upwards due to inflationary

concerns, the 1-year OIS Interest Rate swap may

trade at around 6.95%-7.00%. Bank A wanting to

reduce its cost of deposits (or borrowings) can do

an Interest Rate Swap with Bank B wherein the

bank A receives fixed 6.95% p.a. from Bank B and

pays daily MIBOR to Bank B on a notional

principal. Thus, with MIBOR at 6%, the cash flows

for the Bank A which has taken one year deposit

at 8% would be as follows:

Cost of funds:

Outflows:

i) To Depositor 8.00% (Fixed)

ii) To Swap Bank B 6.00% (Floating)

Total 14.00%..................(i)

Inflows:

i) From Swap Bank B 6.95% .................(ii)

ii) Total Cost of funds

(i)-(ii) (14.00 -6.95) 7.05%

Thus, although the 1-year deposits have been

taken at 8%, the actual cost gets reduced to 7.05%

and the bank can deploy these funds profitably at

any rate above that, after taking the administrative

costs into consideration. In the flow chart shown

earlier it is assumed that the funds have been used

to give a loan at 9%.

As long as there is surplus liquidity in the

market, the MIBOR would continue to hover

around 6% and the bank A would be able to

generate 1-year funds at 7.05% and win customers

by outbidding competitors who do not use this

Derivative route for cost reduction. The downside

risk to this swap is that, if the MIBOR rises above

6.95%, the swap flows will result in a “negative

carry” (higher outflows than inflows).

Such swaps as described above can also be

used for enhancing yields and returns by taking

advantage of the “carry trade” in surplus liquidity

and rising interest rate (bearish bond markets)

scenario.

Use of interest rate swaps in capturing yield

differentials between gilts yield curve and

OIS swap curve (spread trades)

Banks having surplus funds from their low cost

deposits growth, or having access to the Call

money or to RBI's Repo window, can lock in the

spread difference between the yield on an OIS

Swap curve and the G-Sec Yield Curve. This is

illustrated by the following cash flow chart:

In the above case, the bank A is able to fund its

acquisition of a 3 year Central Govt. Security with

either its own low cost deposits, or from the Inter-

bank Call money market at MIBOR and locks in an

interest spread of 0.50% for 3 years.

Use of MIFOR Interest Rate Swap in

Managing Foreign Currency Borrowings and

their Deployment in Rupees

A MIFOR (Mumbai Inter-bank Forward

Offered Rate) is a floating bench-mark which is

fixed daily like MIBOR and is a combination of a 6

month USD LIBOR (London Inter-Bank Offered

Rate) and a 6 month USD / INR forward premium

expressed in interest rate terms.

- Thus, if the 6 month USD LIBOR on a day is

say 5.65%,



- And the 6 month USD / INR premium is say

1.05%

- The 6 month MIFOR would be 6.70%

An Interest Rate Swap market exists in India

based on MIFOR as the Floating Bench Mark. The

notional amount is denoted in rupees and the

payments and receipts are in rupees. Thus, if a 5-

year MIFOR swap is quoted at 7.15/7.20%, the

bank quoting the swap is:

- Willing to pay fixed 7.15% and receive 6

month MIFOR (say 6.70%) and

- Willing to receive fixed 7.20% and pay .6

month MIFOR (say 6.70%).

Once the deal has been struck, the counter

parties decide the next MIFOR stream after 6

months.

Let us see how this product is used by bank A

which raises a USD foreign currency floating rate

funds based on 6 month LIBOR for a period of 5

years and decides to lend in rupees to a corporate

at a fixed interest rate of say, 9%.

The cash flow chart for such a transaction

would look as under:

The bank A would approach bank B, which

would give a quote for swapping the USD into

rupees, which is a Foreign Exchange Swap. Since

USD is at a premium to the Indian Rupee, the

bank A would have to pay a premium for the

dollars it sells spot and purchases 6-month forward

(in the FX Swap) to enable it to pay the interest on

the USD borrowing, and also purchase the

principal at the end of the 5th year, if the principal

is paid at the end of the tenor of the loan.

Appropriate FX swaps are worked out depending

upon the mode of repayment of the principal-

bullet or in instalments.

To enable bank A to meet the USD / INR

premium payable, the bank A would

simultaneously take a 5 year MIFOR quote from

bank C, wherein it would pay fixed 7.20% (say)

and receive 6 month MIFOR. As MIFOR is

constituted from 6 month LIBOR and 6 month

USD / INR premium, the 6 month LIBOR received

will be paid to the institution / bank from whom the

5-year dollar loan was raised and the 6 month

USD / INR premium received would be used to

pay the 6 month USD / INR premium to bank B,

which quoted the FX Swap.

With the above structure in place, the bank A

can now lend the USD swapped into rupees to a

corporate in India for 5 years at 9% and make a

profit of 1.80% i.e. the difference between the

fixed rate of 9% received from the corporate and

the fixed rate of 7.20% paid to bank C.

Forward Contracts and FX Swaps:

Forward Contracts are the simplest Derivative

products, whose ‘underlying' is the spot Foreign

Exchange Rates. Foreign Exchange Swaps, which

swap one currency into another currency, are the

building blocks for arriving at ‘forward' rate. Let us

see how these two Derivative products are used in

the Treasury Management of banks.

A. Forward Contracts:

Suppose an exporter, having exported his

goods, and sent the export bill to the foreign buyer

through his bank, is expecting payment for his

export sales after a month, the current exchange



rate of USD to INR being 1 USD = INR 47.25. At

the time of production and invoicing, assume the

exporter had taken the USD/INR exchange rate at

1 USD = Rs 47.00, where he will be making his

normal profit from his exports. In the meanwhile,

the exporter is observing the foreign exchange

markets in India and finds that lot of USD inflows

are coming into India from Flls, resulting in the

USD / INR rate gradually falling down to Rs. 47.00

from Rs. 47.25. Since further fall in the value of the

USD against INR, would eat into the exporter's

profit margin, the exporter would like to hedge his

risk and take a “forward cover”. In other words,

helshe would like to crystallize his receivable

amount now itself, if possible. The product

available for this type of need is a Forward

Contract in USD / INR by banks.

Thus, if the Spot USD / INR exchange rate is 1

USD=Rs. 47.00, the rate for settlement one month

hence (or Forward) may be 1 USD=Rs. 47.05.

The difference between the Spot Rate and the

Forward Rate = Rs. 0.05

This difference between the spot rate and the

forward rate is called the “Premium” as the dollar

is more expensive one month forward.

This “premium” is nothing but the interest rate

differential between USD and INR and can be

worked out mathematically, provided both

currencies are fully convertible and one can

borrow and lend the two currencies freely in the

international markets.

Let us see how this works:

If the exporter in our above example wants to

sell his/her dollars one month forward, the bank

would need to be able to give the exporter rupees

against receipt of dollars after one month at a pre-

determined exchange rate, which has to be fixed

today. If the bank quotes the ongoing spot rate of

1 USD = Rs. 47.00 and takes delivery of the

dollars one month hence and tries to sell the

dollars and generate the rupees to give to the

exporter, there is a chance that the dollar may

depreciate to Rs. 46.50, on account of supply from

Flls, and the bank ends up losing Rs. 0.50 having

bought the dollars from the exporter at Rs. 47.00

and selling in the market at Rs. 46.50.

To avoid this loss, the bank does the following:

1. Borrow the equivalent USD in the market

(which the exporter would give after one

month) and pay interest on the borrowing for

one month.

2. Sell the borrowed dollar at the spot rate of 1

USD=Rs. 47.00 and get equivalent Indian

rupees.

3. Invest the rupees for a period of 1 month at the

going inter-bank rate and earn interest.

4. On the due date, the exporter would give the

dollars to the bank, which the bank would use

to repay the USD borrowing, with interest.

Also on the due date, rupee investment made

in step 3 would mature, the proceeds of which

will be passed on to the exporter.

5. The one-month forward rate for the exporter

would be worked out from the amount of USD

to be paid on the borrowing, being equated to

the amount of rupees receivable from the

investment made.

6. The difference between the spot rate and the

forward rate worked out in step 5 will be the

forward ‘premium' and would be equal to the

interest rate differential between the USD and

Indian rupees.

B. FX swaps

The “premium” is also referred to as “forward

points” and is quoted in the market. Thus a bank,

instead of going through the borrowing and

lending route, may arrive at the forward

transaction by simply doing what is called an “FX

Swap”. This means

1. Selling the Dollar spot (and receiving rupees)

at the spot rate of 1 USD = Rs. 47.00



Followed by the “FX Swap, which is

2. Buying the Dollar Spot at 1 USD = Rs. 47.00

and simultaneously selling the Dollar 1 month

forward at 1 USD = Rs. 47.05

The delivery of the dollar sold one month

forward would be done from the exporter, who

would give the dollars to the bank one month

hence, and collect the rupees at 1 USD = Rs.

47.05 regardless of what the spot exchange rate for

the USD versus INR is on that date.

Use of FX Swaps in enhancing yields on

rupees placement.

While the FX Swap helps the bank in quoting

a forward rate to the exporter or importer, how is

this swap used in Treasury Management ?

As the Indian Rupee is not fully convertible, the

forward premia for the dollar v/s. INR, do not fully

reflect the interest rate differentials between USD

and INR. Thus, if there is a lot of need for Indian

rupees, for funding loan assets or meeting daily

CRR or SLR requirements, a bank having surplus

dollars, may be willing to swap its dollars into

rupees by “Selling dollars spot (and getting rupees)

and buying back the dollars forward (and paying

back the rupees)”. An excess of these ‘Sell-Buy'

transactions lead to the banks “paying higher and

higher premiums” for, such deals as the

differentials between the spot and forward rates

would gradually climb higher. A bank having

surplus rupees, could take advantage of this and

collect higher premiums by being the counter-party

to these transactions by buying Spot dollars

(thereby placing its surplus rupees with the counter

party bank) and Selling back dollars forward

(thereby receiving back the rupees placed out

earlier).

The total returns to the bank having the surplus

rupees would work out higher than the rate

received by a vanilla placement of the funds in the

Call Money Market. This is because of the Forward

Exchange Premiums climbing higher than what

should actually be ruling, if the Indian rupee was

fully convertible and freely borrowed and lent in

the international markets.

FX Swaps or Currency Swaps are widely used

in Treasury Management, as banks make use of

the liberalization and globalization of the Indian

markets and borrow from abroad for funding the

Indian assets, or acquire foreign assets and use the

rupee funds to fund them.

CROSS CURRENCY OPTIONS

While in a forward contract, the counter party

has the obligation to deliver the foreign currency

contracted to be sold (against receipt of the

counter value currency) or take delivery of the

foreign currency contracted to be purchased

(against payment of the counter value currency),

an OPTION is a financial contract, which gives the

buyer the right, but not the obligation, to buy or

sell the agreed amount of an asset, at a pre-

specified price, on or up to a specified date.

The buyer of an option pays a premium for the

same to the seller / writer of the option.

There are broadly two types of Options:

* Call Option : Gives the buyer of the option

the right but not an obligation to buy the

underlying at a pre-specified rate on / before

pre-specified future dates.

For example, an importer may buy a USD Call

Option, which would convey a right to the

importer to buy USD at an USD / INR exchange

rate of 1 USD = INR 47.00, on / before a date, one

month hence. If the spot exchange rate on the

“exercise “ or due date is at 1 USD= INR 46.00,

the importer need not exercise his option and may

buy the USD in the spot market instead at a lower

rate. However, if the spot exchange rate on the

exercise date is 1 USD = INR 48.00, the importer

can exercise his Call Option and buy the USD at

the pre-specified rate of 1 USD = INR 47.00

* Put Option : Gives the buyer of the option

the right, but not an obligation to sell the

underlying at a pre-specified rate on / before

pre-specified future dates.



For example, an exporter may buy a Put

Option, which would convey a right to the exporter

to sell USD at an USD / INR exchange rate of 1

USD = INR 47.00 on/before a date, one month

hence. If the spot exchange rate on the “exercise”

or due date is at 1 USD = INR 48.00, the exporter

need not exercise his option and may sell the USD

in the spot market instead. However, if the spot

exchange rate is at 1 USD=Rs. 46.00, the exporter

can exercise his Put Option and sell the USD at the

pre-specified rate of 1 USD=Rs. 47.00

Options thus give the buyer of the option, an

unlimited upside potential, while limiting his

downside risk.

As the seller/writer of the option faces an

unlimited downside risk, he charges a premium

from the buyer.

Banks can use Options instead of Forward

Contracts, where they have open foreign exchange

risks. However, with more and more corporates

wanting products to hedge their currency risks,

banks are increasingly playing the role of Option

Sellers or Option Writers and this involves a

thorough understanding of knowing how to run an

Options book and hedge the option positions

taken, as the risks for the option seller are

unlimited and the premium alone may not

compensate for the risk in selling the options.

