In the 1990s, the Asian Development Bank had suggested a change in the supervisory set-up of the financial services sector, and to implement it, ADB had provided funding support.

That change converted the Corporate Law Authority into Securities & Exchange Commission of Pakistan (SECP), and in 2002 SBP handed over the regulation of Non-Bank Financial Companies (NBFC) to SECP, admitting SBP’s lack of capacity there for.

However, it fell short of bifurcating monetary management and financial sector supervision and their assignment to two independent authorities. In August 2007, continued pressure for reform of market regulation prompted the drafting of a bill to set up a ‘Financial Services Commission’ but a hot debate between SECP and SBP over bifurcation of authority prevented the enactment of that controversial bill.

That debate has been revived by the SBP, though now it is over the extent of enlargement in the regulatory ambit of the SBP, not the creation of a regulator along the lines of Britain’s Financial Services Authority (FSA). This shift in thinking has generated arguments both for and against it, though both overlook capacity – the critical ingredient – more important than the regulators’ number and their jurisdictions.

SBP’s bid for enhancing its supervisory and regulatory authority implies bringing back 23 NBFCs (12 leasing and three housing finance companies, and eight investment banks) within its jurisdiction besides dozens of bank subsidiaries. The Leasing Association of Pakistan (LAP) is believed to have conveyed its reservations over the move to the ministry of finance, and to overcome them SBP met LAP’s office bearers on July 8.

SBP’s logic for its move, firstly and quiet rightly, is that commercial banks have become cheap funding sources (via their grossly under-paid depositors) for propping up banks’ leasing, investment banking, asset management, brokerage, and insurance subsidiaries. Secondly, in this backdrop, to ensure depositor protection, the deposit/fund mobilisation activities of the NBFCs require SBP supervision.

Finally, because of their intricate linkage to the system as bank subsidiaries, the risk of NBFC failures has magnified the systemic risk because there have been instances wherein banks linked to NBFCs came under stress or even closed. Put these arguments together and you get a sense of the rising systemic risk that builds a case for unified supervision of banks and their subsidiaries.

But the option to limit the chances of crystallisation of risk should be based on improved focus on the risk creation processes, and continuity of efforts needed to make institutional response both adequate and robust, not reducing regulation to a ritual that is bureaucratically convenient. SBP’s strategy doesn’t serve even that purpose because it overlooks the role of ‘capacity’ in focused and effective supervision.

By SBP’s own admission, it is not satisfied with banking sector response to regulation; to burden itself with a larger jurisdiction would only complicate matters. Second, effective supervision implies a large and skilled manpower, its allocation to various market segments on a rational basis, and a robust data processing infrastructure for real-time monitoring of the market players. None of these is in abundance.

Even otherwise, the basic issue is efficacy of combining monetary management with business activity supervision. Experience shows that it is wiser to separate the two to do justice to both; combining them under one roof creates a conflict of interest: during periods of stress, central banks tend to delay crucially important remedial steps on the monetary management front to let poorly managed outfits survive.

The current debate between SBP and SECP is more of a fight for larger fiefdoms than for sharing regulatory authority based on ground realities i.e. the impact of too rapid and excessive deregulation, malpractices that it encouraged, and the failures of the existing regulator-supervisors to effectively ‘supervise’ institutions to blunt the process of decay that is destroying the very roots of the system.

The supervisory capacity residing in SBP and SECP requires impartial assessment because both lack capacity in terms of requisite size of manpower with purpose-oriented skills, market knowledge and stress forecasting abilities to limit market volatility, clarity and focus of supervisory aims, and the realisation that, in isolation, fines only place a price on regulatory violations, not prevent them.

Market players take advantage of the disorganised and weak institutional arrangements for credit referencing, contract registration, asset valuation, and custodial services for storage, up-keep and security of real assets financed by banks or accepted as collateral. Worse still, relying on regulators’ incapacity to supervise and probe their affairs, market players fearlessly confront them once too often.

These vulnerabilities are compounded by the inadequate support the regulators get from law enforcers and the judiciary. This combination of unattended weaknesses dilutes regulation. That’s why broad daylight regulatory violations are alarmingly high, and market volatility is the order of the day. All this highlights the need for ‘supervision’ being taken as a distinct activity, and a separate institution there for.

Given the variety of services and products the financial services sector now offers, supervision is a tall order requiring a variety of expertise smarter than that of the market players’, and the increasing number of financial institutions requires commensurate increase in the staff strength of the supervisors. The demands imply creation of a separate authority to supervise market players’ business operations.

The crux of the problem is ‘ability’ that weakens in direct proportion to the number of objectives an institution aims to achieve. Given the size of the financial services sector, monetary management requires full-time focus on macro indicators and a substantially stronger muscle to prevent volatility-triggered market trends from turning into unmanageable propositions, as they frequently do now.

To credibly enforce good corporate governance, and let shareholders know on a timely basis what the boards and managements of their companies are doing with their money, we need a separate corporate affairs regulator. In effect, we need independent regulators for (a) monetary/exchange rate management, (b) business activity supervision and, (c) authorised and judicious utilisation of shareholder funds.

After the BCCI debacle, Britain assigned these functions to separate regulators. Bank of England now regulates the monetary and exchange rate system, FSA supervises all the financial services, and the Registrar of Companies regulates company-shareholder affairs. All have performed well despite the huge challenges posed by Britain’s not joining the Euro club.

This system has successfully existed in another 49 countries. We need to follow suit. Let us not also forget that correctly focused, adequate for the market size, and truly independent regulators are a pre-condition for attracting foreign investment – something we badly need.