FINANCIAL SECTOR - TESTING TIMES AHEAD

SHAMSUL GHANI
Mar 9 - 15, 2009

The global financial meltdown, which has now become the nemesis of the world economy, has it roots in human greed. It was made possible with the help of the lax control systems. The American banks finding it difficult to carry out business in the wake of the history's lowest bank rate opted for derivatives to create business space. The derivative-market boom led to the generation of sub-standard and finally toxic assets. The banks passed on a good part of their risk to non-bank sector namely insurance companies, investment houses, brokerage companies, hedge funds etc. The house of cards came down when sub-prime mortgages failed to stand the redemption test and defaults surfaced on a mass scale. The entire global finance structure crumbled and many giant organizations came down to the floor. The US and Britain bailout packages designed to produce something out of the wreckages of the system, are yet to show any redeeming signs. The collapse of financial systems is fast reflected on the stock exchanges of the affected economies. FTSE 100, on March 03, 2009 closed at its lowest level after 2003 when it touched the mark of 3,512 points. Although recovering 64 points the next day, FTSE 100 - like most of the global stock exchanges - presents the picture of fragile market confidence. FTSE 100 got battering ostensibly due to the news concerning AIG and HSBC. While HSBC, plans to inject additional capital of $18 billion, AIG, the biggest loss maker in the US corporate history, braces up for another dole-out of $30 billion by the US government. This will be in addition to the $150 billion bailout package already utilized by the giant insurer. Federal Reserve chairman Ben Bernanke made no effort to conceal his indignation by calling AIG a hedge fund operator who exploited the huge gap in the regulatory system. Mr., Bernanke conveniently failed to realize that gaps are always meant to be exploited. On Wall Street, the Dow Jones also touched the lowest mark of 6,726 points, after 1997. The Asian bourses, in sympathetic resonance, are also shown signs of weakness. .

Pakistan's financial sector was awarded certificates of sound health prematurely. The picture of banking sector, in particular, was painted rosy. Few analysts tried to take a holistic view of the entire financial sector, particularly the ramifications of a crashed stock market. How a sector that records a fall of 73 per cent during a short period of less than one year can be termed a sound sector - almost immune from the fallout of global financial meltdown. We were in such a hurry to pass on the judgment that we forgot to factor in the domestic conditions the soaring inflation, the high policy rate, both external and domestic liquidity crises, political turmoil and terrorism-bitten law and order situation. In fact, the good-health certificate referred to past of banking sector when the spread was historically very high. In the changed circumstance, the spread is likely to come down fast, the defaulting loans are going to put pressure on banks bottom lines, and above all, the high policy rate is going to trigger a dogfight for bank deposits. We also forgot that the banking sector was instrumental in diverting money from the real sector to the speculative arenas of real estates and stocks. They not only facilitated the non-financial sector to develop sizeable stock portfolios, but also took huge exposures themselves after reducing focus from their core business.

The speculative sectors, having badly shaken, are now going to disfigure banks balance sheets that were once the source of envy to many. As repeatedly mentioned by this scribe, the stock market big bosses have major stakes in our banking and allied sectors. This deadly combine becomes a formidable force during good times and makes money faster than a currency-printing machine. However, during extremely bad times, this duo of bankers and stock big wigs delivers a deadly blow to the entire economy.

FINANCIAL SECTOR'S MARKET CAPITALIZATION
MILLION RS.
SUB SECTOR MARKET
CAPITALIZATION
ON APRIL 15, 08
WITH KSE-100
INDEX AT 15,538
MARKET
CAPITALIZATION
ON FEB 27, 09
WITH KSE-100
INDEX AT 5,969
ABSOLUTE
DECREASE IN
MARKET
CAPITALIZATION
PER CENT
DECREASE IN
MARKET
CAPITALIZATION
Close end mutual funds 36,408 11,715 24,693 67.82
Modarabas 7,271 4,739 2,532 34.82
Leasing companies 6,685 4,518 2,167 32.42
Investment banks etc. 280,248 60,201 220,047 78.52
Commercial banks 1,481,659 476,112 1,005,547 67.87
Insurance 248,734 6,246 242,488 97.49
Total 2,061,005 563,531 1,497,474 72.66

The IAS 39 issue is causing lot of ripples in the financial sector, as the impaired stock values resulting from a 73 per cent decline in the market capitalization are not easy to honestly report. The ICAP and SECP have failed to design an equitable formula that satisfies all stakeholders, particularly the investors who fear a further decline in stock values once.

The results of the banking and shadow banking sectors for the year ending December-08 are made public. The SECP notification of February 13 says: All companies and mutual funds opting for the said (exemption) accounting treatment, should disclose prominently on the face of their balance sheets, profit and loss account and parameters used by them in determination of the value of their investments and the figures arrived at under both the regular and especially opted accounting treatment. This means that parties concerned can use loose ends left.

A debate regarding US and Chinese models for banking sector control is also on according to which US model of private sector control is blamed for the current crisis whereas the public sector control model of China is projected as the main reason for causing far lesser damage to China's economy. Since Pakistan financial sector is predominantly controlled by the private sector, concerns are being raised that the banking sector might go through still more testing times. The debate makes a lot of sense, yet we should go in retrospect to study the pre-nationalization banking sector model when privately owned banks (HBL, UBL, MCB, ABL) went through the golden era of banking. Competitions were fierce yet healthy. Profitability too was high in comparison to the state-owned bank NBP that enjoyed the advantage of solely handling all government deposits. Perhaps the reason was that, as a finance and business community, we were not as corrupt as we are to-day.