SBP declares gold risk-free collateral for MFB loans

The State Bank of Pakistan (SBP) on Thursday, allowed microfinance banks (MFBs) to treat gold as eligible collateral while calculating their Capital Adequacy Ratio (CAR). “Microfinance banks are allowed to treat gold as eligible collateral with a zero percent risk weight for calculation of Capital Adequacy Ratio,” said BSD Circular Letter No. 08 of 2011 notified to the MFBs by the central bank on June 1.
Referring to Regulation No. 4 of Prudential Regulation for Microfinance Banks, the regulator said all other instructions on the subject would remain unchanged.
According to analysts, the move would help banks increase their lending capacity to borrowers, particularly the smaller ones.
Under SBP’s prudential regulations, banks are required to maintain at least 10 percent CAR against their unsecured loans.
“The State Bank, by issuing this circular has declared gold as 100 percent secured collateral for bank borrowings,” said Asfar bin Shahid while further adding, “The banks would not be required to allocate a certain amount of capital against the loans extended against gold.” The senior analyst noted that microfinance banks, after the categorisation of gold as risk-free collateral, would now be able to hold more capital to be lent out to small borrowers.
Another apparent objective of the SBP’s move, Shahid said, was to bring more and more borrowers into the formal sector. “Traditionally, people have been seeking loans through mortgaging their jewelries with the private lenders,” he said. “This (measure) is to encourage such borrowers to come to banks instead of going to private lenders,” observed the analyst.
The analyst, however, suggested that the central bank, through regulatory changes, should have taken the step with certain conditions to ensure transparency. “The banks (while accepting gold as collateral) must keep official record of the weight and picture of the gold accepted as collateral,”  Shahid commented. CAR, also called Capital to Risk (Weighted) Assets Ratio (CRAR), is a ratio of a bank’s capital to its risk weighted credit exposures.
The regulators, like State Bank in Pakistan, track a bank’s CAR to ensure that the concerned bank can absorb a reasonable amount of loss and complies with statutory capital requirements.
The CAR is used to protect depositors and promote stability and efficiency of financial systems around the world. There are two types of capital that are measured: Tier-1 capital, which can absorb losses without a bank being required to cease trading, and Tier-2 capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.