PRUDENTIAL REGULATIONS

FOR SMALL AND MEDIUM

ENTERPRISES FINANCING

BANKING POLICY AND

REGULATION DEPARTMENT
STATE BANK OF PAKISTAN
 THE TEAM

NAME DESIGNATION TELEPHONE NO. & E-MAIL

Muhammad Kamran Shehzad Executive Director (92-21) 9212512

[email protected]

Syed Irfan Ali Director (BP & RD) (92-21) 9213580

[email protected]
Inayat Hussain Director (BID) (92-21) 9211059
[email protected]

Mohsin Rasheed Joint Director (92-21) 9212434

[email protected]
Allauddin Achakzai Jr. Joint Director (92-21) 2453519
[email protected]

Website Address: www.sbp.org.pk

 CONTENTS

PART-A Definitions. 9
PART-B Regulations. 15

Regulation R-1 Sources and capacity of repayment and 15

cash flow backed lending.

Regulation R-2 Personal guarantees. 15

Regulation R-3 Limit on clean facilities. 15

Regulation R-4 Securities. 16

Regulation R-5 Margin requirements. 16

Regulation R-6 Per party exposure limit. 16

Regulation R-7 Aggregate exposure of a bank / DFI 17

on SME sector.

Regulation R-8 Minimum conditions for taking exposure. 17

Regulation R-9 Proper utilization of loan. 18

Regulation R-10 Restriction on facilities to related parties. 18

Regulation R-11 Classification and provisioning for assets. 18

Annexures - 23-33
 PREFACE

Keeping in view the important role of Small and Medium Enterprises (SMEs) in the
economic development of Pakistan and to facilitate and encourage the flow of
bank credit to this sector, a separate set of Prudential Regulations specifically for
SME sector has been issued by State Bank of Pakistan. This separate set of
regulations, specifically tailored for SMEs, is aimed at encouraging banks / DFIs to
develop new financing techniques and innovative products which can meet the
financial requirements of SMEs and provide a viable and growing lending outlet
for banks / DFIs.

Banks / DFIs should recognize that success in SME lending requires much more
extensive involvement with the SMEs than the traditional lender-borrower
relationship envisages. The banks / DFIs are, thus, encouraged to work in close
association with SMEs. The banks / DFIs should assist and guide the SMEs to
develop appropriate systems and effectively manage their resources and risks.

The banks / DFIs are encouraged to prepare a lending program (including

detailed eligibility criteria) for each specific sub-sector of SME in which they want
to take exposure in a significant manner. For this purpose, the banks / DFIs may
conduct / arrange surveys and research to determine the status and potential of
specific SME sub-sectors. It is expected that banks / DFIs would prepare
comprehensive guidelines / manuals and put in place suitable mechanism /
structure, aided by proper MIS, to carry out the activities related to SME financing
in an effective way. This should, however, not stop banks / DFIs from lending to
SMEs before undertaking the steps mentioned above as the banks / DFIs may
start soft lending operations or test marketing campaigns, as they feel appropriate,
to gain experience and necessary know how. The factors mentioned above gain
more importance and become critical for the success of a bank / DFI in SME
lending, as the exposure of the bank / DFI on SMEs becomes a significant portion
of its loan portfolio.

State Bank of Pakistan encourages banks / DFIs to lend to SMEs on the basis of
assets conversion cycle and future cash flows. A problem, which the banks / DFIs
may encounter in this respect, is the lack of adequate information. In order to
overcome this problem, banks / DFIs may also like to prepare general industry
cash flows and then adjust those cash flows for the specific borrowers keeping in
view their conditions and other factors involved.

As mentioned above, presently most of the SMEs in Pakistan lack sophistication

to have reliable and sufficient data and financial information. In order to capture
this data and information, banks / DFIs will need to assist and guide their SME
customers. The banks / DFIs may come up with the minimum information
requirements and standardized formats for this purpose as per their own
discretion. For better understanding and to facilitate their SME customers, banks/
DFIs are encouraged to translate their loan application formats and brochures in
Urdu and other regional languages.

Banks / DFIs should realize that delay in processing the cases might frustrate the
SMEs. Banks / DFIs are therefore encouraged to process the loan cases
expeditiously and convey the decision to the SME borrowers as early as possible

In order to encourage close coordination of the officials of the banks / DFIs and
SMEs, the banks / DFIs may require the concerned dealing officer to regularly visit
the borrower. For this purpose, at a minimum, the dealing officer may be required
to pay at least one quarterly visit and document the state of affairs of the SME. In
addition, an officer senior to the ones conducting these regular visits may also visit
the SME at least once in a year. The banks may, at their own discretion, correlate
the frequency of visits with their total exposure to the SME borrower.

State Bank of Pakistan will closely monitor the situation on an ongoing basis and
work proactively with banks / DFIs to make SME financing a success. During this
process, we will keep on reviewing regulatory framework to ensure that any
impediment is immediately removed while ensuring that banks / DFIs observe due
prudence and necessary oversight.

SYED IRFAN ALI

Director
Banking Policy & Regulation Department
 PART – A
DEFINITIONS

For the purpose of these regulations:

1. Bank means a banking company as defined in Banking Companies

Ordinance, 1962.

2. Borrower means a SME on which a bank / DFI has taken any exposure
during the course of business.

3. Corporate Card means credit card issued to the employees of a SME where
the repayment is to be made by the said SME.

4. Contingent liability means:

(a) a possible obligation that arises from past events and whose existence
will be confirmed only by the occurrence or non- occurrence of one or
more uncertain future events not wholly within the control of the
enterprise; or
(b) a present obligation that arises from past events but is not recognized
because:
(i) it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient
reliability;
and includes letters of credit, letters of guarantee, bid bonds / performance
bonds, advance payment guarantees and underwriting commitments.

