Special Edition-07.pdf - Lahore School of Economics

The Post-Reform Era Maintaining Stability and Growth 83
sooner or later the exchange rate comes under pressure. For example, in
times of inflation, if the monetary authority were to raise interest rates and
they become higher than the international rates, it will encourage capital
inflows and will depress the real exchange rates.
Banking Regulation and Supervision - Solvency
Improvements in the system of banking regulations and supervision
at the SBP has been one of the leading items from the start of the reform
period and it has paid rich dividends. Since then it has undergone a
significant transformation and the system that prevails today is far superior
than it was at the start of the reforms. Its procedures and practices have
been modernized and these are as sophisticated as one would expect to find
anywhere among the leading countries. The process is supported by the
installation of an upgraded payments system, IT facilities at the SBP as well
as at leading banks, thereby significantly improving the speed and accuracy
of financial information flow so vital for banking supervision.
A major change from the old to the new is transparency in the
processes of supervision and regulation as to what is being regulated and
why and by whom. There hardly was any meaningful information flow in the
public arena concerning the operations of financial institutions, much less
on the state of their financial health or their relative standing with regard to
impaired capital and other systemic weaknesses that were at the root of
their financial distress. This information flow, together with the analysis and
evaluation of financial institutions, started with the launching of annual
series of FSA and BSR reports. This transparency is critical in the postreform
era if stability, soundness and solvency of the financial system are to
be achieved.
Nearly all banking and financial crises that have erupted during the
previous decades, occurred in countries which had a well established system
of supervision and a full awareness of the potential for crisis. It seems that
no amount of banking supervision is sufficient enough to prevent the
emergence of crises, and that is a sobering thought. In times of financial
distress, banks and quasi-banking institutions have a way of going belly-up,
not because of any lack of supervision, but mainly because of excesses of
placements, untenable risk exposure, and herd behavior in garnering golden
opportunities of profit or large capital gains in a red-hot market, be it the
loan market, financial market, exchange market, or real estate market. That
is why there is such rapidity in the onset of the crises and its monumental
dimensions, once it unravels. This has happened in developed countries such
as Japan and the US during the 1990s when a few large commercial banks