With a population of more than 220 million people, Pakistan is one of the largest unbanked countries in the world with only 14% of all adults being financially included, as reported by Financial Inclusion Insights (FII).
Since the beginning of the 21st century, the government and the regulators in Pakistan are focused on technology-assisted solutions to increase financial inclusion. It started with the enactment of the Electronic Transactions Ordinance, 2002, followed by the Payment Systems and Electronic Fund Transfers Act, 2007, and the mobile and branchless banking regulations. However, the process was slow-paced and did not bring about any noticeable change. Inadequate telecom infrastructure, low teledensity, and a disabling regulatory environment were the factors to blame, according to the experts.
In recent years, teledensity in Pakistan has increased manyfold. It is estimated that presently, the country has 183 million cellular subscribers, 99 million 3G/4G subscribers, and 101 million broadband subscribers. Appreciating this changed scenario, the government, and the regulators also stepped-up their efforts to enhance financial inclusion in the country by creating an enabling regulatory environment for digital echo-system. These efforts were spearheaded by Pakistan’s corporate regulator, the Securities and Exchange Commission of Pakistan (“SECP”), and its central bank, the State Bank of Pakistan (“SBP”).
Recent notable steps taken by SBP, which regulates the banking sector including conventional banks, microfinance institutions, exchange companies, electronic money institutions, payment system operators, and payment service providers, include the issuance of regulations for electronic money institutions, the grant of authorizations/licenses to several electronic money institutions, as well as setting up of instant payment system “RAAST” to enable end-to-end digital payments among individuals, businesses and government entities instantaneously. To further develop the digital ecosystem, SBP has now issued the licensing and regulatory framework (the “Framework”) for setting up digital banks in Pakistan as a separate and distinct category in the banking business. Salient features of the Framework are as under:
What is a digital bank?
A digital bank is a bank licensed under section 27 of the Banking Companies Ordinance, 1962, that provides banking and related financial solutions to its customers predominantly through digital and electronic channels, instead of physical branches.
Is there more than one type of digital bank?
The Framework prescribes two types of digital banks, i.e., digital retail bank, and digital full bank.
A digital retail bank can primarily undertake business with or render services to the retail customer segments. However, in certain cases, a digital retail bank can also deal with corporate or commercial segments. A digital full bank, on the other hand, may serve corporate, commercial, and retail customer segments.
Who is eligible to apply for permission/license to establish a digital bank?
The following are the eligible persons to apply for the grant of a license to form and operate a digital bank:
- A local conventional bank, or electronic money institution seeking conversion to a digital bank.
- An international bank, digital bank, electronic money institution, etc.
- Person(s) holding a majority equity stake in or control of a local microfinance bank, local electronic money institution, international bank, or international entity as aforesaid.
- Any other person(s) having a minimum of three years of experience in financial services, financial technology, telecommunication, etc.
Eligible persons listed at serial Nos. (i) to (iii) must possess minimum qualifying experience of delivering digital financial services in the retail customer segment.
Is there a qualification criterion for the sponsors, directors, and principal officer of a digital bank?
The sponsors/initial shareholders (“Sponsors”), directors, and principal officer of the digital bank must satisfy the fit and proper criteria laid down in the Framework and other applicable regulations issued by SBP.
Furthermore, the name of any Sponsor must not be on the United National Security Council Consolidated List or any other list of banned, proscribed, or blacklisted individuals or other entitles maintained by the Government of Pakistan or a foreign government.
What is the process to apply for a license to establish a digital retail bank?
The process for the grant of a license to establish and operate a digital bank in Pakistan involves the following steps:
Step 1: Submission of Application
A Sponsor, which qualifies to be an eligible person, must submit an application accompanied by the prescribed documents to SBP. SBP will not entertain incomplete applications.
The Framework contains a detailed list of documents required to be submitted with the application. These documents include a comprehensive feasibility study, business plan, capital and funding plan, and enablement plan. These documents must contain the information listed in the Framework. The proof of financial strength of the Sponsors, that they meet the eligibility, and the fit and proper criteria must also be submitted to SBP along with the application.
Step 2: Issuance of No-Objection Certificate and Incorporation
If, after reviewing the application, SBP considers it to be satisfactory, SBP may issue a no-objection certificate (“NOC”) to the Sponsor. The NOC will enable the Sponsor to incorporate the digital retail bank as a public limited company with SECP. The NOC will be issued subject to certain conditions.
Step 3: Grant of In-Principal Approval (IPA)
Within 6 months of issuance of the NOC, the Sponsors will incorporate a public limited company (which will be granted the digital retail bank license), satisfy the conditions listed in the NOC, and apply to SBP for the grant of an In-Principal Approval (“IPA”). The IPA will be valid for 12 months and will set out the conditions to be fulfilled before the commencement of pilot operations. These conditions will include minimum capital requirements.
Step 4: Issuance of Restricted License and Pilot Operations
After the digital retail bank complies with the requirements set out in the IPA, within the validity period of the IPA, it will apply to SBP for the issuance of a restricted license to commence pilot operations. The application will accompany prescribed documents including evidence of operational readiness, a bank guarantee from the Sponsors, and evidence of placement of security deposit with SBP.
The restricted license will be non-renewable and will be valid for a fixed term not exceeding 9 months. In certain cases, SBP may issue a second restricted license for a fixed term not exceeding 6 months.
The restricted license will allow the digital retail bank to commence its pilot operations.