5. DFI means Development Financial Institution and includes the Pakistan

Industrial Credit and Investment Corporation (PICIC), the Saudi Pak
Industrial and Agricultural Investment Company Limited, the Pak Kuwait
Investment Company Limited, the Pak Libya Holding Company Limited, the
Pak Oman Investment Company (Pvt.) Limited, Investment Corporation of
Pakistan, House Building Finance Corporation and any other financial
institution notified under Section 3-A of the Banking Companies Ordinance,
1962.

6. Documents include vouchers, cheques, bills, pay-orders, promissory notes,

securities for leases / advances and claims by or against the bank / DFI or
other papers supporting entries in the books of a bank / DFI.

7. Equity of the Bank / DFI means Tier-I Capital or Core Capital and includes
paid-up capital, general reserves, balance in share premium account,
reserve for issue of bonus shares and retained earnings / accumulated
losses as disclosed in latest annual audited financial statements. In case of
branches of foreign banks operating in Pakistan, equity will mean capital

9
 maintained, free of losses and provisions, under Section 13 of the Banking
Companies Ordinance, 1962.

8. Equity of the Borrower includes paid-up capital, general reserves, balance

in share premium account, reserve for issue of bonus shares and retained
earnings / accumulated losses, revaluation reserves on account of fixed
assets and subordinated loans.

The Preference Shares, only with the following features, will also be included
in the equity of the borrower:
• There should not be any provision for redemption or the redemption
should be at the option of the issuer.
• In case the issuer is given an option to redeem the preference shares, as
per agreed terms and conditions, the issuer will redeem the share only
through a sinking fund created out of the profits of the company. Further,
the sinking fund created for this purpose would not be calculated towards
the equity of the issuer.
• The terms and conditions should not give rise to a contractual obligation
on the part of the issuer to deliver another financial asset or exchange
another financial instrument under conditions that are or can be
potentially unfavourable to the issuer. However, an option to convert
preference shares into common shares may be included in the features
of the preference shares.
• The terms and conditions of the preference shares should not be such as
to compel the issuer economically, financially or otherwise to redeem the
shares.
• Payment and distribution of dividend to the holders of preferred shares,
whether cumulative or non-cumulative, should be at the discretion of the
issuer.

Revaluation reserves will remain part of the equity for first three years only,
from the date of asset revaluation, during which time the borrower will
strengthen its equity base to enable it to avail facilities without the benefit of
revaluation reserves. However, if a borrower gets revaluation during the
three years period, the borrower will be allowed the benefit from fresh
revaluation, to the extent of increase in revaluation reserves, but restricting
the benefit of such incremental value to 3 years only. Similarly, if after 3
years, the borrower again gets revaluation of the assets with resultant
addition in their value, the benefit of such revaluation may also be allowed
for the next 3 years, again to the extent of increase in revaluation reserves.

The revaluation reserves to be eligible for benefit should be calculated by the

valuers on the approved panel of the PBA. If the bank / DFI obtains copy of

10
 accounts as per requirement in Prudential Regulation R-3, then such
revaluation reserves should appear in the said accounts, and in such case,
no parallel calculation by the banks / DFIs for amortization purposes will be
required. In case of no requirement of copy of accounts, the borrower may
still be given the benefit of revaluation reserves in the way mentioned above,
but the bank / DFI will calculate the amortization of the same independently.

9. Exposure means financing facilities whether fund based and / or non-fund

based and include:
(i) Any form of financing facility extended or bills purchased/ discounted
except ones drawn against the L/Cs of banks / DFIs rated at least ‘A’
by Standard & Poor, Moody’s, and Fitch-Ibca or credit rating agency on
the approved panel of State Bank of Pakistan and duly accepted by
such L/C issuing banks / DFIs
(ii) Any financing facility extended or bills purchased/discounted on the
guarantee of the person.
(iii) Subscription to or investment in shares, Participation Term Certificates,
Term Finance Certificates or any other Commercial Paper by whatever
name called (at book value) issued or guaranteed by the persons.
(iv) Credit facilities extended through corporate cards.
(v) Any financing obligation undertaken on behalf of the person under a
letter of credit including a stand-by letter of credit, or similar instrument.
(vi) Loan repayment financial guarantees issued on behalf of the person.
(vii) Any obligations undertaken on behalf of the person under any other
guarantees including underwriting commitments.
(viii) Acceptance / endorsements made on account.
(ix) Any other liability assumed on behalf of the client to advance funds
pursuant to a contractual commitment.

10. Forced Sale Value (FSV) means the value which fully reflects the possibility
of price fluctuations and can currently be obtained by selling the mortgaged /
pledged assets in a forced / distressed sale conditions.

11. Government Securities shall include such types of Pak. Rupee obligations of
the Federal Government or a Provincial Government or of a Corporation
wholly owned or controlled, directly or indirectly, by the Federal Government
or a Provincial Government and guaranteed by the Federal Government as
the Federal Government may, by notification in the Official Gazette, declare,
to the extent determined from time to time, to be Government Securities.

11
12. Group means persons, whether natural or juridical, if one of them or his
dependent family members or its subsidiary, have control or hold substantial
ownership interest over the other. For the purpose of this:
(a) Subsidiary will have the same meaning as defined in sub-section 3(2)
of the Companies Ordinance, 1984 i.e. a company or a body corporate
shall deemed to be a subsidiary of another company if that other
company or body corporate directly or indirectly controls, beneficially
owns or holds more than 50% of its voting securities or otherwise has
power to elect and appoint more than 50% of its directors.
(b) Control refers to an ownership directly or indirectly through
subsidiaries, of more than one half of voting power of an enterprise.
(c) Substantial ownership / affiliation means beneficial shareholding of
more than 25% by a person and/or by his dependent family members,
which will include his / her spouse, dependent lineal ascendants and
descendants and dependent brothers and sisters. However,
shareholding in or by the Government owned entities and financial
institutions will not constitute substantial ownership / affiliation, for the
purpose of these regulations.

