Challenges facing Pakistan on the banking sector front are full and formidable. Our response, therefore, cannot and should not be incomplete and fragmented. Unfortunately, though, this seems to have been the case till now. How soon the upcoming government realises this and corrects the course of action is yet to be seen.

One key challenge is capital flight and money laundering. Capital flight is a drain on foreign exchange reserves. Any real or perceived involvement of Pakistani citizens or institutions in money laundering makes it difficult to attract foreign exchange from the outside world.

Ideally, we should have realised long ago the perils of capital flight and money laundering and put our house in order. But all we have been doing for the past few years is tightening our anti-money laundering rules when inaction becomes unaffordable.

The State Bank of Pakistan (SBP) has recently launched a framework of governance for overseas operations of banks. The move precedes an upcoming visit of the Asia-Pacific Group of the Paris-based Financial Action Task Force (FATF).

New guidelines require that banks should bring back at least 50pc of their after-tax profits made from overseas operations

The group will examine whether we’ve tightened the loose ends of our anti-money laundering policy. Based on its findings, the FATF will decide whether to keep us on its watch-list.

The SBP document provides an elaborate framework for the governance of overseas operations of banks. If banks run their foreign operations according to the guidelines, their capacity to understand, identify and manage the risks in foreign operations will increase.

One purpose of the said framework is to help banks keep up with “the changing dynamics of foreign environment” in which they operate. Further strengthening “the governance, risk management and compliance practices for banks’ overseas operations” is another obvious purpose.

The guidelines follow the imposition of a penalty on Habib Bank Ltd (HBL) by the Department of Financial Services of New York in 2017 and the signing of a new agreement by United Bank Ltd (UBL) with New York’s Federal Reserve Bank last month to strengthen its compliance with the anti-money laundering programme.

Identifying and managing the risks in foreign operations of banks do not only require enhanced capacity of bankers, but also greater involvement from their boards of directors, separate monitoring of overseas operations and more frequent reporting to the central bank. The SBP governance guidelines take care of all these elements. For example, banks with foreign assets worth $1 billion “shall consider forming a separate sub-committee” of the board of directors to monitor overseas operations.

Besides, the guidelines require each local bank with overseas operations to develop a comprehensive risk governance framework of its own within six months. They also require banks to develop a mechanism within three months to ensure that their boards of directors oversee and evaluate the performance of their foreign branches or subsidiaries, sub-subsidiaries or joint venture operations.

One key feature is that banks will now have to bring back to Pakistan at least 50 per cent of their after-tax profits made from overseas operations. This will mean some additional foreign exchange inflow. But that will not be enough to make an impact on our foreign exchange reserves in the short run, senior bankers say.

A careful look at the governance framework for banks’ overseas operations drops a few hints about how the SBP will possibly respond to their failure in overcoming compliance weaknesses in the future.

One particular clause of the framework says that the responsibility will be fixed on individuals for not complying with the host country’s regulatory instructions and that there will be a zero tolerance for non-compliance.

Pakistani banks run a network of around 100-plus overseas branches, booths and offshore banking units. Senior bankers say that following the guidelines given by the SBP, individual banks will immediately begin building their own framework of governance for these entities. Given the rising political polarity among big powers and growing regional and sub-regional conflicts, keeping banking institutions free from the undesirable influence is just too difficult.

In the recent past, overseas operations of our banks failed in identifying and mitigating risks for a number of reasons, including incompetence shown by the officials posted in foreign branches, bankers point out. They claim that wilful involvement of bankers in any wrongdoing in international branches happens rarely.

“It’s the incompetence of people and their lax attitude that create a mess not only in overseas operations but also local banking,” according to a senior executive of one of the five largest commercial banks. “Little do they realise how their own bank and the Pakistani nation at large pay the price for their incompetence and negligence,” he lamented.

The SBP now wants all banks to maintain a separate system-based log or inventory of observations related to their overseas operations. The objective must be to record the risk and control deficiencies or gaps identified by internal or external auditors as well as compliance departments and to ensure timely rectification.

It wants chief compliance officers of banks at their headquarters to submit a half-yearly “compliance report” to their boards of directors or the relevant sub-committee providing complete details of the compliance status to the host country’s regulatory requirements, inspection reports and the gaps therein along with the action plan to bridge those gaps.

“This actually is very important. Once implemented in letter and spirit, it will help us avoid any direct action from the regulatory authorities of the host country of our overseas operations,” according to a senior compliance officer of a major bank. “Normally, there’s always a time lag of no less than a year between the gaps identified by financial regulators and harsh penal actions.” —MA

Published in Dawn, The Business and Finance Weekly, August 13th, 2018