Courtesy: “Bank Quest”

The Journal of Indian Institute of

Banking & Finance

July-September 2006 issue.




Opportunities andChallenges of ElectronicBanking

ATHAR AHMADSenior Network EngineerNCR CorporationKarachi

This paper has been selected for

Award of First Prize in IBP Research

Paper Competition (Summer)-2006

Electronic banking or E-Commerce is the wave of

the future. It provides enormous benefits to

consumers in terms of the ease and cost of

transactions. But it also poses new challenges for

country authorities in regulating and supervising

the financial system and in designing and

implementing macroeconomic policy. At the same

time Technology Departments have been provided

with the new challenges to counter all the resulting

threats.

1.0 Introduction

The Internet provides banks with substantial

opportunity to extend their customer reach beyond

their traditional boundaries, including across

national borders. However, the nature of the open

network and the fast evolution of electronic

commerce expose banks to significant competition

from other banks and non-banks. In addition,

electronic delivery channels that operate across

national borders can call into question existing

jurisdictional authorization requirements and the

regulatory processes. The delivery of financial

services over public networks such as the Internet

is bringing about a fundamental shift in the

financial services industry. The changes raise new

concerns and challenges for both bankers and

supervisors in managing Internet banking systems,

including security, integrity and availability of

service.

1.1 What is Commerce or Trade?

Commerce or Trade originated with the start of

communication in prehistoric time. Peter Watson

dates the history of long-distance commerce from

circa 150,000 years ago. There is evidence of the

exchange of obsidian and flint during the Stone

Age. (Source: A History of Thought and Invention

from Fire to Freud, Harper Collins.)

After passing through different stages of

evolution, we are here in this modern world where

we have laws/ regulations, organizations/

governing bodies, trade routes etc. All this evolved

due to a combination of "need" and "innovation".

The time is changing and so are the needs.

Modern life styles call for new trends in today’s

environment of Commerce and Business.

1.2 Today's Life with an Impact of

internet

Only few decades ago life was considerably

different from how we see it today. Today's man is

born with a life which is driven by fierce

competition, personal targets, social pressures etc.

All this compels a man to look for alternatives that

can spare him from basic worries of daily life.

Information technology and particularly internet

has made a significant impact on our lives.

Exponential growth of internet has taken it to a

stage where today over 1200 million users are

connected to it and use its services. Internet which

is not owned by anyone has impacted every aspect

of our lives; be it education, research,

entertainment, sports, weather, traveling etc.

Discussion on the benefits of internet can be

stretched to any length. Hence we should expect

that IT which has reshaped our whole life, will also

try to change how we "trade" today.

1.3 Commerce - Yesterday & Today

Gone are the days when conch shells were

used as money, or when in 550 BC, accepting salt


from a person was synonymous with drawing a

salary. Till only a few years back, opening a bank

account was a challenge by itself. There used to be

long queues at bank counters to withdraw some

money. It used to take a week or so to have an

intercity money transfer done. But today with the

convenience of electronic banking we can do all

these tasks i.e. money transfer, bill payments,

checkbook order etc. with only few mouse clicks

from our bedroom.

2.0 E-Commerce

2.1 Introduction

The opportunity offered by the Internet is for

suppliers to gain direct access to consumers,

without the attendant costs associated with the

maintenance of physical distribution channels -

people, bricks and mortar. In the electronic medium

competitors can emerge from anywhere in the world.

The strategic implications for all businesses are

profound (especially for retailers and financial

services organizations). The value chains of most

markets have fundamentally changed. Using

modern technology is essential for the survival of

banks today. Markets and marketing concepts have

and will further change radically, driven by those

companies who successfully rise to the challenge.

2.2 Background

For many years banks have been providing

basic electronic services i.e. ATMs, electronic funds

transfer etc. But global acceptance of internet has

changed the overall scene for banks as well as

customers. These developments led the Basel

Committee on Banking Supervision to conduct a

preliminary study of the risk management

implications of e-banking and e-money in 1998.

This early study demonstrated a clear need for

more work in the area of e-banking risk

management.

Electronic-banking, whether domestic or

cross-border in nature, can be broadly categorized

into three levels:

(i) Basic information websites

(ii) Simple transactional websites (basic account

information viewing)

(iii) Advanced transactional websites (making

transactions i.e. funds transfer etc.)

2.3 Virtues of E-Commerce - Reasons

for Popularity

The pace with which e-commerce has gained

these heights of popularity and success, talks of its

potential and scope. While analyzing the reasons

of success of any commodity we have to look at

the parts of both sides i.e. consumer (the bank

customer), and the supplier (the bank). The duo-

favoring nature of e-commerce is behind its

sensational popularity. Following are only few of

the basic virtues of e-commerce that took

electronic banking to these heights.

2.3.1 Convenience

Convenience is the first outcome which makes

a product/ service more popular. E-banking

services provide a world of convenience which

makes them so popular today. We will explore

more on this later in this document.

2.3.2 Customer Demand

The awareness of the cut-throat competition

among banks has made today's customers more

demanding. The power of tremendous knowledge



Fig. 1 - E-Commerce - A Logical View

from internet enables them to exploit banks by

choosing different services from different banks.

ATM service in only few years has become

mandatory for every bank today. A local bank has

recently agreed to dispatch a mobile ATM to

customer location for salary withdrawals at their

doorstep! Worldwide e-commerce trends of the

year 2004 are presented in Fig-2. But above

example of mobile ATM gives us an idea of the

nature of demands that our local banks should

expect in near future.

2.3.3 Accessibility and availability

Accessibility from anywhere, anytime has also

contributed significantly to the popularity of

electronic-banking. You don't have to run to make

it to the bank within the allowed times. Now most

of the activities can be done while sitting

thousands of miles away from the branch.

2.3.4 Competition

Like any other sector, financial industry is also

facing severe competition. The concept of

"Customer Loyalty" is almost gone. This has

literally forced the banks to put their innovative

minds into high gears in order to design and offer

new innovative solutions. The innovation of e-

commerce that brings with it speed, convenience,

reliability just makes e-commerce to top the list of

their action plan. The cost effectiveness of

information technology solutions can actually keep

them abreast with growing competition of today.

2.3.5 Immediate Feedback

Immediate feedback through websites and call

centers helps banks to improve their products and

gain better results in terms of quality and enlarged

customer base.

2.3.6 Profitability

The intelligently designed versatile e-banking

products have already amazed the world with

fantastic results of ramping up graphs. Slashed

down global prices of IT sector have enabled the

industry to design solutions that brought down the

cost of a traditional "brick and mortar" transaction

of $1, that used to cost $0.60 through a phone, to

a charge of ONLY $0.02 when processed online.

Multiplying to the volumes of transactions being

processed everyday one can simply imagine the

savings. And this is only one part to of it.

2.3.7 Some other features of e-commerce

Some more capabilities which make electronic

banking popular today are:

· Speed

· Accuracy

· Reliability

2.4 Trends in e-commerce

With a rapid addition of new services to the

profile of e-commerce, the trend of masses turning

towards it has been witnessed today. These trends

on both sides of the front line i.e. banks and

customers, have solid reasons behind them (some

discussed in previous sections). Fig. 3 explains

some regional trends for E-commerce.

Fig-4a and Fig-4b present the trend of

migration from manual to automated processing,

including credit cards, debit cards, and ACHs

(Automated Clearing House).

4.0 Opportunities/ Avenues

"Banking is essential to a modern economy,

Banks are not"

(Quoted in Financial Times 1996)



Fig. 2 - Online Population Language wise

With enormous strength of IT behind it, e-

commerce is providing solution to almost all of our

needs today. Huge research is on its way to design

more innovative processes. Due to the heavy

influence of IT on banking, today every product

before its launching, requires a green signal from

the perspective of technology too. This makes IT

the heartbeat of banking today. Here I will present

only some areas where IT is helping banking

industry to meet the challenges of modern era.

4.1 ATMs

Initially, in 1970 ATMs were only installed at

bank locations. Today we find ATMs everywhere

e.g. markets, fuel stations, long highways, airports

etc. In short we can have access to your money

wherever we need it. Along with providing money,

ATMs can also entertain other needs i.e.

· Balance Enquiries

· Account Statements (Brief versions)

· Checkbook requests.

· PIN change.

· Cash deposits

· Check Deposits

· Offering details of some current campaigns of

the bank.

· Bill payments

Now one can even get tickets for a football

match or cinema from ATM. Idea of using ATMs as

guides on foreign locations is also becoming more

popular now. So once thought to be only cash

dispensing machines, today these silently standing

boxes contain a wealth of intelligence inside them.

Let's see what do they offer us next.

4.2 Credit Cards / Plastic Money

After the introduction of credit cards in 1950

by Dinners Club and American Express, today the

trend of using credit cards is becoming more and

more popular. Today with 500M credit card users

(only in US), 50% of all purchases over $50 are

done via a credit card. Although only 34% of

Internet users have currently purchased

products/services over the Internet, 12% say they

would do so in the future and a resounding 80%

say that their preferred payment method in buying

products/services over the Internet was the credit

card. The Fig. 5 depicts status in April 2005.



Fig. 3 - Online banking trends for 2000 and 2001 Fig. 4 - Migration Trend from manual to e-commercesupported solutions

(Fig. 4a)

(Fig. 4b)

Fig. 5 - Trends in credit card usage

The same credit cards, if not handled with

care, might turn into a serious trouble.

4.3 Smart Cards

Smart cards, which contain an integrated

circuit on them, had their first mass roll out in

1992, when all French banks adopted the card.

More than 10 million cards were issued that year.

MCU smart card shipments have grown

dramatically, with 727 million shipped in 2002,

and over 1 billion expected to ship annually within

the next 2 to 3 years. This rapid growth is due to

the increasing use of smart cards for many

financial, telecommunications, transit, health care

and secure identification applications. (As per the

report by JV Powers and Company, released on

Jan 9th, 2005).

4.4 Mobile Wallet

With the introduction of Mobile Wallets, we

have entered into an age of "M-Commerce". Now

our cell phones can be used to hold our money.

Mobile Wallet had been the biggest hit in Japan.

Mobile wallets, using a new technology called Near

Field Communication (NFC), enable cell phone

users to buy groceries, rent a video, ride public

transit, or even go to a movie. Edy (name of

service) enabled handsets can be charged with up

to 50,000 yen (approximately $450 USD) in many

ways i.e. you can place your phone against a

reader at a charging station, and it will take your

cash, and then credit your cell phone. You can

also load your mobile wallet by going online with

your handset itself, using your credit card or bank

account. To pay for items, all you need to do is

pass your cell phone by the reader-writer, and the

items are yours.

4.5 Internet Banking

Today's internet banking offerings enable you

to do almost everything for which you go to the

bank e.g. transfer funds, pay bills, apply for loans,

request and upgrade in the services, request

checkbooks, give instructions to stop some

payments, see the status of inward clearances, get

the bank statements, change in the addresses, view

your credit history, buy other currencies, pay credit

card bills, view credit card statements etc. Today

all these tasks can be done 24 hours a day while

sitting in our bedroom thousands of miles away

from branch. With every passing moment internet

banking is offering new breathtaking features.

Statistics for 2004, pertaining to households users,

show volumes of end users turning to internet

banking.. For example the figure of average US

citizens using online banking changed from 8.5

Millions to 24 Millions, within a period of 2000 to

2004 (Fig. 6)



Fig. 5 - Trends in credit card usage(Fig. 5a)

(Fig. 5b)

4.6 Online Shopping

For online shopping daily millions of shoppers

use different options like credit cards, debit cards,

digital checks, smart cards etc. Internet takes away

hectic physical market searches by providing the

additional convenience of comparing the products

side by side in desktop windows. For example

while purchasing a digital camera one would like

to compare features i.e. strength of the lens,

zooming options, memory expansion etc. Almost

all the vendors today offer online shopping. On the

other hand there are virtual shopping malls which

offer goods from a pencil sharpener to the

Mercedes. These malls do offer discounts and

promotions, which attract the more price

conscious buyers.

4.7 Online Bill Payment

Just like online shopping, online bill payment

is another great convenience that today e-banking

provides to it customers. A study revealed that

from December 1998 till December 2004, the

number of Bank of America customers using

online bill payment increased by 68 percent.

4.8 Automated Clearing House (ACH)

An ACH payment may include:

· Direct Deposit of payroll, Social Security and

other government benefits, and tax refunds;

· Direct Payment of consumer bills

· Business-to-business payments;

· E-checks;

· E-commerce payments;

· Federal, state and local tax payments.

The number of ACH payments originated by

financial institutions increased to 8.05 billion in

2002, up 13.6 percent from 2001. (Source

www.nacha.org)

Electronic payments i.e. ACH, credit and debit

cards, have recently surpassed the historical

dominance of paper check payments. Figure No. 8

ACHs also help in cheap bill payments e.g.