13. Liquid Assets are the assets which are readily convertible into cash without
recourse to a court of law and mean encashment / realizable value of
government securities, bank deposits, certificates of deposit, shares of listed
companies which are actively traded on the stock exchange, NIT Units,
certificates of mutual funds, Certificates of Investment (COIs) issued by DFIs
/ NBFCs rated at least ‘A’ by a credit rating agency on the approved panel of
State Bank of Pakistan, listed TFCs rated at least ‘A’ by a credit rating
agency on the approved panel of State Bank of Pakistan and certificates of
asset management companies for which there is a book maker quoting daily
offer and bid rates and there is active secondary market trading. These
assets with appropriate margins should be in possession of the banks / DFIs
with perfected lien.

Guarantees issued by domestic banks / DFIs when received as collateral by

banks / DFIs will be treated at par with liquid assets whereas, for guarantees
issued by foreign banks, the issuing banks’ rating, assigned either by
Standard & Poors, Moody’s or Fitch-Ibca, should be ‘A’ and above or
equivalent.

The inter-branch indemnity / guarantee issued by the bank’s overseas

branch in favor of its sister branch in Pakistan, would also be treated at par
with liquid assets, provided the bank is rated ‘A’ and above or equivalent
either by Standard & Poors, Moody’s or Fitch-Ibca. The indemnity for this
purpose should be similar to a guarantee i.e. unconditional and demand in
nature.
12
14. Medium and Long Term Facilities mean facilities with maturities of more
than one year and Short Term Facilities mean facilities with maturities up to
one year.

15. NBFC means Non-Banking Finance Company and includes a Modaraba,

Leasing Company, Housing Finance Company, Investment Bank, Discount
House, Asset Management Company and a Venture Capital Company.

16. Other Form of Security means hypothecation of stock (inventory),

assignment of receivables, lease rentals, contract receivables, etc.

17. PBA means Pakistan Banks Association.

18. Readily Realizable Assets mean and include liquid assets and stocks
pledged to the banks / DFIs in possession, with ‘perfected lien’ duly
supported with complete documentation.

19. Secured means exposure backed by tangible security and any other form of
security with appropriate margins (in cases where margin has been
prescribed by State Bank, appropriate margin shall at least be equal to the
prescribed margin). Exposure without any security or collateral is defined as
clean.

The banks / DFIs may also take exposure against Trust Receipt. They are,
however, free to take collateral / securities, to secure their risks / exposure,
in addition to the Trust Receipt.

Banks / DFIs will be free to decide about obtaining security / collateral

against the L/C facilities for the interim period, i.e. from the date of opening
of L/C till the receipt of title documents to the goods.

20. Subordinated Loan means an unsecured loan extended to the borrower by

its sponsors, subordinate to the claim of the bank / DFI taking exposure on
the borrower and documented by a formal sub-ordination agreement
between provider of the loan and the bank / DFI. The loan shall be disclosed
in the annual audited financial statements of the borrower as subordinated
loan.

21. Small and Medium Enterprise (SME) means an entity, ideally not a public
limited company, which does not employ more than 250 persons (if it is
manufacturing / service concern) and 50 persons (if it is trading concern)
and also fulfills the following criteria of either ‘a’ and ‘c’ or ‘b’ and ‘c’ as
relevant:
(a) A trading / service concern with total assets at cost excluding land and
building upto Rs 50 million.

13
 (b) A manufacturing concern with total assets at cost excluding land and
building upto Rs 100 million.
(c) Any concern (trading, service or manufacturing) with net sales not
exceeding Rs 300 million as per latest financial statements.

An Individual, if he or she meets the above criteria, can also be categorized

as an SME.

22. Tangible Security means readily realizable assets (as defined in these
Prudential Regulations), mortgage of land, plant, building, machinery and
any other fixed assets.

14
 PART – B
REGULATIONS

REGULATION R-1
SOURCE AND CAPACITY OF REPAYMENT
AND CASH FLOW BACKED LENDING

Banks / DFIs shall specifically identify the sources of repayment and

assess the repayment capacity of the borrower on the basis of assets conversion
cycle and expected future cash flows. In order to add value, the banks / DFIs are
encouraged to assess conditions prevailing in the particular sector / industry they
are lending to and its future prospects. The banks / DFIs should be able to identify
the key drivers of their borrowers’ businesses, the key risks to their businesses
and their risk mitigants.

2. The rationale and parameters used to project the future cash flows shall be
documented and annexed with the cash flow analysis undertaken by the bank /
DFI. It is recognized that a large number of SMEs will not be able to prepare
future cash flows due to lack of sophistication and financial expertise. It is
expected that in such cases banks / DFIs shall assist the borrowers in obtaining
the required information and no SME shall be declined access to credit merely on
this ground.

REGULATION R-2
PERSONAL GUARANTEES

All facilities, except those secured against liquid assets, extended to SMEs
shall be backed by the personal guarantees of the owners of the SMEs. In case of
limited companies, guarantees of all directors other than nominee directors shall
be obtained.

