BANKING INDUSTRY FACING MULTIFACETED CHALLENGES

SHAMIM AHMED RIZVI
Nov 10 - 16, 2008

The domestic financial market including the commercial banks experienced a mild shock last month when some commercial banks faced sever liquidity shortage because of many reasons and mainly due to tightening policy by the State Bank of Pakistan. It led to rumors about viability of banks because of their severe liquidity crunch. This led to rush of depositors on banks counters for withdrawals threatening a red liquidity crunch.

However, contrary to its track record, the State Bank of Pakistan moved swiftly to rescue the banking system. It eased the tight monetary policy by cutting down the cash reserve requirements and announced to inject Rs270billion into the banking system. The cash reserve requirements which bank keep with the State Bank as reserve money was reduced by 2% with immediate effect and further by another 1%. This timely action came to the rescue of the banking system and saved the situation.

Apart from the panic created by the rumors, there were some genuine reasons for heavy withdrawal from the bank. The rates of profit on various national saving schemes were increased w.e.f. 01-9-2008. It was raised to 15% on Behbood account meant for people above 60 years of age, widows and orphans and pensioners scheme meant for retired government servants. On many schemes of national savings rate of profit was increased by 1Ω to 2%. This led to heavy withdrawal from commercial banks which are paying much less to their depositors for investment in the National Saving Schemes. According to a source in the central directorate of national savings the deposits have jumped by Rs60billion in their schemes during the last 2 months.

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 on National Saving Schemes operated under Government control mainly for retired and elderly persons was reduced significantly by the former 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 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 for being the main player in the game.

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 U5$100 million 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 still facing multi-faceted challenges as a consequence of ever tightening monetary stances by the central bank, high level of defaults of 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. The non performing loan 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.

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 raising 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.5 billion, 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.

DAWOOD ISLAMIC BANK L.T.D. SIGNS AGREEMENT WITH ISLAMIC INTERNATIONAL RATING AGENCY

Dawood Islamic Bank L.T.D. (DIBL) has signed an agreement with Islamic International Rating Agency (IIRA) to receive Shari'a Quality Rating, Credit Rating and Corporate Governance Rating from the agency.

Pakistan's sixth full-fledged Islamic commercial bank, DIBL officially commenced its operations on Friday, April 27, 2007. The Bank is the result of an initiative of the First Dawood Group who teamed up with Islamic Corporation for the Development of the Private Sector (ICD) Jeddah, Unicorn Investment Bank - Bahrain, Al Safat Investment Company - Kuwait, Gargash Enterprises (LLC) - Dubai, Mr. Azam Essof Kolia - a Singapore based entrepreneur and Shaikh Abdullah Mohammad Al-Romaizan, an entrepreneur from the Kingdom of Saudi Arabia.

With a total capital of 4.1 billion Pakistani Rupees (US$ 67 million), with already 20 operating branches in Pakistan, the Bank is continuously increasing its network of state-of-the-art branches all over the country which are providing financial products and services to all segments of an increasingly Shari'ah conscious business and consumer society.

Based in Bahrain, IIRA is the first Islamic rating agency. It started its operations in 2005. Its aim is to assist the development of the regional financial markets by providing a range of products and services to both Islamic and conventional markets including the Shari'a Quality Rating, which is a unique product offered by IIRA, Sovereign Ratings, Credit Ratings and Corporate Governance Ratings.

IIRA's Chief Executive Officer, Mr. Jamal Abbas Zaidi said that 'IIRA aims to play a critical role in the development of the financial market by providing an assessment of the risk profile of entities, their compliance with Shari'a and with corporate best practices. The ratings add credibility to the entities and also lead to enhanced level of investors' confidence in the rated entities enabling them to play a robust role in the capital market".

Nikolaus Rafique Schwarz, President and CEO of Dawood Islamic Bank Ltd commented:

"In the last 1 1/1 years since inception, Dawood Islamic Bank's Shari'ah based financial products, services and business solutions have significantly expanded to cater to the fast-changing financial needs of all categories of customers. We are looking forward to IIRA's rating exercise as this will further enhance and solidify our core competence in structuring authentic Shariah compliant solutions.