Shadow Banking and Legal Risks in Pakistan: Regulating the Unregulated

https://doi.org/10.5281/zenodo.17821945

Abstract

The development of the shadow banking systems has posed a new regulatory challenge to financial and legal systems being observed throughout the whole world. This has made the construction of a parallel banking system in Pakistan, with its number of informal financial institutions, listed as wins, and operating beyond the reach of control of the State Bank of Pakistan (SBP) and traditional financial oversight. Although these individuals address access to credit gaps particularly within the underserved populations, they are accompanied by lifelong aspects of consumer protection, financial stability and systemic risk.

This paper is a critical analysis of the extent and character of shadow banking in Pakistan, the key participants, framework and the legal loopholes which enable the booms. It examines the danger that unregulated lending presents both legally and economically in regard to predatory interest rates, inability by the consumer to seek recourse, and susceptibility to fraud and money laundering. The paper uses the comparative regulatory models of other jurisdictions like India, the European Union, and China who have tried to control shadow banking in the strict regulatory model. In addition, the paper will assess how the current Pakistani financial regulations; including the State Bank of Pakistan Act, the SECP regulations, and anti-money laundering laws can be effective in limiting the practices of a shadow bank.

It claims that the disjointed legal and institutional framework in Pakistan is hardly suited to cope with the initiative in legal framework and speedy development in this field. The paper ends by making the policy recommendations which argue in favor of a unified legal definition of shadow banking, increased registration and disclosure obligations and the implementation of a risk-based regime of regulation.

The study highlights the fact that although shadow banking can boost financial inclusion, its unchecked growth without any strong legal regulations would destroy financial stability of Pakistan in the long-term, and consumer confidence in the financial system.