REGULATION R-3
LIMIT ON CLEAN FACILITIES

In order to encourage cash flow based lending, banks / DFIs are allowed to
take clean exposure, i.e., facilities secured solely against personal guarantees, on
a SME up to Rs 3 million provided that funded exposure should not exceed
Rs 2 million. Before taking clean exposure, banks / DFIs shall obtain a declaration
from the SME that it has not availed clean facilities from any other bank/DFI to
ensure that the accumulated clean exposure of banks / DFIs on a SME does not
exceed the prescribed limit mentioned above.

2. It may be noted that the clean exposure above to an SME entity, will not
include the clean consumer financing limits (Credit Card and Personal Loans etc.),
15
allowed to the sponsors of the said SME under Prudential Regulations for
Consumer Financing.

REGULATION R-4
SECURITIES

Subject to the relaxation in Regulation R-3, for facilities upto Rs 3 million,

all facilities over and above this limit shall be appropriately secured as per
satisfaction of the banks / DFIs.

REGULATION R-5
MARGIN REQUIREMENTS

Banks / DFIs are free to determine the margin requirements on facilities

provided by them to their clients taking into account the risk profile of the
borrower(s) in order to secure their interests. However, this relaxation shall not
apply in case of items, import of which are banned by the Government. Banks /
DFIs are advised not to open import letter of credit for these items in any case till
such time the lifting of ban on any such item is notified by the State Bank of
Pakistan.

2. Banks / DFIs will continue to observe margin restrictions on shares / TFCs

as per existing instructions under Prudential Regulations for Corporate/
Commercial Banking (R-6). Further, the cash margin requirement of 100% on
Caustic Soda (PCT heading 2815.1200) for opening Import Letter of Credit as
advised by the Federal Government and notified in terms of BPD Circular Letter
No. 5 dated 4th May, 2002, will also continue to remain applicable.

3. State Bank of Pakistan shall continue to exercise its powers for fixation /
reinstatement of margin requirements on financing facilities being provided by
banks/DFIs for various purposes including Import Letter of Credit on a particular
item(s), as and when required.

4. In addition to above, the restrictions prescribed under paragraph 1.A of

Regulation R-6 of the Prudential Regulations for Corporate / Commercial Banking
will also be applicable in case of SMEs Financing.

REGULATION R-6
PER PARTY EXPOSURE LIMIT

The maximum exposure of a bank / DFI on a single SME shall not exceed
Rs 75 million. The total facilities (including leased assets) availed by a single SME
from the financial institutions should not exceed Rs 150 million provided that the
facilities excluding leased assets shall not exceed Rs 100 million. It is expected
16
that SMEs approaching this limit should have achieved certain sophistication as
they migrate into larger firms and should be able to meet the requirements of
Prudential Regulations for Corporate / Commercial Banking.

REGULATION R-7
AGGREGATE EXPOSURE OF A BANK / DFI ON SME SECTOR

The aggregate exposure of a bank / DFI on SME sector shall not exceed
the limits as specified below:
PERCENTAGE OF CLASSIFIED SMEs ADVANCES TO MAXIMUM LIMIT
TOTAL PORTFOLIO OF SMEs ADVANCES
a. Below 5% No limit
b. Below 10% 3 times of the equity
c. Below 15% 2 times of the equity
d. Upto and Above 15% Upto the equity

REGULATION R-8
MINIMUM CONDITIONS FOR TAKING EXPOSURE

While considering proposals for any exposure (including renewal,

enhancement and rescheduling / restructuring) exceeding such limit as may be
prescribed by State Bank of Pakistan from time to time (presently at Rs 500,000/-),
banks / DFIs should give due weightage to the credit report relating to the
borrower and his group obtained from a Credit Information Bureau (CIB) of State
Bank of Pakistan. However, banks / DFIs may take exposure on defaulters
keeping in view their risk management policies and criteria, provided they properly
record reasons and justifications in the approval form. The condition of obtaining
CIB report will apply to exposure exceeding Rs 500,000/- after netting-off the liquid
assets held as security.

2. Banks / DFIs are encouraged to refer the prospective SME borrower to

SME Associations for obtaining information about its character and credit
worthiness. The information so obtained may be helpful for banks/DFIs, especially
in those circumstances where no information is available from CIB of State Bank of
Pakistan.

3. Banks / DFIs shall, as a matter of rule, obtain a copy of financial

statements duly audited by a practicing Chartered Accountant, relating to the
business of every borrower who is a limited company or where the exposure of a
bank / DFI exceeds Rs 10 million, for analysis and record. The banks / DFIs may
also accept a copy of financial statements duly audited by a practicing Cost and
Management Accountant in case of a borrower other than a public company or a

17
private company which is a subsidiary of a public company. However, banks /
DFIs may waive the requirement of obtaining copy of financial statements when
the exposure net of liquid assets dose not exceed the limit of Rs 10 million.
Further, financial statements signed by the borrower will suffice where the
exposure is fully secured by liquid assets.

4. Banks / DFIs shall not approve and / or provide any exposure (including
renewal, enhancement and rescheduling / restructuring) until and unless the Loan
Application Form (LAF) prescribed by the banks / DFIs is accompanied by a
‘Borrower’s Basic Fact Sheet’ under the seal and signature of the borrower as per
approved format of the State Bank of Pakistan (Annexure-I for SMEs other than
individuals and Annexure-II for individual borrowers).

REGULATION R-9
PROPER UTILIZATION OF LOAN

The banks / DFIs should ensure that the loans have been properly utilized
by the SMEs and for the same purposes for which they were acquired / obtained.
The banks / DFIs should develop and implement an appropriate system for
monitoring the utilization of loans.

REGULATION R-10
RESTRICTION ON FACILITIES TO RELATED PARTIES

The bank / DFI shall not take any exposure on a SME in which any of its
director, major shareholder holding 5% or more of the share capital of the bank /
DFI, its Chief Executive or an employee or any family member of these persons is
interested.

