Sep 15 - 21, 2008

After making easy and unchecked profits during the last five years (2002-2007) commercial banks in Pakistan are now faced with multifaceted challenges threatening their profitability. The banking sector fully exploited pro-rich and pro-elite economic policies followed during the last 7/8 years of Musharraf /Shaukat Aziz Government, rapidly making rich richer and poor poorer. Rate of profits in National Saving Schemes operated under Government control mainly for retired and elderly persons was reduced significantly by the Government. Following the trend, the Government as well as private commercial banks, through a clandestine collusion, reduced the rate of profit on saving accounts drastically (bringing it down to about 3 to 4 percent ) leaving the depositor high and dry.

For years the spread what banks were paying to their depositor and what they were charging form their borrowers ranged between 8 to 9 percent against normal and internationally accepted standard of 2 to 3 percent. In the process, banks swelled their profits to a level unprecedented in the baking history. This continued for years under protection of the Government and the regulator of the banking sector in Pakistan.

This scenario changed with the banging of the current fiscal year and the credit goes to the newly established Competition Commission of Pakistan (CCP) which took notice of this cartel like behavior of the banks that are depriving depositors of their dues. The CCP imposed heavy fines of Rs.25 Million each on seven banks, Rs.30 Million on Pakistan Banking Association (PBA) for being the main player in the game. PBA has challenged the CCP decision in the High Court, but the basic objective of the CCP to break the cartelization in the baking system and protect the interest of depositors has been achieved.

During the last 6 month, many commercial banks have not only announced increase in the rate of profit for their depositors, they also have come out with new scheme for their depositor ranging form 8 percent to 16.25 percent on long term deposit. They had to do it to hold back their deposits.

The Banking system of Pakistan is made up of 53 banks, which include 30 commercial banks, four specialized banks, six Islamic banks, seven development financial institutions and six micro-finance banks. The 5 largest commercial banks account for 55% of system assets, while eight second-tier banks account for a further 35% indicating moderate concentration. However, the banking sector has witnessed huge investments, mergers and acquisitions during FY2007-08.

The most highlighted investment during FY2007-8 is the entry of Barclays in Pakistan as it will not only strengthen the baking system of the country but will also bring a significant amount of foreign direct investment and technology to launch innovative financial products. Barclays will be established in Pakistan as a foreign banking company and operate in branch mode with a capital of US$100 mn and will initially set up 10 branches in various cities of the country. The issuance of license to Barclays will add to the presence of foreign banks in Pakistan.

The banking industry is facing multifaceted challenges as a consequence of ever tightening monetary stances by the central bank, high level of defaults with the two best customers i.e. textile and consumers, huge write offs, and colossal raise in salaries and perquisites of the directors of the banks. The efficiency of the banks was actually veiled in making record profits at the cost of depositor's money. SBP has recently announced raise in discount rate by 1.5% which has not only jolted the banking system but also took its toll on already deteriorating capital markets.

The non performing loan (NPLs) kept mounting and rose to Rs. 170 billion by end 2007 from Rs. 141 billion in 2006. During the current year, it is feared to be multiplied more heavily.

State Bank Governor Dr. Shamshad Akhtar in her meeting with the heads of banks recently also pointed out towards the problem of rising NPLs.

She asked the banks to closely monitor rising nor-performing loans and to keep them in loaned with international standard. High inflation at 24 percent, removal of subsidies on electricity and petroleum products have suddenly increased the cost of doing business or default on the banking loans.

Banks have been forced by the State Bank to clean up their balance sheets by heavy provisioning of NPLs, which drastically reduced their profits but the fresh NPLs will not allow the banks to clean up their balance sheets. The next year balance sheets of the banks would be heavily burdened with the fresh NPLs.

Commercial banks in their half yearly reports have shown an addition of Rs.26 billion as NPLs pushing the banking sector's total NPLs to Rs.194 billion. Laid down in economy and higher interest rate scenario are main reasons behind this rising NPLs. The SBP circular states that in order to further strengthen the solvency of individual bank/DFI, SBP has decided to raise minimum paid up capital requirements for all locally incorporated banks to Rs23 billion (net of losses ) to be achieved in a phased manner.

Moreover, SBP said that foreign banks operating in Pakistan (FBs) are also required to increase their assigned capital to Rs.23 billion (net of losses) within the above prescribed timelines. However, FBs operating with up to five branches are required to increase their assigned capital to Rs. 3billion, FBs operating with 6 to 20 branched are required to raise their assigned capital to Rs. 6 billion by December 31, 2010 provided their Head Office hold paid up capital (free of losses) at least equivalent to $300 million and have a CAR of at least 8 percent or minimum prescribed by their home regulator, whichever is higher.

Similarly, DFIs will raise their paid up capital (free of losses) to Rs. 5 billion by December 2008 and Rs. 6 billion by December 2009 as presently required.

Banks are also required to meet specific condition(s) if any regarding capital requirement imposed on them under the banking license issued by the State Bank of Pakistan. All new banks including branches of foreign banks licensed after the date of this circular will be required to meet the paid up/assigned capital requirement of Rs.23 billion before commencement of their operation.

The required minimum CAR on consolidated as well as on standalone basis has been increased for banks/DFIs to 10%. Those banks/DFIs whose CAR is at present less than 10% are advised to meet the shortfall latest by 31st December, 2008. Furthermore, all banks/DFIs are required to maintain variable CAR as under:

The variable CAR will now be based on CAMEL-S Rating as signed by the State Bank to each bank and DFI. Banks/DFIs which CAR falls short from the required ratio (determined on the basis of CAMEL-S) shall meet the short fall within 6 months form the assignment of the latest rating. The required MCR and CAR can be achieved by the banks/DFIs either by fresh capital injection or retention of profits.

Any bank/DFI that fails to meet the minimum paid up capital requirement or CAR within the stipulated period shall render itself liable to the following action:

Imposition of such restrictions on its business including restriction on acceptance of deposits and lending as may be deemed fit by the State Bank. De-scheduling of the bank, thereby converting it into no-scheduled bank.

Cancellation of the banking license if the State Bank believes that the bank is not in a position to meet the minimum paid up capital requirement or CAR.

There is almost a panic in the banking sector. It is feared that smaller banks are likely to vanish form the fence as attaining the minimum capital requirement of Rs.23 billion during the next 5 years would be difficult for them. It may lead to mergers or more winding ups. The new rules will hardly pose any problems for the leading Pakistan banks like National Bank, Habib Bank, United Bank, Muslim commercial Bank and Allied Bank. Foreign Bank operating in Pakistan would also be least bothered because of huge financial support of their parent companies. It is apprehended in the concerned circles that the new rules have been designed with a purpose to wipe out the small players.

What is happening in the Stock Market these days? You cannot recommend it as a place to invest especially to small savers who do not belong to big money class. Incidentally the Competition Commission of Pakistan has issued notice to Karachi Stock Exchange for misusing its dominant position in the stock markets. The KSE has also gone to Sindh High Court against CCP.