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SBP proposes rules to end traditional badla financing

KARACHI (November 07 2003): The State Bank of Pakistan (SBP) in its draft regulations on margin financing has proposed an increase in minimum margin, bank/DFIs to lend money only to credit rated brokers and lending is limited to a maximum of 20 percent of their paid-up capital and reserves.

The SBP has posted draft regulations for financing of brokers by banks and DFIs. These regulations have been issued with a view to facilitating the transition from badla financing to margin financing.

The SBP aims to encourage the active participation of banks/DFIs in the area, and has invited comments on these regulations by November 20, 2003.

Banks/DFIs will extend margin financing to only those broker, who are incorporated as limited companies, and credit rated from a credit rating agency on the approved panel of State Bank of Pakistan.

The State Bank is not prescribing any minimum credit rating for the eligibility purposes.

The sole objective is to ensure that the lending bank/DFI gets this important information before taking exposure on any broker.

The regularisation period of one-year from the date of issuance of these regulations is granted to those brokers, who are not credit rated.

The margin financing shall be provided by banks/DFIs only against approved shares in Central Depository Company of Pakistan.

The brokers availing the margin financing from banks/DFIs would be prohibited from lending, the funds obtained from banks/DFIs or their own funds, directly or indirectly to either their own or of lending bank's connected entities, directors or major shareholders and relatives of directors or major shareholders.

RISK MANAGEMENT AND INTERNAL CONTROLS: Before undertaking margin financing, the banks/DFIs will prepare comprehensive policies and procedures for the purpose.

The policies in this respect will be duly approved by the Board of Directors, if not already covered appropriately in the current credit policy.

The banks/DFIs will obtain legal opinions to ensure that the manner in which they are accepting shares (especially those of the clients/customers of the broker) as collateral is legally sound, the documentation (including the authority/consent of the clients/customers of the broker in case their shares are being pledged) is sufficient to create an effective pledge over the collateral and they are fulfilling all the legal requirements appropriately.

In order to bring uniformity, the Pakistan Banks Association will prepare Master Agreements and Standardised Documents for the purposes of extending margin financing to brokers.

Banks/DFIs will put in place an effective system for monitoring margins and their exposures on the shares of various companies and brokers, keeping in view the quantum of their margin financing.

They would review, on an ongoing basis, their exposure in margin financing with a view to assessing the risks due to volatility in assets prices.

The surveillance and overall monitoring of a banks/DFIs' investment in shares, margin financing, financing against shares, etc will be done by a separate and independent committee of the bank/DFI.

The Committee will review the total exposure of the bank to capital market, besides ensuring compliance with all the SBP regulations, relevant rules, laws and policies and procedures adopted by the bank/DFI.

MARGIN REQUIREMENTS: Banks/DFIs will provide margin financing only against the security of approved shares.

A minimum margin of 30 percent of the current value of the shares will be retained by the bank/DFI at all times. They may, however, set higher margin, if they so desire.

They will monitor the margin on at least once a day basis, and will take appropriate steps for top-up and sell-out on the basis of their approved policy in this respect and agreements with their customers (brokers). For the purpose of this regulation, value shall be based on the last closing price of the share on the preceding market day.

PER PARTY LIMIT: Banks/DFIs must make efforts to avoid concentration of margin financing to a few brokers. In this respect, they may prescribe internal limit for margin financing to a single broker.

It is expected that the margin financing would be spread out by a bank/DFI amongst a reasonable number of brokers.

A bank/DFI shall not extend financing to any broker in excess of 20 percent of its own paid up capital and reserves.

The total margin financing portfolio, at any given point in time, should not exceed the paid-up capital and reserves of the bank/DFI.

The total financing, including margin financing, availed by a broker from the financial institutions shall not exceed 10-times its paid-up capital and reserves, subject to the condition that margin financing will not exceed five-times its paid-up capital and reserves.

Banks/DFIs shall make arrangements to effectively monitor this limit in co-ordination with each other.

For this purpose, the banks/DFIs shall obtain, at least on weekly basis, detail of total financing facilities availed by a broker from various financial institutions.

The total margin financing against the shares of one company will be determined by the Bank/DFI.

However, such total financing should not exceed 10 percent of the paid-up capital and reserves of the bank/DFI extending margin financing.

The banks are cautioned that they should keep in mind and ensure compliance at all times with the requirement of subsection (2)of Section 23 of the Banking Companies Ordinance, 1962 which requires that they do not hold shares, whether as pledgee, mortgagee or absolute owner, in excess of 30 percent of the paid-up capital of the company.

The DFIs are also advised to ensure compliance with this requirement.

Banks/DFIs in breach of limits mentioned above will ensure compliance with these limits within three months of date of issuance of these regulations.

While extending financing to brokers, banks/DFIs shall ensure that they remain compliant with the overall limits set in Prudential Regulations.

The margin financing extended to the directors or major shareholders of a broker shall be considered a part of the margin financing allowed to the broker for the purposes of these regulations.

The limits mentioned above are overall financing limits and total financing facilities to brokers (eg working capital financing, financing against receivables of brokers, financing to brokers for their proprietary trading, or any other financing to brokers by whatever name called) should not exceed the limits prescribed above.

Further, for the purposes of monitoring and better controls, the banks will keep separate records of the following facilities:

(I) Financing against the shares of clients of brokers. Financing against own shares of brokers,(ii) Financing against receivables of brokers, (iii) Working capital finance against any other security, and (iv)Any other financing facility to brokers.

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