Step 5: Pilot Operations Stage under Restricted License
During the pilot operations stage, the digital retail bank will engage only with a select group of individual customers to seek deposits up to a certain limit and provide them with basic banking services. Likewise, it will be able to undertake lending operations up to a certain amount. However, it will be prohibited from soliciting deposits from the public.
The minimum duration of the pilot operations stage shall be 3 months. However, in certain cases, SBP may exempt the pilot operations stage or relax any applicable requirements.
Step 6: Grant of License to Commence Commercial Operations
Upon successful completion of the pilot operations stage, the digital retail bank will apply to SBP for a license to commence commercial operations. This new license will replace the restricted license and will contain new terms and conditions.
Step 7: Transition Phase
After the grant of the new license, the digital retail bank will undergo a transition phase which will last for a minimum period of 3 financial years, as determined by SBP. In certain cases, SBP may exempt the transition phase, or relax any conditions applicable during this phase.
During the transition phase, SBP will closely monitor the performance of the digital retail bank. Certain restrictions will also apply to the digital retail bank and its Sponsors during this phase. The digital retail bank’s aggregate deposits will be capped at a certain level, and it will be liable to maintain certain advances to deposits ratio.
After the transition phase, these limitations will either cease to apply or will be relaxed. The transition phase will conclude only with the SBP’s approval.
What is the process to apply for a license to establish a digital full bank?
The process to obtain a digital full bank license will include the following steps:
Step 1: Submission of Application and Grant of Approval
Upon conclusion of its transition phase, a digital retail bank may apply to SBP for the grant of a digital full bank license.
The application will accompany the prescribed documents listed in the Framework. The prescribed documents include audited financial statements, customer experience surveys, and service quality reports of the applicant bank.
SBP will assess the application and the performance of the applicant bank and based on its assessment, may approve the applicant bank. The approval will contain the terms and conditions for the grant of the digital full bank license to be fulfilled by the applicant bank within the prescribed period.
Step 2: Grant of License
After the applicant bank has completed all the terms and conditions mentioned in the SBP’s approval, it will be issued the digital full bank license by SBP enabling it to commence the progression phase. This license will be in addition to the digital retail bank license already held by the applicant bank.
Step 3: Progression Period
Upon the grant of the digital full bank license, the applicant bank will undertake a progression phase during which it will meet the applicable minimum capital requirements. The applicant bank will also comply with other terms and conditions laid down in the license. The applicant bank will also be required to be listed on Pakistan Stock Exchange before the conclusion of the progression period. However, this requirement will not apply in certain cases.
The progression phase will continue for a minimum period of 2 years. It will conclude only with the SBP’s approval. After the progression phase, SBP may revise the terms and conditions of the license for subsequent commercial operations.
Can an eligible person directly apply for a digital full bank license?
As the general rule, only a digital retail bank licensed by SBP may apply for the grant of a digital full bank license, after it has completed its transition phase. However, SBP may consider a request made by a local conventional bank or an international conventional or digital bank for the grant of a license to form and operate a digital full bank.
Is a separate license required for a digital bank to provide Islamic banking services?
The application for the grant of license for a digital bank may be made for either conventional banking services or Islamic banking services. However, a digital bank holding the license for conventional banking services may also offer Islamic window operations after obtaining approval from SBP.
Does the Framework specify any minimum capital requirements for digital banks?
The digital banks shall be subject to certain minimum capital requirements.
The minimum capital requirement for a digital retail bank at the grant of restricted license is PKR 1.5 billion (approximately USD 8.6 million) which will be gradually increased to PKR 4 billion (approximately USD 22.8 million).
The minimum capital requirement for a digital full bank at the time of grant of license is PKR 6.5 billion (approximately USD 37 million) which will be gradually increased to PKR 10 billion (approximately USD 57 million). These requirements are significantly lower than those applicable to local conventional banks.
Does the Framework specify any capital adequacy requirements for digital banks?
Digital banks must comply with the minimum capital adequacy ratio prescribed in the Framework. The minimum capital adequacy ratio for a digital retail bank will be 15%. For a digital full bank, the minimum capital adequacy ratio during the progression phase will be 12.5%. Thereafter, the same capital adequacy requirements as applicable to conventional banks will apply.
Digital banks will also adhere to certain advances to capital ratio, portfolio caps, and aggregate advances cap. Some of these requirements may be relaxed by SBP.
Are the digital banks subject to the same regulatory requirements as applicable to conventional banks?
The business, governance, and operational requirements applicable to conventional banks shall apply to digital banks except where such requirements are inconsistent with the Framework.
Similarly, digital banks will be subject to the same liquidity and leverage as applied to conventional banks. Digital banks shall also comply with all regulatory requirements relating to risk management, customer onboarding, KYC, anti-money laundering, terrorist financing, consumer protection, and cyber security, as applicable to conventional banks.
Can the Sponsors of a digital bank freely transfer or dispose of their shares?
The Sponsors will not dispose of their shareholding in the digital retail bank until the conclusion of its transition phase. The disposal of shareholding by the Sponsors of a digital bank will require SBP’s approval.
Is there a processing fee to apply for a license to establish a digital bank?
The applicant shall deposit a sum of PKR 1,000,000 (One Million Rupees) as a processing fee along with the application. The fee may be deposited through demand draft, pay order, or digital channel and shall be non-refundable, even in case of an unsuccessful application.
Is there a deadline to apply for the grant of digital bank license?
SBP has set a deadline of 31 March 2022 for the submission of applications for the grant of digital bank licenses. Initially, SBP will issue up to 5 digital bank licenses.