BellSouth Corp reports ACH as the least expensive

form of electronic payment for bills. It costs the



Fig. 6 - Trend of using online banking for households

(Source: Office of the Comptroller of the Currency usingdata from various industry sources)

Fig. 7 - ACH Pyramid

Fig. 4 - Electronic Payments Overtake checks

utility around $2.00 when a customer pays a

phone bill with a credit card, and $0.50 to $0.60

for PIN debit, compared to only $0.10 to $0.15 for

an ACH payment.

4.9 Virtual Banks

Banks offer Internet banking in two main ways.

First, an existing bank with physical offices can

establish a Website and offer its customers internet

banking in addition to its traditional delivery

channels. Second, a bank may be established as a

"virtual," "branchless," or "Internet-only" bank, with

a computer server at its heart that is housed in an

office that serves as the bank's legal address or at

some other location. Virtual banks may offer

customers the ability to make deposits and

withdraw funds at automated teller machines

(ATMs) or other remote delivery channels owned

by other institutions.

4.10 Wireless Banking

Wireless communication is another dimension

where users can further benefit from the ease

provided through today's wireless networks. Be it

within a campus or on road, one can use the

wireless enabled laptop in the waiting lounge of an

airport or in a café, inside an airplane, or even in

a train to get hooked up and make use of the e-

commerce tools just as being connected to network

through some cable connection. Banks are also

launching more and more cell phones based

services too.

4.11 Marketing

With the introduction of the incredible medium

of internet, now marketing teams can plan to roll

out the new products/ services overnight. Reaching

the customers worldwide is not an issue at all. With

national boundaries demolished playfield now is

unlimited. Using historical research data from

internet, comparing products of other competitors,

getting immediate feedback from customers,

offering websites in different languages - all these

can be used for a modern, well-planned and

responsive marketing strategy.

5. Threats / Challenges

Because of internet, today markets have

shrunk significantly, thus providing enormous

potential for vertical and horizontal business

growth. These market opportunities, coupled with

competitive pressures, provide impetus for the

development of e-banking on a broader scale. It is

important that banks contemplating such activity

recognize and manage the associated risks in a

safe and sound manner. Although these risks are

not new, electronic banking can increase certain

banking risks such as strategic, reputational and

operational risks and expose a bank to country

risk. These risks are encompassed by the eight risk

categories identified in the Basel Committee's

Core Principles for Effective Banking Supervision

(September 1997).

Challenges that e-commerce faces today is a

multifaceted phenomenon. Challenges vary in

nature and severity. We can broadly divide these

challenges into two categories i.e. Non-

Technological Challenges and Technological

challenges. Some of the solutions to these

challenges are proposed in appendix-A.

5.1 Non-technological Challenges

Some of the most prominent Non-technology

related challenges for e-commerce include:

· Regulatory Challenges

· Macroeconomic Challenges

· Jurisdictional and Legal Challenges

· Marketing Challenges

· Privacy Law

· Electronic Disclosures' Challenges

· Management Challenges etc.

Though each of these challenges can be

explained comprehensively, and might require

voluminous reports to justify their actual scopes.

But I will limit myself to only very basic

introduction to all these.



5.1.1 Regulatory Challenges

This changing financial landscape brings with it

new challenges for bank management and

regulatory & supervisory authorities. The major

ones stem from increased cross-border

transactions resulting from drastically lower

transaction costs and the greater ease of banking

activities, and from the reliance on technology to

provide banking services with the necessary

security. The main risks involved are:

* Regulatory risk.

* Legal risk.

* Operational risk.

* Reputational risk.

E-commerce indeed has presented regulators

with a very tough challenge to perform a vigilant

monitoring in order to keep things in shape.

5.1.2 Macroeconomic Challenges (due

to cross-border nature of e-banking)

E-banking due to its nature, quickly changes

the financial landscape and increases the potential

for quick cross-border capital movements.

Macroeconomic policymakers face several difficult

questions in this regard i.e.:

* If electronic banking does make national

boundaries irrelevant by facilitating capital

movements, what does this imply for

macroeconomic management?

* Effect on monetary policy when for example,

the use of electronic means makes it easier for

banks to avoid reserve requirements, or when

business can be conducted in foreign

currencies as easily as in domestic currency?

* When offshore banking and capital flight are

potentially only a few mouse clicks away, does

a government have any leeway for

independent monetary or fiscal policy?

* How will the choice of the exchange rate

regime be affected, and how will e-banking

influence the targeted level of international

reserves of a central bank?

* Can a government afford to make any

mistakes? Will the spread of electronic banking

impose harsh market discipline on

governments as well as on businesses?

5.1.3 Jurisdictional and legal

Challenges

Like any other banking process, every initiative

related to electronic commerce, would also require

legal and jurisdictional issues to be addressed

before being made available to customers. These

issues mainly relate to cross border transactions

and the risks involved, which is due to the

differences in laws prevailing in different countries

or regions. Most of the time there is a compatibility

issue among the regional laws. In order to make

things smooth, the countries' governing bodies

need to be in full synchronization at all times. The

issues become even more serious when authorities

have to deal with a fraudulent transaction. With

exceptionally dynamic nature of information

technology it becomes even more difficult for the

law makers to formulate the directives that will

ensure clean and smooth e-commerce.

5.1.4 Marketing Strategies

Cut-throat competition, expectations from

customer, innovation from opponents, limits from

regulatory bodies etc. pose serious hurdles for any

aggressive marketing plan.



Fig. 9 - Multidimensional scope for e-commerce

The "many-to-many" communication model of

the Web (in fact many instances of many-to-one)

turns traditional principles of mass media

advertising inside out. The advertising approaches

which assume a passive, captive consumer are

redundant on the Web. Due to the characteristics

of electronic-banking, the first three stages of

traditional customer loyalty ladder (Suspect,

Prospect, Customer, Client, Partner and Advocate)

are instantaneous. The transition from customer to

advocate relies on loyalty earned through trust.

The instantaneous nature of the Internet makes

this more difficult.

5.1.5 Electronic Disclosures' Challenges

Increasingly, national banks are replacing their

paper-based consumer notices or disclosures with

electronic disclosures. However, the failure to

provide such electronic disclosures in a proper

manner can expose the bank to significant

compliance, transaction, and reputation risk. The

technology used by the bank to provide electronic

disclosures to consumers e.g. emails (insecure by

nature) deserves careful consideration.

5.1.6 Management Challenges

Board of Directors and senior management

being the ultimate show runners, should review the

new e-banking projects that may have a significant

impact on the bank's risk profile. They should also

go for appropriate strategic and cost/reward

analysis. Without adequate up-front strategic

review and ongoing performance to plan

assessments, banks are at risk of underestimating

the cost and/or overestimating the payback of their

e-banking initiatives. Also, the Board and senior

management should keep the bank from entering

into new e-banking businesses or from adopting

new technologies unless it has the necessary

expertise to provide competent risk management

oversight.

5.2 Technological Challenges

Exponential advancement being witnessed on

the technological horizon brings us new tools and

utilities, which help fulfill our banking needs. But at

the same time, we can't condone the fact that new

technology brings with it the associated risks. Since

in-depth technology details are beyond the scope

of this document, I will only present the very basic

information pertaining to only some of the

significant technological challenges in the context

of electronic-banking.

5.2.1 Availability of technical expertise

One of the biggest challenges that banking

industry faces today is the availability of competent

technical individuals. In-house resources can

always play the most vital role in countering any

threats whatsoever. In-House professionals assist

in planning and can help smooth down the

operations as well. With the ever changing

technology and related solutions it has become

exceptionally difficult to find and retain the trained

and experienced resources.

5.2.2 Consumer Training

Statistics suggest that even today, mistakes like

writing PIN on ATM card or opting for some

attractive advertisement on web are behind many

serious cyber crimes. All this demands for

educating today's customers to understand the

tricks and tactics used by criminals on internet.

(Appendix-B lists top tips for avoiding internet

frauds - released by National Consumer League,

NCL)



Fig. 10 - Modern Business paradigm: E-commerce atthe Core of the model

5.2.3 In-House threats

In-house threats being the very first

intimidation that an organization faces, might

result in extremely serious consequences effecting

profitability and the continuity of operations. In-

house threats could be caused by someone,

planted purposefully by a competitor, or some

unhappy employee etc. Having direct physical

access to systems and network makes these

internal threats to be most alarming.

5.2.4Availability and Accessibility

Keeping a bank system available and

accessible 24x365 is a big challenge esp. when

under DoS and other attacks.

5.2.5 DoS (Denial of Service) attacks

DoS attacks are a very common way to

interrupt the services provided by a bank or any

other online service provider. Criminals send huge

number of packets to the internet connection of the

bank's network. Due to this extremely heavy load

the routers or firewalls become so much congested

that they are unable to even entertain the genuine

incoming requests. This causes the end user to

view the bank's system or website as unavailable.

5.2.6 New Virus Attacks

New viruses and other capable variants are an

increasing threat to networked systems esp.

financial institutions. Institutions with internet

access may be vulnerable to these viruses, and

should institute appropriate measures to mitigate

the risks posed to their devices esp. servers. Some

of the actions performed by these viruses are:

* Disable security software of device.

* Install spy-ware.

* Capture keystrokes to obtain authentication

information.

* Collect and use e-mail addresses to further

distribute the virus.

5.2.7 Wireless Networks

Due to the broadcast nature of wireless

networks, they can affect a bank's risk profile in a

variety of ways. These pose security challenges

that can expose a bank to significant transaction

and reputation risks. Managing the broadcast area

involves controlling radio transmissions that can

travel through walls, windows, and doors.

Traditional weaknesses of encryption i.e. "Wired

Equivalent Privacy" (WEP) used by wireless

networks can also result in serious security related

issues.

5.2.8 Internet Frauds

The term Internet fraud refers to any type of

fraud scheme that uses email, websites, chat rooms

or message boards to present fraudulent

solicitations to prospective victims, to conduct

fraudulent transactions or to transmit the proceeds

of fraud to financial institutions. On internet fraud

is committed in several ways. According to FBI's

figures, U.S. companies' losses due to Internet

fraud in 2003 surpassed US$500 million.

Some statistics released by National Council of

Consumers show that in the year 2000, 78% of

overall internet frauds were "Internet Auctions"

with an average loss of $1155, while 10% frauds

were of the general merchandise, having an

average loss of $2528 etc. Losses overall were

$3,387,530, and average loss per person rose to

$427 in 2000. (Detailed statistics are added to

appendix C)

5.2.9 Credit Card Frauds

"Annual credit card losses are over $3 Billion -

yet few are caught or convicted"

Most internet frauds are done through the use

of stolen credit card information, which is obtained

in many ways i.e.

* Copying information from retail sites (online or

offline)

* Obtaining huge quantities of credit card

information from companies' databases



* Employees of companies selling this

information to criminals.

In another way of credit card frauds, fraudsters

use online check issuing system Ochex (that only

requires a working email). Another popular Credit

Card fraud is "skimming", where card details in the

magnetic strip are copied by someone at a

legitimate merchant and then sold to the black

market for cloning. Skimming has become slightly

less prevalent after the introduction of CVV or CVS

codes, which are not encoded on the magnetic

strip, but are printed on the card.

So passing credit card to an unknown waiter or

filler at fuel station or leaving it at the front desk of

a hotel, might bring you surprises later.

5.2.10 ATM Cards Frauds

ATM Card Frauds can be listed down as:

* Forceful use of ATM cards i.e. making the user

a hostage - The most common in our society.

* Skimmer Devices connected to card slot to

read the magnetic strip information

* Attaching a fake fascia over the actual screen

or keyboard to collect PIN digits

* Attaching a camera inside the machine behind

the invisible screen to record the PIN

* ATM Card Copiers, which copy details from

magnetic strip.

* Producing Fake ATM White Cards, which

contain the actual valid stolen information.

* Spoofing through Telephone line connecting

the ATM.

5.2.11 Website Spoofing

Web-site spoofing is a method of creating

fraudulent Websites that look similar, if not

identical, to an actual site, such as that of a bank.

Customers are typically directed to these spoofed

Websites through "phishing" schemes or

"pharming" techniques. Once at the spoofed

website, the customers are deceived and critical

information is collected from them by presenting

some fake forms etc. Spoofing exposes a bank to

strategic, operational, and reputational risks;

jeopardizes the privacy of bank customers; and

exposes banks and their customers to the risk of

financial fraud.

5.2.12 Fake Emails - "Phishing"

A steady increase in unsolicited e-mails/ scams

is contributing to a rise in identity theft, credit card

fraud, and other Internet-based frauds. E-

commerce customers, including bank customers,

have fallen victim to these scams. Phishing

involves sending customers a seemingly legitimate

e-mail request for sensitive account information.

Customers are deceived by using false addresses in

"from" field or using web-links or bank logos and

other graphics to convince the user of the

legitimacy of the mail. The emails even direct

customers to pages which look like bank's official

pages and collect useful information in the form of

online forms and then misuse the same

information.

