UNDER the SBP Order 1948, the central bank, when it was established that year, was charged with “regulating the issue of bank notes and operating the currency and credit system with a view to securing monetary stability in Pakistan”.

This narrow mandate for a newly established central bank in a newly founded country was primarily meant for the issuance of the national currency as well as the rehabilitation of banking faculties that were largely disrupted in the wake of partition.

Since these objectives were successfully met in a short span of just eight years, it was considered necessary to assign the role of a full-fledged central bank to the State Bank of Pakistan (SBP).

This was done through the SBP Act 1956, where the bank was made responsible for three distinct tasks: regulation of money and credit system; fostering growth in the best national interest; and fuller utilisation of the country’s productive resources.

This legal authority helped the SBP emerge as an effective regulator and supervisor of the banking sector till the 1970s. But certain developments of the 1980s made it vulnerable in the 1990s.

What will happen if the SBP fails to achieve the desired results despite having full autonomy?

The decade of the nineties is very important in Pakistan’s banking history. At the start of this decade, all commercial banks in the country went into red (loss) mainly due to the misuse of bank credit by influential borrowers in agricultural and industrial sectors under different development schemes started at the behest of the SBP.

This situation started debates in different policy circles for banking reforms with the main focus on the SBP’s autonomy and a market-based banking system that was free from the influence of politicians and bureaucrats. In 1997, the SBP Act 1956 was amended to grant autonomy to the central bank. And the remaining agenda for commercial bank reforms was also completed in the next two years.

Pakistan was expected to enter the 21st century with an autonomous central bank and viable commercial banks, as both were provided with legal mandate to work in the best interest of the country. However, the performance of banking sector in the coming years, by and large, remained under criticism on different accounts.

Arguments forwarded in support of autonomy are very interesting and convincing. Theoretically, a central bank is the creator of money, while the government is the user of money. Therefore, the creator of money should not be under the thumb of the user of money. Furthermore, the central bank belongs to the country and not to the sitting government, so it should work in the larger national interest.

However, practically, an autonomous and independent SBP has to work in collaboration with the sitting government, which is also the appointing authority of the chief executive and the board of directors of the central bank. Thus, for meaningful autonomy, constitutional protection is provided for the tenure of the chief executive and the members of the board of directors, which enables them to independently prepare and implement the monetary policy.

In simple words, autonomy empowers a central bank to refuse accommodation to the government if it considers it counterproductive for the economy. And the amended SBP Act 1956 provided both types of independence to the SBP — a protected tenure of three years for the governor and the board of directors and the right to refuse more-than-agreed-upon supply of funds from banks to the government.

The latest amendments made in the SBP Act 1956 are of two types. Some are of ordinary nature, like those that give the SBP the power to inspect commercial banks and status of lender of last resort; and those that further its role in promoting Islamic banks and protecting deposits etc.

And then there is again the issue of the SBP’s autonomy. Presently, the SBP is facing two main problems from the government: larger loans and too much interference in foreign-exchange management.

To overcome these problems, a new arrangement has been proposed in the latest amendment. A statutory monetary policy committee will formulate the monetary policy and the exchange rate policy etc and get these approved by an independent board of directors instead of the government.

There was no demand from any quarter for amending the banking law for this purpose. Rather, there was much criticism on the SBP for not implementing the autonomy it was already provided with under the previous law. Only the IMF was repeatedly asking for giving more autonomy to the SBP during its period reviews.

In developing countries, interference from sitting governments is a known and accepted fate for central banks. The Reserve Bank of India is also going to amend its banking law to make itself more independent from the government in the conduct of monetary policy.

There is a serious need to devise an implementation mechanism for autonomy, and it also needs to be made part of the legal framework. What will happen if the SBP fails to achieve the desired results despite having full autonomy?

During the past eight years of democratic rule, some chronic imbalances in our economy have intensified. For example, the repayment of the huge heap of government debt will remain a difficult task for the existing and the coming government. And this has happened in the presence of an autonomous central bank.

The recent amendment has put a great responsibility on the SBP’s shoulders. To accomplish the new task in the desired manner, it has to increase manifold its analytical capability as well as the level of intellectual honesty as all eyes are now focused on it now that it has been made autonomous once again.

The writer is president, Institute of Banking and Business Learning.

munir5911@outlook.com

Published in Dawn, Business & Finance weekly, December 21st, 2015