R-11
CLASSIFICATION AND PROVISIONING FOR ASSETS

LOANS / ADVANCES
Banks / DFIs shall observe the prudential guidelines given at Annexure-III
in the matter of classification of their SME asset portfolio and provisioning there-
against.

2. In addition to the time-based criteria prescribed in Annexure-III, subjective

evaluation of performing and non-performing credit portfolio shall be made for risk
assessment and, where considered necessary, any account including the
performing account will be classified, and the category of classification determined
on the basis of time based criteria shall be further downgraded. Such evaluation
shall be carried out on the basis of credit worthiness of the borrower, its cash flow,

18
operation in the account, adequacy of the security, inclusive of its realizable value
and documentation covering the advances.

3. The rescheduling / restructuring of non-performing loans shall not change

the status of classification of a loan / advance etc. unless the terms and conditions
of rescheduling / restructuring are fully met for a period of at least one year
(excluding grace period, if any) from the date of such rescheduling / restructuring
and at least 10% of the outstanding amount is recovered in cash. However, the
condition of one year retention period, prescribed for restructured / rescheduled
loan account to remain in the classified category, will not apply in case the
borrower has repaid or adjusted in cash at least 50% of the total restructured loan
amount (principal + mark-up), either at the time of restructuring agreement or later-
on during the grace period if any.

The unrealized mark-up on loans (declassified after rescheduling / restructuring)

shall not be taken to income account unless at least 50% of the amount is realized
in cash. However, any short recovery in this respect will not impact the
de-classification of this account if all other criteria (meeting the terms and
conditions for at least one year and payment of at least 10% of outstanding
amount by the borrower) are met. The banks / DFIs are further directed to ensure
that status of classification, as well as provisioning, is not changed in relevant
reports to the State Bank of Pakistan merely because a loan has been
rescheduled or restructured. However, while reporting to the Credit Information
Bureau (CIB) of State Bank of Pakistan, such loans / advances may be shown as
‘rescheduled / restructured’ instead of ‘default’.

Where a borrower subsequently defaults (either principal or mark-up) after the

rescheduled / restructured loan has been declassified by the bank / DFI as per
above guidelines, the loan will again be classified in the same category it was in at
the time of rescheduling / restructuring and the unrealized markup on such loans
taken to income account shall also be reversed. However, banks / DFIs at their
discretion may further downgrade the classification, taking into account the
subjective criteria.

At the time of rescheduling / restructuring, banks / DFIs shall consider and

examine the requests for working capital strictly on merit, keeping in view the
viability of the project / business and appropriately securing their interest etc.

All fresh loans granted by the banks / DFIs to a party after rescheduling /
restructuring of its existing facilities may be monitored separately, and will be
subject to classification under this Regulation on the strength of their own specific
terms and conditions.

19
4. Banks / DFIs shall classify their loans / advances portfolio and make
provisions in accordance with the criteria prescribed above. Moreover, where
banks / DFIs wish to avail the benefit of collateral held against loans / advances,
they can consider the value, determined in accordance with the guidelines laid
down in Annexure-IV, of assets mortgaged / pledged with them, for deduction from
the outstanding principal amount of loan / advance against which such assets are
mortgaged / pledged, before making any provision. The value of the mortgaged /
pledged assets, other than liquid assets, to be considered for this purpose shall be
the forced sale value. Further, Forced Sale Value (FSV) once determined, shall
remain valid for three years from the date of valuation during which period the
underlying collateral will not be revalued for provisioning purpose. The adjustment
factors of 80%, 70% and 50% shall be applied on the value so determined for the
purpose of determining provisioning requirement in 1st, 2nd and 3rd year of
valuation, respectively. Thereafter, the assets shall be revalued and the
adjustment factor of 50% shall be applied for all subsequent years. However, the
FSV of the collateral shall be restricted to fresh revaluation or previous value,
whichever is less. All valuations conducted during the years 2002 & 2003 shall
also be considered 1st year valuations only for the application of adjustment factors
referred to above. However, after completion of three years, from the date of last
valuation, such assets will also have to be revalued.

For loans which are classified after the issuance of these Prudential Regulations,
the benefit will be available for a period of three years going forward up to 80%,
70% & 50% of the FSV for the years 1, 2 & 3 respectively. From year 4, the
benefit for provisioning purposes will then remain at 50% of either the previous
FSV or the fresh valuation whichever is less. As for loans which are already
classified as of the date of issuance of these Prudential Regulation, the banks /
DFIs may take benefit of FSV of collateral for the year ended 2003, in accordance
with the previous guidelines on the subject. From year 2004, FSVs will be subject
to the adjustment factors of 80%, 70% & 50% in 1, 2 & 3 years respectively and
then remain at 50% in subsequent years.

To illustrate this new requirement, two scenarios are presented below. Scenario-1
shows the treatment of an existing classified loan and Scenario-2 shows the
treatment for an existing satisfactory category loan which becomes classified after
the issuance of these Prudential Regulations.

Scenario-1: The collateral has been evaluated in the year 2003 and FSV has been
worked out as Rs 300 million. FSV of the collateral has been revalued in the years
2006 & 2009 at Rs 400 million and Rs 450 million respectively, when revaluation is
required to be done after completion of three years, if a bank / DFI wishes to avail
the benefit of FSV for the purposes of provisioning.
YEAR 2003 2004 2005 2006 2007 2008 2009
FSV (in Million) 300 300 300

20
 Adjustment Factors None * 80% ** 70%
Benefit for Provisioning 300 240 210
FSV (Revalued) 400
Value taken *** 300 300 300
Adjustment Factors 50% 50% 50%
Benefit for Provisioning 150 150 150
FSV (Revalued) 450
Value taken *** 300
Adjustment Factors 50%
Benefit for Provisioning 150
* In accordance with the previous guidelines on the subject.
*** Valuations conducted during the year 2002 and 2003 will be considered
1st year valuations for the purposes of application of adjustment factors.
** Fresh FSV after three years or previous FSV, whichever is lower.