5.2.13 PIN theft (thru DTMF trace)

With more banks using call centers, where

agents ask the users to enter PIN through their

digital phones, the idea of spoofing through the

telephone lines to collect the PINs by tracing the

DTMF is also becoming popular. With some basic

spoofing device one can monitor the telephone

line and easily collect actual PIN digits..

5.2.14 Data Integrity

Ensuring integrating of data esp. while

transiting a public network i.e. internet is also a

serious concern.

5.2.15 Keeping pace with the speed of

changing technology

Due to the highly dynamic nature of

information technology, both legal and technical

teams have to be on their toes all the time. The

legalities formed and the proactive approach to be

taken against any possible threat would always



require updates now and then. The technology is

changing overnight and hence the counter

measures being devised need to cater for these

changes as well. So if not faster (the true proactive

approach), then at least the solution should be

there before it has become too late.

5.2.16 Some Other Technology-

related Challenges

List of challenges that electronic-banking is

facing today is long. Only some significant of these

are presented here. Some other include

* Man-in-the-middle attacks

* Authentication and development of encryption

technologies i.e. 3DES etc.

* Personality theft (everyday 1000+ new

victims)

* Identity theft

6 Conclusion

Yes, risks are there, frauds have been taking

place, issues and challenges are there. But it is

another fact that today no bank can even think of

rolling back to non-electronic banking channels.

User demands, Competition, Cost saving etc. are

only few of the factors that will not let a bank back-

off from using this wonderful technology. The true

challenge that financial industry as well as

information technology industry face today is two-

fold:

i. To develop more secure, reliable, and

trustworthy channels and procedures which

enable a protected and harmonious e-trade

culture

ii. To devise stronger legal, supervisory and

regulatory procedures with assurance of strict

monitoring, that will force a clean e-trade

culture.

Speaking pragmatically, as yet we are far from

the moment when everything is crystal clear. But in

my view, if above two challenges are met with

quality, then opportunities that electronic banking

provides us are going to take us nowhere else, but

to high skies of convenience, trust and success.

Appendix - A

Proposed Solutions for the challenges

As I mentioned in the essay, suggesting

solutions to the challenges that electronic banking

faces today was not within the scope of this essay.

But in order to make the overall document more

useful, I am giving some additional information on

some of the devised solution for some of the

challenges. I hope that this will help the reader in

developing an understanding, as how the

professionals of today are combating the discussed

complexities.

A.1 Proposed Solutions for Data

Integrity related Challenges

Common practices used to maintain data

integrity within an e-banking environment include

the following:

* E-banking transactions should be conducted in

a manner that makes them highly resistant to

tampering throughout the entire process.

* E-banking records should be stored, accessed

and modified in a manner that makes them

highly resistant to tampering.

* E-banking transaction and record-keeping

processes should be designed in a manner as

to make it virtually impossible to circumvent

detection of unauthorized changes.

* Adequate change control policies, including

monitoring and testing procedures, should be

in place to protect against any e-banking

system changes that may erroneously or

unintentionally compromise controls or data

reliability.

* Any tampering with e-banking transactions or

records should be detected by transaction

Appendixes



processing, monitoring and record keeping

functions.

A.2 Proposed Solutions for

Authentication related Challenges

* Any authentication related tampering should

be detectable and audit trails should be in

place to document such attempts.

* Any addition, deletion or change of an

individual, agent or system to an

authentication database is duly authorized by

an authenticated source.

* Appropriate measures are in place to control

the e-banking system connection such that

unknown third parties cannot displace known

customers.

* Authenticated e-banking sessions remain

secure throughout the full duration of the

session or in the event of a security lapse the

session should require re-authentication.

A.3 Proposed Solutions for the Virus

Attacks related Challenges

* Increasing awareness among system users so

they can help identify and stop the spread of

computer viruses.

* Ensuring anti-virus software is installed on all

servers and clients with updated anti-virus

signatures.

* Contacting service providers and other

vendors to ensure appropriate awareness and

response.

* Installing specific intrusion detection system

signatures.

* Following-up closely on abnormal system and

printer behavior.

* Changing passwords on potentially

compromised systems.

* Following-up rigorously any suspected

infection.

* Verifying configurations and patch levels.

* Updating the information security program to

address any new threats or controls.

A.4 Proposed Solutions for "Phishing"

related Challenges

Provide notices on Web sites reminding

customers that the bank will never request

confidential information through e-mail and to

report any such requests to the bank.

* Print warnings and notices on customer

statements or other paper mailings.

* Improve authentication methods and

procedures to protect against the risk of user ID

and password theft from the customer through

e-mail and other frauds. Authentication

methods solely reliant on shared secrets (e.g.,

passwords) are more susceptible to phishing

schemes than stronger authentication

methods.

* Review and, if necessary, enhance practices for

protecting confidential customer data.

* Maintain current Web site certificates and

describe how the customer can authenticate

the bank's Web pages by checking the

properties on a secure Web page.

* Refer customers to or use Federal Trade

Commission (FTC) resources to develop

educational brochures to explain the red flags

and risks of identity theft.

– FTC, "How Not to Get Hooked by the

'Phishing' Scam," July 2003

http://www.ftc.gov/bcp/conline/pubs/alerts/

phishingalrt.htm

– FTC, "ID Theft: When Bad Things Happen to

Your Good Name," September 2002

http://www.ftc.gov/bcp/conline/pubs/credit/

idtheft.htm

A.4.1 Detection

* Monitor accounts individually or in aggregate

for unusual account activity such as address or

phone number changes, large or a high

volume of transfers, and unusual customer

service requests.

* Monitor for fraudulent Web sites using

variations of the bank's name.

* Establish a toll-free number for customers to

verify requests for confidential information or



to report suspicious e-mails.

* Train customer service staff to refer customer

concerns regarding suspicious e-mail request

activity to security staff.

A.4.2 Response

* Incorporate notification of known e-mail-

related frauds into the response program to

alert customers of fraudulent requests for

information and to caution them against

responding.

* Establish a process to notify Internet service

providers, domain name issuing companies,

and law enforcement to shut down fraudulent

Web sites and other Internet resources that are

being used to facilitate phishing or other

fraudulent e-mail practices.

* Increase suspicious activity monitoring and

employ additional identity verification

controls.

* If fraud is detected in connection with

customer accounts, the bank should report the

fraud and consider offering its customers

assistance consistent with the comprehensive

guidance on reporting and customer assistance

given in OCC Advisory Letter 2001-4, "Identity

Theft and Pretext Calling."

In the event your institution is a victim of an e-

mail-related scam, you should promptly notify

your OCC supervisory office. As appropriate, you

should also report the event to law enforcement by

filing a Suspicious Activity Report.

A.5 Proposed Solutions for "Spoofing"

related Challenges

Banks can improve the effectiveness of their

response procedures by establishing contacts with

the Investigative Bureaus, and local law

enforcement authorities in advance of any

spoofing incident. Additionally, banks can use

customer education programs to mitigate some of

the risks associated with spoofing attacks.

Education efforts can include statement stuffers

and Web-site alerts explaining various Internet-

related scams, including the use of fraudulent e-

mails and Web-sites in phishing attacks. In

addition, because the attacks can exploit

vulnerabilities in Web browsers and/or operating

systems, banks should consider reminding their

customers of the importance of safe computing

practices.

A.5.1 Detection

Banks can improve their ability to detect

spoofing by monitoring appropriate information

available inside the bank and by searching the

Internet for illegal or unauthorized use of bank

names and trademarks. The following is a list of

possible indicators of Web-site spoofing:

* E-mail messages returned to bank mail servers

that were not originally sent by the bank. In

some cases, these e-mails may contain links to

spoofed Web sites;

* Reviews of Web-server logs can reveal links to

suspect Web addresses indicating that the

bank's Web site is being copied or that other

malicious activity is taking place;

* An increase in customer calls to call centers or

other bank personnel, or direct

communications from consumer reporting

spoofing activity.

Banks can also detect spoofing by searching

the Internet for identifiers associated with the bank

such as the name of a company or bank. Banks

can use available search engines and other tools to

monitor Web sites, bulletin boards, news reports,

chat rooms, newsgroups, and other forums to

identify usage of a specific company or bank

name. The searches may uncover recent

registrations of domain names similar to the bank's

domain name before they are used to spoof the

bank's Web site. Banks can conduct this

monitoring in-house or can contract with third

parties who provide monitoring services.

Banks can encourage customers and

consumers to assist in the identification process by

providing prominent links on their Web pages or

telephone contact numbers through which

customers and consumers can report phishing or

other fraudulent activities. Banks can also train



customer-service personnel to identify and report

customer calls that may stem from potential Web-

site attacks.

A.5.2 Information Gathering

After a bank has determined that it is the target

of a spoofing incident, it should collect available

information about the attack to enable an

appropriate response. The information that is

collected will help the bank identify and shut down

the fraudulent Web site, determine whether

customer information has been obtained, and

assist law enforcement authorities with any

investigation. Below is a list of useful information

that a bank can collect. In some cases, banks will

require the assistance of information technology

specialists or their service providers to obtain this

information.

* The means by which the bank became aware

that it was the target of a spoofing incident

(e.g., report received through Web site, fax,

telephone, etc.);

* Copies of any e-mails or documentation

regarding other forms of communication (e.g.,

telephone calls, faxes, etc.) that were used to

direct customers to the spoofed Web sites;

* Internet Protocol (IP) addresses for the spoofed

Web sites along with identification of the

companies associated with the IP addresses;

* Web-site addresses (universal resource locator)

and the registration of the associated domain

names for the spoofed site; and

* The geographic locations of the IP address

(city, state, and country).

Banks can take the following steps to disable a

spoofed Web site and recover customer

information. Some of these steps will require the

assistance of legal counsel.

* Communicate promptly, including through

written communications, with the Internet

service provider (ISP) responsible for hosting

the fraudulent Web site and demand that the

suspect Web site be shutdown;

* Contact the domain name registrars promptly,

for any domain name involved in the scheme,

and demand the disablement of the domain

names;

* Obtain a subpoena from the clerk of a U.S.

District Court directing the ISP to identify the

owners of the spoofed Web site and to recover

customer information in accordance with the

Digital Millennium Copyright Act;

* Work with law enforcement; and

* Use other existing mechanisms to report

suspected spoofing activity.

A.6 Proposed Solutions for Wireless

related Challenges

* Security risk assessments, appropriate policies,

and adequate internal controls should be in

place before wireless networks are used.

* Security measures should protect bank

networks and wireless-enabled devices from

unauthorized access, intercepted

transmissions, and disclosure of confidential

customer information, and other vulnerability

threats.

* Security test plans should address wireless

networks.

* Performance levels of service level agreements

should be monitored to ensure that wireless

solutions are effective.

* Total cost of ownership or return on

investment objectives to implement and

maintain the network, including incremental

security costs (e.g., authentication, monitoring,

updating, testing), should be considered as a

component in determining project success.

Other issues that would need addressing could be:

Implementing User Policies and Procedures

Identifying Available Information

Identifying Wireless Access Points

Controlling Broadcast Areas

Encrypting Information and Data.

Maintaining Authentication Controls.

Protecting Against Logical and Physical Attacks

Monitoring System Vulnerabilities

Completing Security Tests



A WLAN security policy should consider the need

to:

* Identify who may use WLAN technology;

* Identify whether Internet access is required;

* Describe who can install access points and

other wireless equipment;

* Provide limitations on the location of and

physical security for access points;

* Describe the type of information that may be

sent over wireless links;

* Describe conditions under which wireless

devices are allowed;

* Define standard security settings for access

points;

* Describe limitations on how the wireless device

may be used, such as location;

* Describe the hardware and software

configuration for any access device;

* Provide guidelines on reporting losses of

wireless devices and security incidents;

* Provide guidelines on the use of encryption

and other security software; and,

* Define the frequency and scope of security

assessments.

Access Point Configuration should consider the

need to:

* Update default passwords;

* Establish proper encryption settings;

* Control the reset function;

* Use Medium Access Control (MAC) Access

Control Lists (ACL) functionality;

* Change the Service Set Identifier (SSID);

* Change default cryptographic keys;

* Change default Simple Network Management

Protocol (SNMP) Parameter;

* Change default channel; and,

* Use Dynamic Host Control Protocol (DHCP).

A.7 Proposed Solutions for Unauthorized

Access related Challenges

There are set guidelines for banks that "when a

financial institution becomes aware of an incident

of unauthorized access to sensitive customer

information, the institution should conduct a

reasonable investigation to promptly determine the

likelihood that the information has been or will be

misused. If the institution determines that misuse

of its information about a customer has occurred

or is reasonably possible, it should notify the

affected customer as soon as possible." However,

notice may be delayed if an appropriate law

enforcement agency determines that notification

will interfere with a criminal investigation and

provides the institution with a written request for a

delay.

