The State Bank of Pakistan (SBP) has invited comments and suggestions by 31st March 2004 on the draft 'Guidelines on Internal Controls' (ICs) to encourage the banks/DFIs to institute adequate internal control system commensurate with the nature
, complexity, and risk inherent in their activities and responsive to the changing environment.
These guidelines apply to all the banks/DFIs. According to the SBP, the control activities contained in this guide are not presented as all-inclusive or exhaustive of all the specific controls appropriate in each department/activity of banks/DFIs. Over time, controls may be subject to change to reflect changes in our operating environment.
A properly designed and strictly enforced system of internal controls helps protect the organization's assets and profitability from operational losses, frauds and forgeries, produces reliable financial and management reports, helps compliance with laws and regulations, and finally, creates value for the stakeholders.
The new guidelines aim at bringing our local practices to the level of the best practices in the developed world. It is more of re-focussing attention to the key areas having strong bearing on the existence, organisational structure, growth and profitability of banks and the DFIs.
One Control Principle in the SBP draft states that the costs associated with control processes should not exceed expected benefits. The costs are easily quantifiable but the benefits are not that easy. In the banking institutions, the ICs are sometimes relegated to a secondary level by creating a situation of high costs that are termed as 'unnecessary'.
To avoid such situations it would be appropriate that the costs associated with the ICs be linked to the volume of total assets or the business volume. The quality and the commitment of the personnel assigned to the ICs function and the costs allocated to this head might be carefully monitored.
The Control Principles provide that the documented policies and procedures promote employee understanding of duties and help ensure continuity during employee absences or turnover.
The ICs draft also provides an additional reference tool for all managers to identify and assess basic weaknesses in operating controls, financial reporting, legal/regulatory compliance and to take action to strengthen controls where needed.
By developing effective compliance programmes, management can contribute to reducing the bank's potential liability from fines and penalties that could be imposed for violations. This is typical of the supervisory authorities. It is urged that the SBP and other supervisory authorities also suitably modify their approach to supervision in line with the present day conditions.
Until recently, some of the banks/DFIs had the culture of dubbing as 'negative' the officers who strictly followed the rules in business and were often superseded or discriminated in promotion probably because of the 'negative' image they carried.
It is presumed that with the introduction of the ICs now the SBP will also be taking measures so that the officers who go by the rules are not penalized in their postings and promotions.
A clear message need to be passed that whosoever violates the prescribed policies and procedures shall be taken to task. Thorough understanding and knowledge of the prescribed policies and procedures by the employees at different levels might be useful in the application of the ICs and must be appreciated by the management as well as the external supervisory authorities.
Lessons learnt from banking crisis have been adopted in the form of widely accepted 'Controls Principles' and have been included in the SBP draft. For example, if any employee or a member of the Board has a potential conflict of interest in any bank transaction, the fact should be brought on record and that person should never participate in decision making in that matter. Another principles could be arm-length transaction when the bank is dealing with a sister company or associated concerns.
One cardinal principle is the separation of the executive and the supervisory authority in the banks/DFIs. The Chief Executive Officer/the Managing Director and the Chairman of the Board of Directors should be two different persons.
Historically, the Joint Venture DFIs in Pakistan have had such an arrangement throughout. As against this, the Pakistani DFIs or banks were mostly having the same person as the CEO/MD who was also the Chairman of the Board of Directors.
The Joint Venture DFIs have been mostly profitable since inception whereas the Pakistani banks and DFIs had mixed results. This principle might be considered for making part of the new ICs.
These days the banks and DFIs are making lot of money from trading of shares on the stock exchanges. There might be cases where the officers handling or approving these transactions are also engaged in trading of shares on their personal accounts.
These people might also be aware of affairs/developments of their borrower companies. It is apprehended that there might be certain cases, which sometime border the insider trading. The proposed Guidelines might also add a control principle to effectively check potential malpractices in this area.
The proposed Guidelines might also protect the legitimate interests of two important stakeholders namely, the bank borrowers and the depositors. The banks and the DFIs are expected to be fair to both the groups.
The bank borrowers should not be given the short shrift in the methodology used in calculating interest/mark up or other fees or charges collected from them.
These days the SBP has been trying to sort out the disagreements between the banks and the borrowers over the past due interest/mark-ups. As regards the depositors, the banks and the DFIs might not be allowed collection of unduly large fees or charges for their services or the levy of penalty for failure to maintain the minimum balance in their bank accounts. Certain banks are prescribing unreasonably large minimum balance to discourage the depositors.
Sometimes, the banks do not allow credits on timely basis to the depositors' accounts for encashment of government securities. The SBP might consider introducing Fair Practices Principle to give solace to these two groups under the proposed Guidelines.
The draft Guidelines states that the success of control environment is judged according to; the integrity, ethics, and competence of personnel; the organizational structure of the institution; oversight by the board of directors and senior management; management's philosophy and operating style; attention and direction provided by the board of directors and its committees, especially the audit and risk management committees; personnel policies and practices and; external influences affecting operations and practices.
Now that the Guidelines on the ICs are about to be formally prescribed for the first time, the SBP might consider requiring the banks and the DFIs to help compile a comprehensive report on all respects.
The SBP has been doing very well by issuing new guidelines and by amending the existing ones as per needs of the current situation. However, one glaring omission is that not much appears to be done to better safeguard the interest of the depositors, especially the return paid to them. The banks receiving these deposits are making big profits. The pay out to the depositors have no link with the bank profits.
Depositors are hard hit especially the ones who are old and are dependent on the profits from their life savings. The SBP is urged to explore this area urgently. The depositors expect the return to be at least equal to the inflation in the country, after covering Zakat and withholding tax.