Scenario-2: When the property has been evaluated after the year 2004, say in
year 2005 and FSV is Rs 200 million and revalued FSV in year 2008 is
Rs 250 million. The benefit of the provisioning would be available in the following
manner:

YEAR 2004 2005 2006 2007 2008 2009 2010

FSV (in Million) 200 200 200
Adjustment Factors 80% 70% 50%
Benefit for Provisioning 160 140 100
FSV – Revalued 250
Value taken * 200 200 200
Adjustment Factors 50% 50% 50%
Benefit for Provisioning 100 100 100

* Fresh FSV after three years or previous FSV, whichever is lower.

SUBMISSION OF RETURNS:
5. Banks / DFIs shall submit the borrower-wise annual statements regarding
classified loans / advances to the Banking Inspection Department.

TIMING OF CREATING PROVISIONS:

6. Banks / DFIs shall review, at least on a quarterly basis, the collectibility of
their loans / advances portfolio and shall properly document the evaluations so
made. Shortfall in provisioning, if any, determined, as a result of quarterly
assessment shall be provided for immediately in their books of accounts by the
banks / DFIs on quarterly basis.

REVERSAL OF PROVISION:
7. In case of cash recovery, other than rescheduling / restructuring, banks /
DFIs may reverse specific provision held against classified assets, subject to the
following:
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 i) In case of Loss account, reversal may be made to the extent that the
remaining outstanding amount of the classified asset is covered by
minimum 100% provision.
ii) In case of Doubtful account, reversal may be made to the extent that
the remaining outstanding amount of the classified asset is covered by
minimum 50% provision.
iii) In case of Substandard account, reversal may be made to the extent
that the remaining outstanding amount of the classified asset is
covered by minimum 25% provision.

While calculating the remaining provision required to be held after cash recovery
and reversal of provision there-against, the bank / DFI will still enjoy the benefit of
netting-off the amount of liquid assets and FSV of fixed assets from the
outstanding amount, in the light of guidelines given in this regulation. Further, the
provision made on the advice of State Bank of Pakistan will not be reversed
without prior approval of State Bank of Pakistan.

VERIFICATION BY THE AUDITORS:

8. The external auditors as a part of their annual audits of banks / DFIs shall
verify that all requirements of Regulation R-11 for classification and provisioning
for assets have been complied with. The State Bank of Pakistan shall also check
the adequacy of provisioning during on-site inspection.

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 ANNEXURE I

BORROWER’S BASIC FACT SHEET- FOR SMEs OTHER THAN INDIVIDUALS

PRESCRIBED UNDER REGULATION R-8

Date of Request._______________

(TO BE COMPLETED IN CAPITAL LETTERS OR TYPEWRITTEN)

1. BORROWER’S PROFILE:
Name Address

Phone # Fax # E-mail Address

Office Res.
Computerized National Identity Card # National Tax # Sales Tax #

Import Export Date of Date of opening of A/c.

Registration # Registration # Establishment

2. DETAILS OF DIRECTORS/OWNERS/PARTNERS:
Name Address

Phone # Fax # E-mail Address

Office Res.
Computerized National Identity Card # National Tax #

Share-holding Amount % of Share-holding

3. MANAGEMENT:
A) EXECUTIVE DIRECTORS/PARTNERS:
Name Address CNIC # Phone #
1.
2.
B) NON-EXECUTIVE DIRECTORS/PARTNERS:
Name Address CNIC # Phone #
1.
2.

4. CORPORATE STATUS:
Sole Proprietorship Partnership Public / Private Limited Company

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5. NATURE OF BUSINESS:
Industrial Commercial Agricultural Services Any other

6. REQUESTED LIMITS:
Amount Tenor
Fund Based
Non-Fund Based

7. BUSINESS HANDLED/EFFECTED WITH ALL FINANCIAL

INSTITUTIONS DURING THE LAST ACCOUNTING YEAR:
Imports Exports Remittances effected (if any)

8. EXISTING LIMITS AND STATUS:

Status
Amount Expiry Date Regular Amount Overdue
(if any)
Fund Based
Non-Fund Based

9. ANY WRITE-OFF, RESCHEDULING/ RESTRUCTURING

AVAILED DURING THE LAST THREE YEARS:
Amount during Amount during Amount during
Name of 1st Year 2nd Year 3rd Year
Financial Write- Rescheduled/ Write- Rescheduled/ Write- Rescheduled/
Institution off Restructured off Restructured off Restructured

10. DETAILS OF PRIME SECURITIES MORTGAGED/ PLEDGED:

A) AGAINST EXISTING FACILITIES:
Name of Financial Nature of Total Amount Rank of Charge Net Realizable
Institution Security Value
1.
2.
B) AGAINST REQUESTED/ FRESH/ ADDITIONAL FACILITIES:
Name of Financial Nature of Security Total Amount Net Realizable
Institution Value
1.
2.

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11. DETAILS OF SECONDARY COLLATERAL MORTGAGED/ PLEDGED:
A) AGAINST EXISTING FACILITIES:
Name of Financial Nature of Total Amount Rank of Charge Net Realizable
Institution Security Value
1.
2.
B) AGAINST REQUESTED/ FRESH/ ADDITIONAL FACILITIES:
Name of Financial Nature of Security Total Amount Net Realizable
Institution Value
1.
2.