Sensitive customer information is defined to

mean a customer's name, address, or telephone

number, in conjunction with the customer's social

security number, driver's license number, account

number, credit or debit card number, or a personal

identification number or password that would

permit access to the customer's account. Sensitive

customer information also includes any

combination of components of customer

information that would allow someone to log onto

or access the customer's account, such as user

name and password or password and account

number.

A.8 Proposed Solutions for Availability

related Challenges

To protect banks against business, legal and

reputation risk, e-banking services must be

delivered on a consistent and timely basis in

accordance with customer expectations. To

achieve this, the bank must have the ability to

deliver e-banking services to end-users from either

primary (e.g. internal bank systems and

applications) or secondary sources (e.g. systems

and applications of service providers). The

maintenance of adequate availability is also

dependent upon the ability of contingency back-



up systems to mitigate denial of service attacks or

other events that may potentially cause business

disruption. The challenge to maintain continued

availability of e-banking systems and applications

can be considerable given the potential for high

transaction demand, especially during peak time

periods. In addition, high customer expectations

regarding short transaction processing cycle times

and constant availability (24 X 7) has also

increased the importance of sound capacity,

business continuity and contingency planning.

A.9 Proposed Solutions for Record

Systems related Challenges

Banks should conduct proper planning and

due diligence before acquiring or developing an

electronic record retention system. An effective

planning process will include representation from

all affected areas in the bank, including

management and personnel from the relevant

business lines, information technology, operations,

audit, legal, and compliance. The electronic

record retention system should be fully consistent

with the bank's general corporate records

management program. Management should

assess the risks and objectives associated with the

new electronic system and consider the potential

effect on current business processes and internal

controls.

A.9.1 Data Security

The failure to properly secure and protect bank

electronic record retention systems that contain

confidential customer information will violate the

minimum security standards. However, the

security device utilized must not prevent

accessibility of the record to those legally entitled

to it, including OCC examiners. Bank

management should confirm that its record

systems are properly secure from unauthorized

access and data alteration, and this aspect of the

systems should be adequately tested. The record

systems architecture should be fully documented

and systems adequately indexed.

Verisign Inc., the leading Certificate Authority

who completed the acquisition of Thawte

Consulting in Feb 2000 owns 72% of the unique

SSL Certificates on the web. These results are

based on Netfactual's "automatic survey" of

113,000 Digital Certificate Owners.

A.9.2 Internal controls

When appropriate because of the nature of the

records stored in the system, banks should

implement effective internal controls to protect

electronic record retention systems from

unauthorized access and alteration, including

associated business and information management

practices. Internal controls include methods such

as segregation of duties, physical and logical

access controls, retention requirements,

documentation of changes to records, elimination

of write-access to records after capture, encryption

for transmission and storage, software integrity

checks, and equipment and record media disposal

procedures. The effectiveness of these controls

should be subject to audit review.

A.9.3 Back-up and recovery

A bank with an electronic records retention

system with inadequate back-up and recovery

processes may find that its records are inaccessible

following an emergency. Thus, national banks

should ensure that their electronic records are

sufficiently backed up so that recovered records

will meet the same accuracy and integrity

standards as the primary electronic versions.

National banks should assess whether they have a

consistent process for periodic record back-up that



Fig. A-1 - E-Commerce Certificate Industry Analysis

stores the records in a secure off-site location with

proper access controls, and for periodically testing

their ability to recover the records.

A.9.4 Record destruction and disposal

Record destruction and disposal should

generally occur only in accordance with a

systematic and well-documented procedure and

an approved records retention and disposition

schedule. Among other things, the bank's

procedures for disposal of electronic records

should contain provisions for suspending records

destruction if warranted by litigation or regulatory

requests. This procedure should also comply with

the guidelines and rules on safeguarding customer

information. Additionally, the procedure must

conform to OCC's requirements issued under

Section 216 of the Fair and Accurate Credit

Transactions (FACT) Act., requiring "any person

that maintains or otherwise possesses consumer

information … derived from consumer reports …

to properly dispose of any such information or

compilation."

A.9.5 Change management

A bank's plan for its electronic records systems

should provide for continuing accessibility despite

future changes in technology that will require that

record systems be updated and that records be

migrated to the updated systems.

Banks should assess and test the impact on the

integrity and accessibility of their electronic records

that may be caused by any changes in their

systems or those of their service provider. Banks

should consider change management controls that

address risks to electronic record systems before,

during, and following a change

A.10 Proposed Solutions for Cross-border

commerce related Challenges

Before a bank initiates cross-border e-banking

products and services, bank management should

conduct appropriate risk assessment and due

diligence to ensure that the bank can adequately

manage the attendant risks. The bank must also

comply with any applicable laws and regulations.

This includes the laws and regulations of the

bank's home country as well as those of any

foreign country that may assert jurisdiction over e-

banking services that are directed at its residents.

Further, the bank should ensure that it has an

effective and ongoing risk management program

for its cross-border e-banking activities. Initial risk

assessment, due diligence and ongoing risk

management considerations should include, but

are not limited to, such factors as country risk,

compliance risk, regulatory requirements, local

business practices, accounting standards and the

legal environment, as well as the operational,

security, privacy, and customer service challenges

presented by the online delivery of banking

products and services to foreign customers. Banks

should recognize that substantial differences might

exist between jurisdictions with respect to bank

licensing, supervisory and customer protection

requirements. Effective home country supervision

can mitigate local supervisors' concerns to some

extent by ensuring that banks have in place

appropriate risk management systems to manage

and control the risks involved.

A.11 Role of Technology Department

Along with the overall supervision of

technology related issues and operations, basic

steps that need to be taken by the technology

department of a bank are:

* Physical Security to be ensured..

* Access to Data to be secured

* Network Audits to be conducted regularly to

find out loopholes in the setup

* Technology Department, should arrange for

regular network audits, so as to find and

resolve the loopholes in the IT infrastructure.

* Development of new and more vigilant tools

i.e. Encryption etc.

* Using network technology like Firewalls, IDS,

IPS, Enhanced security on Routers, Switches.



A.12 Role of "Management" to counter

the Challenges

The Board of Directors and senior

management should establish effective

management oversight over the risks associated

with e-banking activities, including the

establishment of specific accountability, policies

and controls to manage these risks.

Vigilant management oversight is essential for

the provision of effective internal controls over e-

banking activities. In addition to the specific

characteristics of the Internet distribution channel

discussed in the Introduction, the following aspects

of e-banking may pose considerable challenge to

traditional risk management processes:

* Major elements of the delivery channel (the

Internet and related technologies) are outside

of the bank's direct control.

* The Internet facilitates delivery of services

across multiple national jurisdictions, including

those not currently served by the institution

through physical locations.

* The complexity of issues that are associated

with e-banking and that involve highly

technical language and concepts are in many

cases outside the traditional experience of the

Board and senior management.

In light of the unique characteristics of e-

banking, new e-banking projects that may have a

significant impact on the bank's risk profile and

strategy should be reviewed by the Board of

Directors and senior management and undergo

appropriate strategic and cost/reward analysis.

Without adequate up-front strategic review and

ongoing performance to plan assessments, banks

are at risk of underestimating the cost and/or

overestimating the payback of their e-banking

initiatives.

In addition, the Board and senior management

should ensure that the bank does not enter into

new e-banking businesses or adopt new

technologies unless it has the necessary expertise

to provide competent risk management oversight.

Management and staff expertise should be

commensurate with the technical nature and

complexity of the bank's e-banking applications

and underlying technologies. Adequate expertise is

essential regardless of whether the bank's e-

banking systems and services are managed in-

house or outsourced to third parties. Senior

management oversight processes should operate

on a dynamic basis in order to effectively intervene

and correct any material e-banking systems

problems or security breaches that may occur. The

increased reputational risk associated with e-

banking necessitates vigilant monitoring of systems

operability and customer satisfaction as well as

appropriate incident reporting to the Board and

senior management. Finally, the Board and senior

management should ensure that its risk

management processes for its e-banking activities

are integrated into the bank's overall risk

management approach. The bank's existing risk

management policies and processes should be

evaluated to ensure that they are robust enough to

cover the new risks posed by current or planned e-

banking activities. Additional risk management

oversight steps that the Board and senior

management should consider taking include:

1. The Board of Directors and senior

management should establish effective

management oversight over the risks

associated with e-banking activities, including

the establishment of specific accountability,

policies and controls to manage these risks.


management should review and approve the

key aspects of the bank's security control

process.


management should establish a

comprehensive and ongoing due diligence and

oversight process for managing the bank's

outsourcing relationships and other third-party

dependencies supporting e-banking.



A.13 Regulatory Tools to Counter

Challenges

There are four key tools that regulators need to

focus on to address the new challenges posed by

the arrival of e-banking.

A.13.1 Adaptation. In light of how rapidly

technology is changing and what the changes

mean for banking activities, keeping regulations up

to date has been, and continues to be, a far-

reaching, time-consuming, and complex task. In

May 2001, the Bank for International Settlements

issued its "Risk Management Principles for

Electronic Banking," which discusses how to

extend, adapt, and tailor the existing risk-

management framework to the electronic banking

setting. For example, it recommends that a bank's

board of directors and senior management review

and approve the key aspects of the security control

process, which should include measures to

authenticate the identity and authorization of

customers, promote non-repudiation of

transactions, protect data integrity, and ensure

segregation of duties within e-banking systems,

databases, and applications. Regulators and

supervisors must also ensure that their staffs have

the relevant technological expertise to assess

potential changes in risks, which may require

significant investment in training and in hardware

and software.

A.13.2 Legalization. New methods for

conducting transactions, new instruments, and

new service providers will require legal definition,

recognition, and permission. For example, it will

be essential to define an electronic signature and

give it the same legal status as the handwritten

signature. Existing legal definitions and

permissions-such as the legal definition of a bank

and the concept of a national border-will also need

to be rethought.

A.13.3 Harmonization. International

harmonization of electronic banking regulation

must be a top priority. This means intensifying

cross-border cooperation between supervisors and

coordinating laws and regulatory practices

internationally and domestically across different

regulatory agencies. The problem of jurisdiction

that arises from "borderless" transactions is, as of

this writing, in limbo. For now, each country must

decide who has jurisdiction over electronic

banking involving its citizens. The task of

international harmonization and cooperation can

be viewed as the most daunting in addressing the

challenges of electronic banking.

A.13.4 Integration. This is the process of

including information technology issues and their

accompanying operational risks in bank

supervisors' safety and soundness evaluations. In

addition to the issues of privacy and security, for

example, bank examiners will want to know how

well the bank's management has elaborated its

business plan for electronic banking. A special

challenge for regulators will be supervising the

functions that are outsourced to third-party

vendors.

A.14 Key Findings of Successful

E-banking

Following can help establish an e-banking

system that can deliver with minimum risks of the

threats arising from the use of technology.

* Active vendor management

* Ongoing board involvement

* Sufficient technical expertise

* Proactive network security that effectively

prevents, detects, and responds to intrusions

* Strong authentication practices

* Encrypted communications

* Periodic compliance and legal reviews

* Appropriate Backup and Recovery



Appendix - B

Top Tips for Avoiding Internet Frauds

* Do business with those you know and trust.

* Understand the offer: Look carefully at the

information about the products or services

offered, and ask for more information, if

needed. A legitimate business will be glad to

provide it; a fraudulent telemarketer won't.

Check out the company's or individual's track

record. Ask your state or local consumer

protection agency if the business has to be

licensed or registered, and check to see if it is.

* Never give your bank account numbers, credit

card numbers or other personal information to

anyone you don't know or haven't checked

out. And don't provide information that isn't

necessary to make a purchase. Even with

partial information, con artists can make

unauthorized charges or take money from your

account.

* If you have a choice between using your credit

card and mailing cash, check, or money order,

the League recommends using a credit card.

You can always dispute fraudulent credit card

charges, but you can't get cash back.

* Take your time. While there may be time limits

for special offers, high-pressure sales tactics are

often danger signs of fraud.

* Don't judge reliability by how nice or flashy a

web site may seem.

* Know that people in cyberspace may not

always be what they seem. Someone who is

sharing a "friendly" tip about a money-making

scheme or great bargain in a chat room or on

a bulletin board may have an ulterior motive:

to make money. Sometimes friendly people

are crooks!

* Know that unsolicited e-mail violates computer

etiquette and is often used by con artists

* Don't download programs to see pictures, hear

music, or get other features from web sites

you're not familiar with. You could unwittingly

download a virus that wipes out your

computer files or even hijacks your Internet

service, reconnecting you to the Net through

an international phone number, resulting in

enormous phone charges.

