KARACHI, June 4: The World Bank has advised Pakistan to “sharpen” the legal and regulatory framework to reduce investment risks for general public by limiting the non-banks’ ability to borrow.

In a report, the World Bank has counselled “demarcating borrowing from the general public (widows and orphans), in whatever form, from borrowing from sophisticated and institutional investors (smart money)”.

The World Bank officials have, however, cautioned against limiting business lines of non-banking institutions, which, they feel, could easily lead to fragmentation rather than reduction of risk.

Since the commercial banks are the principal mobilizers of retail deposits, they are tightly regulated and supervised by the central bank. The situation in respect of NBFIs is now being improved through laws facilitating mergers and integration.

While stressing that risks to general investors should be reduced, the World Bank wants regulatory arbitrage to be limited between different financial instruments.

Investments in equities, modarabas, annuities and other insurance products are alternative to a bank deposit. Similarly, short-term fixed certificates of investments issued by the investment bank or leasing company compete with the commercial bank deposits. Hence the regulatory arbitrage needs to be limited, say World Bank officials.

The World Bank has identified three main issues in respect of non-banks that need improvement: Protection of general public from risky operations, avoidance of regulatory arbitrage and fragmentation of financial system.

New laws have been promulgated to change the old model of NBFIs (with a variety of separate, compartmentalized, specialized institutions, such as leasing investment banks and DFIs) that led to fragmentation of the financial sector and a proliferation of institutions with inadequate capital.

Now, such diverse business as leasing, investment banking, modaraba, venture capital, house-building finance, asset management, etc., can be done under one corporate umbrella and regulations have been amended to encourage mergers. For each type of business, separate capital has been prescribed.

The World Bank officials say a higher minimum capital, with improvements in information quality and disclosure helps reduce the risk return trade off to the public.

No new mergers have taken place since the new law has been promulgated, though market reports indicate that some are under consideration and might take place as soon as the current environment improves.

However, the market perception is that there are still some policies that tend to discourage financial integration.

For example, the authorities do not give approval to a local applicant for an asset management business and life insurance unless it is a joint venture with a foreign company, says a company executive.