12. CREDIT RATING (WHERE APPLICABLE):

Name of Rating Agency Rating

13. DETAILS OF ASSOCIATED CONCERNS

(AS DEFINED IN COMPANIES ORDINANCE, 1984):
Name of Concern Name of Directors Share-holding % of Total Share Capital

14. FACILITIES TO ASSOCIATED CONCERNS BY THE CONCERNED FI:

Name of Nature & Outstanding Nature & Overdues Defaults
Concern Amount of as on-------- Value of
Limit Securities

15. DETAILS OF PERSONAL GUARANTEES PROVIDED BY THE

DIRECTORS / PARTNERS ETC. TO FIs TO SECURE CREDIT:
Names of Institutions/persons to Amount of Validity NIC # NTN Net-
the whom Guarantee given Guarantee Period worth
Guarantors

16. DIVIDEND DECLARED (AMOUNT) DURING THE LAST THREE YEARS:

During 1st Year During 2nd Year During 3rd Year

17. SHARE PRICES OF THE BORROWING ENTITY:

Listed Company Break-up Value of the Shares
Current Price Preceding 12 Months Average in case of Private Limited Company

25
18. NET-WORTH (PARTICULARS OF ASSETS OWNED IN THEIR
OWN NAMES BY THE DIRECTORS/PARTNERS/PROPRIETORS):
Owner’s Name Particulars of Assets Market value Particulars of Liabilities

19. DETAILS OF ALL OVERDUES (IF OVER 90 DAYS):

Name of Financial Institution Amount

20. Details of payment schedule if term loan sought.

21. Latest Audited Financial Statements as per requirements of Regulation R-8 to be

submitted with the LAF (Loan Application Form).

22. Memorandum and Articles of Association, By-laws etc. to be submitted by the borrower
alongwith the request

I certify and undertake that the information furnished above

is true to the best of my knowledge.

CHIEF EXECUTIVE’S/ BORROWER’S

SIGNATURE & STAMP

COUNTER SIGNED BY:

AUTHORISED SIGNATURE & STAMP

(BANK / DFI OFFICIAL)

26
 ANNEXURE II

BORROWER’S BASIC FACT SHEET - FOR INDIVIDUALS

PRESCRIBED UNDER PRUDENTIAL REGULATION R-8

Date of Request._______________

(TO BE COMPLETED IN CAPITAL LETTERS OR TYPEWRITTEN)

1. BORROWER’S PROFILE:
Name Address

Phone # Fax # E-mail Address

Office Res.
Computerized National Identity Card # National Tax #

Father’s Name Father’s Computerized National Identity Card #

2. REFERENCES (AT LEAST TWO):

Name Address

Phone # Fax # E-mail Address

Office Res.
Computerized National Identity Card # National Tax #

3. NATURE OF BUSINESS/ PROFESSION:

Industrial Commercial Agricultural Services Any other

4. EXISTING LIMITS AND STATUS:

Status
Amount Expiry Regular Amount Over- Amount Rescheduled/
Date due (if any) Restructured (if any)
Fund Based
Non-Fund Based

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5. REQUESTED LIMITS:
Amount Tenor
Fund Based
Non-Fund Based

6. Details of payment schedule if term loan sought.

7. Latest Income Tax / Wealth Tax Form to be submitted by the borrower.

I certify and undertake that the information furnished above is

true to the best of my knowledge.

APPLICANT’S SIGNATURE & STAMP

COUNTER SIGNED BY:

AUTHORISED SIGNATURE & STAMP

(BANK / DFI OFFICIAL)

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 ANNEXURE-III

GUIDELINES IN THE MATTER OF CLASSIFICATION

AND PROVISIONING FOR ASSETS (REGULATION R-11)

All Financing Facilities (including Short, Medium and Long Term)

CLASSIFICATION DETERMINANT TREATMENT OF PROVISIONS TO

INCOME BE MADE
(1) (2) (3) (4)
1. Substandard. Where mark- Unrealized mark- Provision of 10%
up/ interest or up/interest to be (25% from 31st
principal is kept in December 2006) of
overdue by Memorandum the difference
90 days or Account and not resulting from the
more from to be credited to outstanding balance
the due date. Income Account of principal less the
except when amount of liquid
realized in cash. assets realizable
Unrealized mark without recourse to
up/interest a Court of Law and
already taken to adjusted forced sale
income account value of mortgaged/
to be reversed pledged assets
and kept in (subject to Note 1
Memorandum below) as valued by
Account. valuers fulfilling
prescribed eligibility
criteria, in
accordance with the
guidelines provided
in this regulation.

2. Doubtful. Where mark- As above. Provision of 50% of

up/ interest or the difference
principal is resulting from the
overdue by outstanding balance
180 days or of principal less the
more from amount of liquid
the due date. assets realizable
without recourse to
a Court of Law and
adjusted forced sale
value of mortgaged/
pledged assets
(subject to Note 1
29
 below) as valued by
valuers fulfilling
prescribed eligibility
criteria, in
accordance with the
guidelines provided
in this regulation.

3. Loss. (a) Where As above. Provision of 100% of

mark-up/ the difference
interest or resulting from the
principal is outstanding balance
overdue by of principal less the
one year or amount of liquid
more from the assets realizable
due date without recourse to
a Court of Law and
adjusted forced sale
value of mortgaged/
pledged assets
(subject to Note 1
below) as valued by
valuers fulfilling
prescribed eligibility
criteria, in
accordance with the
guidelines provided
in this regulation.

(b) Where As above As above.

Trade Bills
(Import/Expor
t or Inland
Bills) are not
paid/adjusted
within 180
days of the
due date.