Source: National Council of Leage -

http://www.natlconsumersleague.org

Appendix - C

2000 Internet Fraud Statistics

1999 Top 10 Frauds

Online Auctions 87%

General Merchandise Sales 7%

Internet Access Services 2%

Computer Equipment/Soft. 1%

Work-At-Home 1%

Advance Fee Loans 0.2%

Magazine Sales 0.2%

Information Adult Services 0.2%

Travel/Vacations 0.1%

Multilevel Market/Pyramids 0.1%

2000 Top 10 Frauds

Online Auctions 78%

General Merchandise Sales 10%

Internet Access Services 3%

Work-At-Home 3%

Advance Fee Loans 2%

Computer Equipment/Soft. 1%

Nigerian Money Offers 1%

Information Adult Services 1%

Credit Card Offers 0.5%

Travel/Vacations 0.5%

Methods of Contact

Web sites are the most common way that

consumers are solicited for fraudulent Internet

offers, but the statistics reveal an increase in the

number of initial contacts made by con artists in

newsgroups:

1999 Solicitation Method

Web Sites 90%

E-Mail 9%

Newsgroups 0.5%



2000 Solicitation Method

Web Sites 82%

E-Mail 12%

Newsgroups 4%

Ages of Consumers

Under 20 2%

20-29 20%

30-39 28%

40-49 29%

50-59 15%

60-69 5%

70-79 1%

80+ 0%

Money Lost

The amount of money consumers are losing to

Internet fraud, like telemarketing fraud, is

increasing. Losses overall are $3,387,530. The

average loss per person rose from $310 in 1999 to

$427 in 2000.

1999 Top 5 Payment

Money Order 46%

Check 39%

Credit Card 5%

Cashier's Check 5%

Cash 1%

2000 Top 5 Payment

Money Order 43%

Check 30%

Credit Card 11%

Cashier's Check 6%

Cash 3%

There are dramatic differences in methods of

payment for each of the top Internet fraud

categories.

Internet Fraud Method of Payment

Online Auctions Money Order 48%

Check 32%

Cashier's Check 7%

Credit Card 6%

Cash 3%

General Credit Card 28%

Merchandise Sales Money Order 25%

Check 24%

Cashier's Check 5%

Debit Card 5%

Internet Access Services Credit Card 37%

Telephone Bill 15%

Check 14%

Bank Account Debit 13%

Debit Card 9%

Work-At-Home Check 40%

Money Order 23%

Credit Card 19%

Bank Account Debit 9%

Cash 3%

Computer Money Order 27%

Equipment Software Credit Card 24%

Check 22%

Wire 13%

Cashier's Check 8%

For additional information, check out press

material at the National Consumers League Web

site.



Highlights ofEconomic Events(October - December, 2006)

* State Bank of Pakistan (SBP) is aiming to

establish Islamic banking as a parallel banking

system comparable and compatible with

conventional banking with opportunities for it

to become banking of first choice relative to

market demands.

* The Central Directorate of National Savings

has decided to allow institutional investment in

its various schemes, previously held in

abeyance. The facility would not be available

to those schemes designed to meet special

segments of the society.

* The government is aiming to finalize the

strategy for realizing “Textile Vision - 2015”.

Its main focus would be to: (i) ensure an

investment of $ 7-10 billion; (ii) ensure a

contamination free cotton production of 20

million bales; (iii) promote exports beyond $

15 billion; (iv) generate employment for skilled

and semi-skilled.

* The government has sanctioned three licenses

to the Petroleum Exploration (Pvt) Limited

(PEL) to undertake oil and gas exploration in

deep offshore blocks. PEL is the first Pakistani

company to be allowed to undertake ultra

deep exploration.

* The SBP has decided to restrain commercial

banks from advancing loans to commercial

and industrial sectors against hypothecation of

residential properties. The measure is part of

Basel-II conditions on assets portfolio.

* According to the SBP data banking spread

during the first eight months of 2006 stood at

7.3% as against 5.8% in the same period of

2005.

* MCB Bank of Pakistan has been listed at the

London Stock Exchange; the first Pakistani

company in the country's history to have done

so.

* The government has set a target of introducing

338,000 tons of high yielding varieties of

wheat, cotton and rice seed by 2009-10 which

would increase per acre yields by 20 to 40%

compared to the conventional types of seed

currently being used.

* The Government has approved a coastal oil

refinery to be set up at Khalifa Point near Hub,

in Balochistan, by International Petroleum

Investment Company (IPIC) of Abu Dhabi and

Pak Arab Refinery Co. (PARCO). IPIC and

PARCO will share equity in 75:25 proportion.

At a cost of $ 4-5 billion it will have a refining

capacity of 200,000 - 300,000 barrels of oil per

day and would come on stream by 2010-11.

* Malaysia has agreed in principle to undertake

construction work of Karachi Northern Bypass

on build, operate and transfer (BOT) basis.

MoU to be signed would cover construction of

Rawalpindi-Tarnol Interchange, Shahdara

Interchange, Lahore, and Rawalpindi Bypass.

The total cost of the projects is estimated at Rs

12.5 billion.

* The SBP Governor has urged the Islamic

banks to focus their attention and target the

rural sector which is largely unexplored in

preference to the urban sector and thus

compete directly with conventional banking

which, however, has a significant presence in

the rural sector also.

* This year Cotton production may be around

12.5 million bales against the target of 13.8

million bales. This may necessitate import

between 1 to 1.5 million bales.

* According to SBP, the non-performing loans



(NPLs) of all banks increased from Rs. 176.7

billion at end-March, 2006 to Rs. 183.8 billion

at the end-June, 2006. The NPLs in the

commercial banks increased by Rs. 2.4 billion

while for specialized banks by Rs. 4.8 billion.

The increase in NPLs is mainly due to defaults

in consumer financing.

* Although the country's earnings through

exports have almost doubled to over $ 16

billion in the last few years, it compares

unfavourably with China and India as a

proportion of GDP. In the case of Pakistan the

export-GDP ratio stands at 13% against India's

16% and China's 40%.

* Production of rice during current crop year,

April to November is around 5.6 million tons

against last fiscal's 5.4 million tons. With

domestic consumption estimated at 2.3 million

tons, a surplus of 3.3 million tons valuing $ 1.3

billion would be available for export. Pakistan

exported 2.9 million tons of rice in 2005-06

valued at $ 1.1 billion against $ 933 million in

2004-05. Main buyers are African countries,

Sri Lanka and Afghanistan.

* The President has inaugurated the Mirani dam

in Balochistan. First conceived in 1956,

construction work on it started in 2002. Built

at a cost of Rs. 6.0 billion including Rs. 1.5

billion as compensation to affected people, it

has a catchment area of 12,000 sq. km and a

storage capacity of 300,000 million acre feet.

* Provincial Government of Punjab has

developed a five-year plan for the

establishment of “Cluster Development

Centres” in key industrial cities of the province.

In the initial phase, emphasis would be on

sports goods industry in Sialkot, wood

furniture industry in Chiniot, electrical fitting

industries in Sargodha and auto-parts industry

in Lahore.

* Moody's Investor Service has upgraded its

ratings of Pakistan's foreign and local currency

bonds from B2 to B1 notwithstanding

reservations about the country's current

account deficits, fiscal policies and inflationary

pressures all considered reversible in

foreseeable future.

* Cement production in the country is estimated

to reach a level of 47 million tons by 2009

against a projected output of 38 million tons in

2006. While Afghanistan is Pakistan's biggest

export market of portland cement, the demand

for sulphur-resistant cement, white cement and

slag cement is on the increase from Gulf states.

* Pakistan and China have signed 18

agreements and MoUs covering a vast range of

economic cooperation deals including trade

and energy sectors. The Free Trade Agreement

(FTA) deal could push bilateral trade in the

range of $ 15.0 billion, a three-fold increase,

during 2007-2011. The FTA is to be effective

from July 1, 2007.

* Pakistan has increased the importable items

from India to 1,074 products compared to

previously admissible 774 products. Due to

this textile sector can now import any textile

machinery from India. Until now, textile

machinery used to be imported from USA,

Japan, Germany and some other Western

countries at fairly high prices pushed up by

freight costs too.

* The Ministry of Finance has issued standing

instructions to the SBP to retire government

debt to the extent of 90% from the

privatization proceeds without reference to it

on a case to case basis. The Ministry would

utilize the remaining 10% on poverty reduction

programs.

* A consortium of local and foreign banks

operating in the country is to provide Rs. 23

billion to fund a “green field” industrial project

namely Fatima Fertilizer. The total cost of the

complex is estimated at Rs. 35 billion (debt

Rs. 23 billion and equity Rs. 12 billion). On

completion, it will produce 1.5 million tons of

nitrogenous and phosphotic fertilizer.

* According to the Pakistan Electronic Media



Regulatory Authority, the country has attracted

Rs. 5 billion of investment and has created

80,000 new jobs during the last three years,

mostly in the private sector.

* The State Bank's Annual Report, 2005-06 has

identified four areas of main concerns namely

(i) narrow growth base, (ii) level of inflation,

(iii) fiscal deficit and (iv) stagnant tax-GDP

ratio in the ratio of 10-11% for almost a

decade.

* The SBP Governor has said that the Central

Bank may intervene if the rate of return paid to

depositors does not improve. Although such

returns have shown some increase, these, she

thought were not adequate enough.

* China's Great United Petroleum Holdings

Company Limited has started the feasibility

study for constructing a petrochemical city at

Gawadar costing $ 12.5 billion. The

government has allocated 12,500 acres for the

purpose.

* According to industry sources data, the textile

sector grew by 4.3% in FY06 against a growth

of 27.1% in the proceeding fiscal. Its

contribution in large scale manufacturing

(LSM) fell to 13.7% in 2005-06 against 39.1%

in 2004-05.

* WAPDA is undertaking eight power projects

likely to be completed by 2012, resulting in

generation of 1,155 MW of electricity. Raising

the reservoir capacity of Mangla Dam at a cost

of Rs. 62.5 billion would provide additional

2.8 million acre-feet of water for irrigation and

644 MW of electricity.

* Government allocation for the agricultural

sector has increased almost four fold from

Rs. 3.0 billion in 2000-01 to Rs. 11.8 billion in

2006-07. A major objective is to line all the

87,000 water courses throughout the country.

Agriculture is contributing 22% to the GDP,

60% to export earnings and providing direct

employment to 45% of the total work-force.

Credit off take is targeted at Rs. 160 billion

during the current fiscal having increased from

Rs. 44 billion to Rs. 137 billion during 2000-01

to 2005-06.

* SBP has ruled out devaluation of Pak Rupee

and has stated that the country's exchange rate

regime would continue to be governed by

market fundamentals.

* The government has allocated 100 million

cubic feet of natural gas per day to Engro

Chemicals, being the only bidder, at a

premium price of Rs. 101 million from its

Qadirpur gas field in Sindh, for setting up a

urea fertilizer plant. The total cost of project is

estimated at $ 1.0 bn. Its production capacity

is 1.3 million tons per annum.

* National Saving Schemes deposits currently

stand at Rs. 1.0 trillion as compared to Rs. 2.8

trillion deposits of commercial banks.

* The Global Depository Receipts of the OGDC

has been oversubscribed by 100% to $ 1.5

billion, against institutional investors target of $

713 million. The government has closed the

deal at $ 813 million inclusive of $ 100 million

of over allotment option.

* The SBP has allowed Islamic banks to invest in

shares in the ready cash and future provided

that the business of such company is not

prohibited under Shariah Laws.

* Pakistan and India have signed a shipping

protocol allowing transit to third-country cargo

from each other's ports as also to foreign ships

to ply the two countries.

* The Government expects Pakistan's linkage

by rail track to Iran, Afghanistan, China and

Central Asian Republics to be completed by

end-December, 2007. The project is being

executed by Frontier Works Organization at a

cost of Rs. 5.5 billion.

* The SBP Governor has spelled out

development of fixed income securities

markets as the policy measure for the next



phase of financial sector reforms.

* Standard and Poor's Rating Agency has

affirmed Pakistan's credit worthiness as under:

B+ for foreign currency; “BB” for local

currency long-term loans; and, 'B' for short

term sovereign rating. The Agency has revised

upwards the local currency rating from “stable”

to “positive” and foreign currency rating as

“positive”.

* Government anticipates Foreign Direct

Investment at $ 5.0 billion and remittances $

4.5 billion during current fiscal. Coupled with

assistance from international financial

institutions this is expected to help in off-setting

trade and fiscal deficits.

* The Monopoly Control Authority (MCA) has

disallowed the non-competition agreement

between Unilever Pakistan Limited (UPL) and

Dalda Foods (Pvt) Limited (DFL) and has

ordered UPL to refund the amount of Rs. 250

million to DFL. This is the first of its kind action

by MPA taken on ground of restrictive trade

practices.

* Mid Roc Tussonia, a Saudi-Kuwait joint

venture company, intends to invest $ 3-4

billion over the next seven years in Pakistan's

power generation, crude oil refining and real

estate sectors. A MoU signed to set up two 100

MW wind-power plants costing $ 200 million.

Work on the proposed oil refinery at Port

Qasim costing $ 1.5 billion may be initiated in

March, 2007.

* Foreign direct investment during July-

November, 2006, rose by 96% to $ 1.5 billion

against $ 752 million in the same period of

2005. Portfolio investment rose by 130% to $

624 million against $ 271 million during the

same period of 2005.

* During July-September, 2006, nine resident

companies/investors have made equity-based

investment of over $ 13 million in foreign

companies on repatriable basis.

* Export earnings during July-November 2006,

rose by 5% to $ 6.9 billion against $ 6.6 billion

in the same period of 2005, while import

payments stood at $ 12.3 billion against $ 11.2

billion, an increase of 10.4% over the same

period of 2005.

* The Provincial Government of Sindh has

signed an agreement with Soneri Energy

Company, a joint American Canadian venture

to explore the possibility of extracting coal-

based methane gas from huge deposits of coal

in the province.

* Gwadar Port Authority has issued its Letter of

Intent to Port of Singapore Authority

International to start formal negotiations as

port operator.

* Goldman Sachs, an international top rating

body in its concept of Next Eleven (N-11) has

identified Pakistan as a country with a

potential to emerge as an important player on

the world economic scene by 2050. Countries

forming part of N-11 concept are: Bangladesh,

Egypt, Indonesia, Iran, Korea, Mexico, Nigeria,

Philippines, Turkey and Vietnam.





LAHORE

ChairmanMr. Barbruce IshaqChief ManagerState Bank of PakistanPh: 9210452, 9210479Fax: 9210440, 9210471

Mr. Masood AzizOfficer InchargeUAN: 111-111-564Ph: 9210479 Fax: 9210471E-mail: [email protected]

RAWALPINDI

ChairmanMr. Taslim KaziChief MangerState Bank of Pakistan (BSC-Bank)Ph: 9270751, 9272529Fax: 9272529

Mr. Shahid Hamid QureshiOfficer InchargeUAN: 111-111-564Ph: 9272529Fax: 9272529E-mail: [email protected]

ISLAMABAD

ChairmanMr. Shabbir Ahmad AwanChief MangerState Bank of Pakistan (BSC-Bank)Ph: 051-9201715Fax: 051-9204991

Mr. Irfan Ahmed KhanOfficer InchargePh: 051-9204611E-mail: [email protected]

PESHAWAR

ChairmanMr. Muhammad Humayun KhanChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 9211975, 9211986Fax: 9211963

Mr. Kamran Ahmed KhanOfficer InchargeUAN: 111-111-564Ph: (091) 9213616 Fax: (091) 9213616E-mail: [email protected]

FAISALABAD

Chairman

Mr. Mahmood-ul-HasanChief ManagerState Bank of Pakistan (BSC-Bank)Ph: (041) 9200444, 9200421-30 Ext.234Fax: (041) 9200412

Honorary Secretary

Mr. Hussain KhanAsstt. Chief ManagerState Bank of Pakistan (BSC-Bank)Ph: 041-9200421-29, 041-9200881Fax: 041-9200412E-mail: [email protected]

MULTAN

ChairmanMr. Akbar AliChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 9201088Fax: 9200591Honorary SecretaryMr. Hafiz Imran Ahmad AbdullahState Bank of Pakistan (BSC-Bank)Ph: 9200581 - 90, 9200592, 9200595Fax: 9200591

SUKKUR

ChairmanMr. Ghulam Muhammad PhulChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 071-9310260-61Fax: 071-9310259 Honorary SecretaryMr. Saifullah SalimAssistant Chief ManagerState Bank of Pakistan (BSC-Bank)Ph: 071-9310261Fax: 071-9310259

HYDERABAD

ChairmanMr. Sher Alam KhanChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 022-3200605Fax: 022-9200604 Honorary SecretaryMr. Abrar HussainDy. Chief ManagerState Bank of Pakistan (BSC-Bank)Ph: 9200605, 9200606, 9200501-6Fax: 9200604

QUETTA

ChairmanMr. Sajid Ali ShahChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 081-920286, 9202029, 2822164Fax: 081-9201518, 2822164Officer InchargeMr. Waheed Ahmed KhanAssistant Chief ManagerUAN: 111-111-564Ph: 081-2822164 Fax: 081-2822164

MUZAFFARABAD

ChairmanMr. A.D. ButtChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 058810-32004Fax: 058810-32003Honorary SecretaryMr. Syed Asad Abbas ZaidiAssistant Chief ManagerState Bank of Pakistan (BSC-Bank)Ph: 058810-32004

Local Centres of the Institute of Bankers Pakistan



SIALKOT

ChairmanMr. Saeed HasanChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 0432-9250351, 9250355Fax: 0432-9250353

Honorary SecretaryMr. Muhammad BootaAssistant Chief ManagerState Bank of Pakistan (BSC-Bank)Ph: 0432-9250351-9250355

BAHAWALPURChief CoordinatorMr. Muhammad Hashim MirjatChief ManagerState Bank of Pakistan SBP BSC (Bank)Ph: (0621) 9255038 Fax: (0621) 9255037Coordinating OfficerMr. Salamuddin AlviState Bank of Pakistan (BSC-Bank)Ph: (0621) 9255038 Fax: (0621) 9255037

GUJRANWALAChief CoordinatorMr. Muhammad Munir AhmedChief ManagerState Bank of Pakistan SBP BSC (Bank)Ph: (055) 9200310 Fax: (055)9200309Coordinating OfficerMr. Muhammad Sharif KhanState Bank of Pakistan (SBP-BSC Bank)Ph: (055) 9200310 Fax: (055) 9200309

D.I. KHANChief CoordinatorMr. Muhammad Rauf KhanChief ManagerState Bank of Pakistan SBP BSC (Bank)Ph: (0966) 9280043 Fax: (0966) 9280044Coordinating OfficerMr. Mohammad IshaqState Bank of Pakistan SBP BSC (Bank)Ph: (0966) 9280043 Fax: (0966) 9280044

KARACHI (NAZIMABAD BRANCH) Chief CoordinatorMr. Muhammad Yamin KhanChief ManagerState Bank of Pakistan (BSC-Bank)Ph: 9260702 Fax: 9260712Coordinating OfficerMr. Syed Mahboob HassanState Bank of Pakistan (BSC-Bank)Ph: 9260705-9 Fax: 9260712

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ABBOTTABAD

Chief Co-ordinatorMr. Sardar Alam KhanRegional Operations ChiefNational Bank of PakistanRegional Office, Circular Road,Ph: (0992) 9310144 Fax: (0992) 9310318

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Chief Co-ordinatorMr. Sardar Alam KhanRegional Operations ChiefNational Bank of PakistanRegional Office, Bank Road,Ph: (0937) 9230328 Fax: (0937) 9230057

NAWABSHAH

Chief CoordinatorMr. Haji Anwar BalochManager National Bank of PakistanMain Branch, Main Bazar,Ph: (0244) 9370401 - 2 Fax: (0244) 9370403

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Chief CoordinatorMr. Anjum KhanManager National Bank of PakistanMain Branch, Bank Square, Ph: (0936) 9240035-37 Fax: (0936) 9240036

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USAMr. M. Rafiq Bengali,SEVP & Regional Chief Executive,National Bank of Pakistan,Regional Office, New York,100 Wall Street,P.O. Box 500,New York, N.Y. 10005,Fax # 1-212-3448826

CANADAMr. Rasool Ahmed Kaleemi,SEVP/Chief Representative,National Bank of Pakistan,Representative Office, Toronto (Canada),175 Commerce Valley Drive West,Suite 210, Thornhill, Ontario L3T 7P6,Fax # 1-9057071040

UNITED KINGDOMMr. Abid H. Mufti,Chief Executive Officer,United National Bank,2 Brook Street,London W1S 1BQ,Fax # 44-207-2904950

FRANCEMr. Nausherwan Adil,Regional Chief Executive,National Bank of Pakistan,Regional Office, Paris (France) 90, Avenue Des Champs Elysees 75008, ParisFax # 33-145636604

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BELGIUMMr. Asad Ansari,EVP & General Manager,Habib Bank Limited,19, RUE-DE-LOI 1040,Brussels,Granite House,Fax # 322-2804651

JAPANMr. Chaudhry Muhammad Rafique,EVP/General Manager,National Bank of Pakistan,CJ Bldg, 3rd Floor,Nishi Shimbashi 2-7-4,Minato-ku,Tokyo 105-0003,Tel # 81-3-3502-0331Fax # 81-3-3502-0359

AFGHANISTAN.Mr. Syed Mahmood-ul-Hassan,General Manager,National Bank of Pakistan, Kabul Branch, House No. 2, St. No. 10,Wazir Akbar Khan, Kabul, AFGHANISTAN.Fax # 93-20-2301659

BANGLADESHMr. Q.S.M. Jehanzeb,General Manager,National Bank of Pakistan,Dhaka Branch,79, Motijheel Commercial Area,Dhaka-1000,Tel # 880-2-9560248-9Fax # 880-2-9560247

NEPALMr. M. Fahim Butt,SVP & General Manager,Himalayan Bank Limited,Karamcharia Sanncharya,Kosh Building, Tridevi Marg, Thamel, GPO Box 20590 KTM,Kathmandu, NEPAL.

EGYPTMr. Mujahid Abbas Khan,General Manager,National Bank of Pakistan, Cairo Branch74, Gameat Al-Dawal, Al-Arabia Street, 3rd Floor, Mohandessen, Giza,

MAURITIUSMr. Abdul Razzak Kapadia,Senior Vice President & Country Manager,Habib Bank Limited,Sir William Newton Street, P.O. Box 505, Port Louis,MAURITIUS.Tel: (230) 208 0848

(230) 208 5524Fax: (230) 212 3829

KENYAMr. Hamid Mukarrum Baig EVP & Regional General Manager,Habib Bank Limited,Exchange Building,Koinange Street,P.O. Box 43157-00100, NairobiTel # 020-246613/41Fax # 020-214636

KAZAKHISTANMr. Syed Azhar Ali,General Manager,National Bank of Pakistan,Subsidiary Almaty, Hotel Complex "OTRAR", 73 Gogal Street, AlmatyKAZAKHSTAN.

HONG KONGMr. Asif Hassan,SEVP/Regional Chief Executive,National Bank of Pakistan,Regional Office Hong Kong,Unit 1801-1805, 18th Floor,ING TOWER, 308-320,DES VOEUX Road Central,Hong KongTel # 852-2851-4292Fax # 852-2139-0298

SINGAPOREMr. Ashraf M. Wathra,EVP & Regional General Manager,Asia Pacific Region,Habib Bank Limited,No. 3, Phillip Street # 01-04,Commercial Point,SingaporeFax # 65-64380644

U.A.E.Mr. Wajahat Husain,Head of Middle East,United Bank Limited,Khalid Bin Waleed Street,Bank Street Building, P.O. Box 1367, Dubai.Fax # 97-14-3523560

KINGDOM OF BAHRAINMr. Zubair Ahmed,EVP/Regional Chief ExecutiveNational Bank of Pakistan, Regional Office Bahrain,9, Manama Center, Government Avenue,P.O. Box 775. Manama,Tel # 97-17224191Fax # 97-17224411

SULTANATE OF OMANMr. Jawed Z. Karim,EVP& Country Manager,Habib Bank Limited, Regional Office, MBD Area, Qurrum House, P.O. Box 1326, Ruwi, Postal Code 112,Tel # 00968-24817163Fax # 7715809

IRANMr. S. Anwar Saeed,EVP & General Manager,Habib Bank Limited,Koye Nasr (Geesha) Building No. 170/4,2nd Floor, P.O. Box 14395-739, Tehran, Fax # 98-218273900

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I. Attachment of Shares of a Company

II. Attachment of Debt:i) before the debt is

due;ii) when the debt is in

joint names.

PROF. SYED SABIR ALI JAFFERYEx-Director General (Training & Statistics)Allied Bank LimitedKarachi

I. ATTACHMENT OF

SHARES OF A COMPANY

Sarangdhar Singh and Others v.

Mkt. Parvati Kaur

AIR 1968 Patna 370

Facts of the case: The executing Court

issued an attachment order under Order 21, Rule

No. 46 of the Code of Civil Procedure against the

judgment debtors and the secretaries of the

companies whose shares were the subject matter

of the execution petition.

There were seven lots of shares. The registered

offices of all the companies were situated outside

the State of Bihar. Of the seven lots of shares, six

stood in the name of a person who had since died.

One lot stood in the joint names of judgment

debtors and another person, who had also died.

The part pertaining to shares of Order 21 Rule

46 reads as follows:

(1-ii) In the case of a share in the capital of a

corporation, the attachment order shall be

made by a written order prohibiting the person

in whose name the share may be standing

from transferring the same or receiving any

dividend thereon.

(2) A copy of such order shall be affixed on some

conspicuous part of the courthouse, and

another copy shall be sent to the proper officer

of the corporation.