Note:
The benefit of FSV is allowed against NPLs of over Rs 5 million only and from December 31, 2006
against NPLs of over Rs 10 million only.

Classified loans / advances that have been guaranteed by the Government would not require
provisioning, however, mark up / interest on such accounts to be taken to Memorandum Account
instead of Income Account.

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 ANNEXURE-IV

UNIFORM CRITERIA FOR DETERMINING THE VALUE

OF ASSETS MORTGAGED / PLEDGED (REGULATION R-11)

Only assets having registered mortgage, equitable mortgage (where NOC

for creating further charge to another bank / DFI / NBFC has not been issued by
bank / DFI) and pledged assets shall be considered. Assets having pari-passu
charge shall be considered on proportionate basis of outstanding amount.

2. Hypothecated assets and assets with second charge and floating charge
shall not be considered.

3. Valuations shall be carried out by an independent professional valuer who

should be listed on the panel of valuers maintained by the Pakistan Banks’
Association (PBA) for this purpose. PBA shall lay down the minimum eligibility
criteria with the prior approval of the State Bank of Pakistan for placement of
valuers on the panel to be maintained by it. The valuer while assigning any values
to the mortgaged / pledged assets, shall take into account all relevant factors
affecting the salability of such assets including any difficulty in obtaining their
possession, their location, condition and the prevailing economic conditions in the
relevant sector, business or industry. The values of mortgaged / pledged assets so
determined by the valuers must have to be a reasonably good estimate of the
amount that could currently be obtained by selling such assets in a forced /
distressed sale condition. The valuers should also mention in their report the
assumptions made, the calculations / formulae / basis used and the method
adopted in determination of the values.

4. Full Scope Valuation shall be done at least once in three years. For
example any valuation done on November 01, 1999 would be valid for
consideration for the accounting periods ending on December 31, 1999, December
31, 2000 and December 31, 2001, thus for subsequent accounting periods, a fresh
valuation would be required. The valuation process will include conducting a ‘Full-
Scope Valuation’ of the assets in the first year and then followed by ‘Desktop
Valuations’ in the second and third year. Evaluators on the panel of the PBA will
be eligible to conduct only two Full Scope valuations consecutively of a company,
as such the companies being evaluated will require to change evaluator after two
consecutive Full Scope valuations i.e. for a full period of six years.

The following may be noted in respect of the Desktop and Full-scope Evaluations:
• Desktop Evaluation is defined as “an Interim Brief Review of Full-scope
Evaluation, so that any significant change in the factors, on which the full-
scope valuation was based, is accounted for and brought to the notice of the
lending bank.”

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• In case the loans exceed 10% of the banks/DFIs’ equity, the Desk-top
valuation will be done by the same evaluator, who had conducted the full-
scope evaluation, (the evaluator should be on the approved panel of the PBA);
whereas, for loans below this threshold, the Desktop evaluation can be
evaluated by the banks themselves. For conducting Desktop Evaluation, the
evaluators will pay a short visit to the bank and the borrower’s site. The bank’s
responsibility in this respect will be to ensure that the evaluator is contacted for
conducting Desktop Evaluation, and will provide all necessary information to
the evaluators, which are materially important for the interim review (Desk-top
Evaluation).
• The Desktop Evaluation will only be for the use of credit management purpose
of the respective banks, thus the same will have no impact on provisioning
requirement, assessed on the basis of Full-scope evaluation.
• In cases where the evaluators are not allowed by the borrowers to enter in
their premises, the full-scope evaluation, conducted as such, will not be
accepted for provisioning benefit.

5. State Bank may check the valuations of the mortgaged assets through an
independent evaluator, on random basis, to verify the reasonableness of the
valuations. The unjustified differences in the valuations of the banks / DFIs and
State Bank of Pakistan shall render the concerned bank / DFI and evaluator to
penal actions.

6. The categories of mortgaged / pledged assets to be considered for

valuation along with discounting factors to be applied would be as under (no other
assets shall be taken into consideration):

a) Liquid Assets:
Valuation of Liquid Assets shall be determined by the bank / DFI itself
and verified by the external auditors. However, in the case of pledged
shares of listed companies, values should be taken at market value as
per active list of Stock Exchange(s) on the balance sheet date and as
per guidelines given in the TR-23 issued by the Institute of Chartered
Accountants of Pakistan (ICAP). Moreover, valuation of shares
pledged against loans/advances shall be considered only if these have
been routed through Central Depository Company of Pakistan (CDC),
otherwise these will not be admissible for deduction as liquid assets
while determining required provisions.

b) Land and Building:

Valuation of land and buildings would be accepted as determined by
the valuers in accordance with the criteria given above and no further
discounting factor would be applied on forced sale value determined by
them.
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c) Plant and Machinery:
Entities of classified borrowers shall be divided into following
categories at the balance sheet date and discounting factors shall be
applied to forced sale value as under:

Category Discounting factors to be applied

to forced sale value

A) In operation. No discounting factor to be applied.

B) In operation at the time of • 15% of forced sale value on the

valuation but now closed / date of closure.
in liquidation.
• 1st year after closure-25% of
forced sale value
• 2nd year-50% of forced sale
value.

C) Closed / in liquidation at • After valuation-1st year 25% of

the time of valuation and forced sale value.
no change in situation.
• 2nd year-50% of forced sale
value.

d) Pledged Stocks:
In case of pledged stocks of perishable and non-perishable goods,
forced sale value should be provided by valuers, which should not be
more than one year old, at each balance sheet date. The goods should
be perfectly pledged, the operation of the godowns should be in the
control of the bank / DFI and regular valid insurance and other
documents should be available. In case of perishable goods, the valuer
should also give the approximate date when these are expected to be
of no value.

33