The judgment debtors preferred an

appeal against the attachment order on the

following grounds:

(i) Lack of territorial jurisdiction of the execution

court to attach shares of the companies

registered outside the State of Bihar;

(ii) Lack of jurisdiction of the executing court to

attach the shares standing in the name of the

deceased person; and

(iii) The prohibitory order in pursuance of the

order of attachment was not affixed on some

conspicuous part of the courthouse.

The Hon'ble High Court of Patna made the

following observations:

(i) Under clause (1-ii) of Rule 46 the attachment is

made by a written order prohibiting only the

person who holds the share in his name, from

transferring that share or receiving dividend on it.

(ii) The ‘dividend' here mentioned is not a debt

within the meaning of clause (ii) of sub-rule (1)

(iii) Copy of the prohibitory order was sent to the

principal officer of the corporation merely for

information about its issuance against the

judgment debtors. The plea that the providing

of a copy of the prohibitory order to the

principal officers of the companies registered

outside Bihar State did not fall within the

jurisdiction of the executing court was,

therefore, not tenable. Hence, rejected.

(iv) As is apparent from sub-rule (1), a prohibitory

order attaching a share can be issued in the

name of an existing person in whose name the

share is held. Thus, no prohibitory order can

be issued against a deceased person.

(v) As no evidence has been produced regarding

non-affixation of the prohibitory order on a


Legal Decisions Affecting Bankers

conspicuous part of the courthouse,

presumption under section 114 (e) of the

Evidence Act that the proceedings of the court

were validly carried out shall be resorted to.

The plea is, therefore, ruled out.

Held:

The appeal was allowed; it was held that only

the interest of the judgment debtor in the lot of

shares, which stood in the joint names of the

judgment debtor and a deceased person, could be

attached.

II. ATTACHMENT OF DEBT

Manddiikaatta Anjanna and Others v.

Bandi Raamkrisshna and Others

AIR 1971 Andhra Pradesh 165

The case adjudged on the following two issues

of prime importance for practicing bankers.

(i) Whether the attachment of debt due to the

judgement debtor was illegal, and therefore

invalid, because the application for atachment

was moved before the debt and had actually

fallen due for payment?

(ii) Whether the attachment of a debt jointly due

to a judgement debtor and another was illegal?

Facts of the case: Application for

attachment was moved before the debt had

become due for payment, while the attachment

was acually put to effect after the debt had become

due. Moreover, the attachment was in respect of a

debt jointly due to a judgement debtor with

another.

The fact that the application was filed before

the debt was due was not disputed. What was

contended was that since the attachment was

based on the application made before the debt

was due, it (the attachment) was in respect of a

contingent liability, and was therefore bad.

The High Court took the view that the date on

which application for attachment was made was

immaterial. It was the date on which attachment

was actually made that was of essence. Thus, if the

debt was due by the date on which attachment

was put to effect, the attachment was valid and in

order. It could not be questioned on the ground

that the application was made before it was due.

The contention was, therefore, rejected.

While dealing with the plea that the

attachment of a debt jointly due to a judgement

debtor with another was illegal, the Honorable

High Court referred to the Macdonald v. Tacquash

Gold Mines Co., [1884] 113 QBD 535. In this case

it was held that a debt owing by a garnishee to a

judgement debtor could only be attached to

answer a judgement debt if the debt was due to the

judgement debtor alone, and where it was due to

him jointly with some other person, it could not be

so attached.

The High Court further referred to the

judgement in Batcha v. Sulaiman Sahib, AIR 1956

Madras 163 wherein it was held that under Order

211 Rule 46 of the Civil Procedure Code the

attachment could be made of a debt due to the

judgement debtor alone, and not a debt due to the

judgement debtor and another.

The Honourable High Court, therefore, held

that the attachment ordered by the lower court was

not valid, and accordingly set aside the order of

attachment.




PROF. SYED SABIR ALI JAFFERYEx-Director General(Training & Statistics)Allied Bank LimitedKarachi

QUESTION:

Mr. Muhammad Ashraf of Bank AI-Habib Ltd.,

Karachi has addressed the following question.

Can the adverse information received from the

Credit Information Bureau of SBP in respect of an

intending borrower be passed on to that borrower

in order to:

(i) get rectified any misreporting by the CIB, and

(ii) convey specific reason for declining the

proposal ?

What procedure is to be followed for the

rectification of mis-reporting found in the CIB

report ?

Kindly answer in the light of prevailing banking

practice and Banking Companies Ordinance 1962,

Section 25-A.

ANSWER:

Sec. 25-A of the 1962 Ordinance deals with

the information provided to, or supplied by, the

CIB. No such thing as ‘misreporting' or its

‘rectification procedure' is dealt with by this

Ordinance.

The report that may have been furnished to

you by the CIB on any of your customers should

be based on the information provided to the CIB

by the previous bank of that customer. Ordinarily,

credit report of that bank on that customer should

already be on your file before you decided to

process his credit proposal. Moreover, his track

record with you along with his Basic Fact Sheet

compiled in compliance with Prudential

Regulation # R-3 should also fall in line with the

two reports.

Nevertheless, if you find the CIB report very

much in contrast with the report furnished by the

previous banker of that customer, and also with

your own experience about him, you may make a

reference to the Credit Division of your Head

Office, who, depending upon the merit of the case,

may like to seek clarification from the SBP.

As regards the second part of your question

pertaining to the passing on of the CIB report to

the concerned intending borrower as a reason for

your declining his credit proposal, it is advisable

not to do that. No reason is required to be given

for such decisions. Any adverse remark from you,

although simply a reproduction, tends to

jeopardize your interest at any stage.

Your attention is also drawn to sub-sections (2)

& (3) of Section 25-A of the Banking Companies

Ordinance 1962, which prohibit in unequivocal

expression disclosing of any such information to

any person. These sub-sections read as under:

“(2) Any credit information furnished by the

State Bank to a banking company under sub-

section (1) shall be treated as confidential and shall

not, except for the purposes of this section or with

the prior permission of the State Bank, be

published or otherwise disclosed.

“(3) No Court, Tribunal or other authority,

including an officer of Government, shall require

the State Bank or any banking company to

disclose any information furnished to, or supplied

by, the State Bank under this section.”


Questions and Answers on Practice and Law of Banking

QUESTION:

Mr. Ahsan Rafique, a student of MBA, has

asked the following question.

One bank is willing to extend credit facility

against the security of its TDR held in the name of

any person on charging the borrower only 2 % as

service charges. On the other hand, another bank

is agreeable to extend this facility only to the

person in whose name TDR is issued, and not to

any third person. Why this anomaly? Are there

any instructions in this regard by SBP?

ANSWER:

When the beneficiary of a TDR borrows

against that TDR, as a matter of fact, he borrows

his own money kept with the bank. It is for this

consideration that banks generally, and without

needing any formal directive from any quarter,

accommodate such borrowers on nominal

surcharge. It is also advantageous to either party,

as under:

1 . Normally, a part of the deposit is borrowed

when the maturity of the deposit is far away. In

the given example also Rs. 1 (m) are required

against a deposit of Rs. 2.5 (m). This advance

is likely to be adjusted well before the deposit

matures. Thus, the return on deposit far

exceeds the cost of the loan.

2. The deposit remains intact.

3. If, as an alternative, the depositor gets his TDR

encashed before maturity, he is required to

pay penalty at the prescribed rate, based on

the unexpired period of deposit. Further, he

loses the profit for the unexpired period of

deposit.

4. Once a deposit is encashed, chances of its

dissipation, partly or wholly, increase

tremendously.

5. The bank retains its deposit, which matters a

lot in the wake of present day fierce

competition among banks.

Advances against security of TDRs to persons

other than the beneficiaries of these TDRs do not

merit such consideration, and, therefore, are not

eligible for any preferential treatment. I doubt

whether any bank does it.

QUESTION:

A “banker” has sought answer to his following

query.

“A” is maintaining at my branch an account in

his sole name with “B” , a duly constituted attorney

of “A” , authorized to operate on the account

singly. “A” has since died. “B” desires to continue

with this arrangement on the basis of a clause in

the power of attorney which states that it shall

remain valid even after A's death. In the mean

time, “C” a son of “A”, has submitted an

application requesting to terminate the

arrangement, and allow him, in lieu of “B”, to

operate on the account of his deceased father.

What should I do?

ANSWER:

A power of attorney stands revoked with the

death of the donor. Any extension clause

incorporated in it, as in the question, is illegal and

unlawful, having no legal force. This should have

been taken note of while opening the account.

However, request of “B” should be turned down,

and operation in the account stopped.

Request of 'C' shall also not be entertained. He

should be advised to obtain succession certificate

from a competent court of law. You should act as

per the succession certificate.

QUESTION:

During one of my lectures in MBA Executive

Program on “Banking Practices in Pakistan”, one

of the course participants, a senior practising

banker, asked the following question, which,

according to him, was set in the Banking Diploma



Examination of the IBP almost a decade back, and

he was still on a hunt for a satisfactory answer to it.

Although appropriate answer was offered in the

class, it is reproduced here, along with the

question, for the greater benefit of those who may

wish to be so benefited.

A remittance of Rs. 50,000/- was received from

Bank Al-Jazeera, Jeddah for credit into Account

No. 1101 of Syed Rashid Ali. The account was

accordingly credited. Two days later, the

accountholder came to the branch to enquire his

balance, which was furnished to him, written on a

piece of paper. After another two days, a fax

message was received from the remitting bank

stating that the aforesaid remittance was meant for

the credit of Account No. 1011 running in the

name of S. Rasheed Ahmad. A request was made

to pass on the credit to the correct account. The

correcting entry was passed promptly by debit to

the former account. The very next day, on the eve

of half-yearly closing, statements of accounts were

dispatched to all the accountholders. After about

two weeks, a cheque for Rs. 50,000 drawn on A/c

No. 1101 was presented in clearing, which was

returned for want of sufficient balance in the

account. The party sued the bank for wrongful

dishonour, and claimed damages. The bank's plea

was that the statement of account sent to him a

fortnight ago was sufficient evidence of the credit

entry of Rs. 50,000/- having been reversed, and of

the available balance. How would you deal with

the case?

ANSWER:

The question pertains to the validity of the

statement of account. According to an earlier view,

when passbooks were not substituted by

statements of accounts, entries made in the

passbook were conclusive and unquestionable

record of the transactions between banker and

customer. This view was based on the judgment in

the case of Devaynes v. Noble, 1816 wherein it

was observed that on delivery of the passbook to

the customer, he “examines it and if there appears

any error or omission, brings or sends it back to be

rectified; or if not, his silence is regarded as an

admission that the entries are correct”.

Later, successive court judgments led to the

conclusion that there was no basis to hold that

when a customer returned the passbook to the

bank without making any objection, the account

between them is regarded as settled and is binding

on both. In Keptigalla Rubber Estate Co. v.

National Bank of India, his lordship on the bench

observed, “how absurd it would be to hold that the

taking out of the passbook and its return

constituted a settled account”.

A statement of account, unlike passbook, is not

required to be returned to the bank. Nevertheless,

the behaviour of the customer in not pointing out

any discrepancy is not tantamount to his

confirmation to the correctness of the statement.

Precisely, the entries on a statement of account are

taken only as prima facie evidence, and the law

does not impose upon the customer any obligation

to examine his statement of account.

In the given situation, the customer relying on

the balance advised to him by the bank drew

against it. It was not his obligation to check the

statement received in the meanwhile. Moreover,

by relying on the balance, he altered his position

by issuing a cheque in favour of the third party,

which the bank now cannot force him to reverse

without damaging his credibility.

The bank's negligence is evident from the

following facts.

(i) It debited the account arbitrarily, i.e. without

taking the accountholder into confidence. The

correct procedure should have been to inform

him about the mistake and the date, a

reasonable number of days ahead, when the

bank would reverse the entry, and request him

not to make any drawings. The reversing entry

should have been passed only after the expiry

of the stipulated period.

(ii) The bank relied on the statement of account,

expecting that the customer will scrutinize it

forthwith. This was not a valid plea, as the

customer was not duty bound to check the



entries made on the statement of account.

(iii) The customer altered his position. The bank

shall now be estopped from claiming

restitution.

(iv) The bank did not care to contact the

accountholder even at the time of returning his

cheque. An arbitrary decision to return the

cheque cannot be justified.

(v) The bank should also have asked the Aljazeera

to indemnify it should any loss be accrued to

it, which it did not do.

The principle was illustrated in the case of

Lloyds Bank Ltd. v. Brooks (1950) and was

reconfirmed in a more recent case United

Overseas Bank v. Jiwani (1976) where it was

clearly stated that the customer is liable to refund

the over-credited sum unless the bank is estopped

from claiming restitution. The bank could be so

estopped if the customer honestly believed that the

entries were correct, and in relying on it was misled

into materially altering his position to such an

extent that it would be inequitable to require him

to repay the money.

In view of the foregoing, the bank may have to

refund the money to the aggrieved customer, and

may also be required to pay damages as

determined by the court.



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