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The central bank aims at implementing the second phase of reforms in consultation with the banks

June 24 - 30, 2002

The GoP had initiated a restructuring programme for financial sector in early nineties. Prior to this monetary and credit management was carried out through direct allocation and credit ceilings. The system has gradually replaced and now the monetary management uses indirect instruments such as open market operations, reserve requirements and changes in discount rate. Pricing and remuneration for most of the financial services are determined by banks on competitive basis.

The GoP is also pursuing the broader policy objectives of privatization of Nationalized Commercial Banks (NCBs). A number of important measures have been taken to strengthen the central bank's capacity for supervision. After the completion of first phase, the second phase of restructuring has to be implemented. The positive point is that the central bank is not following the policy of directives but a consultative process to ensure that players themselves suggest the ways and means and also participate in the process with the sense of ownership.

In this connection during this past week State Bank of Pakistan (SBP) organized a one-day conference on 'Financial System of Pakistan'. The main objective of the conference to elicit considered response to a host of issues confronting the financial system of Pakistan. In all, nine groups were formed to deliberate on topics: 1) Fragmentation of financial system, 2) Monetary management, 3) The system of credit, 4) Cost and pricing structure of banking system, 5) The burden of non-performing loans (NPLs) on the banking system, 6) Governance and regulation, 7) Financial market development, 8) Foreign Exchange markets and 9) The non-banking financial institutions. The terms of reference were given to these groups and they were asked to adjust or change the list of suggested issues for deliberations, if deemed appropriate.

In Pakistan too many and undercapitalized banks are operating, some with negative equity. The aim was to find ways to consolidate the sector to enable it to play the due role. Over the years monetary management mechanism has improved but a need was felt to improve it further. It was also deemed necessary to explore the impact of abolishing directed sectoral credit system. A group was assigned the responsibility to look into the present weaknesses of cost and pricing structure to rationalize interest rate structure. NPLs are still eroding profitability of banks and causing insolvency. The overhang has been handled by write-offs, provisioning and recapitalization but further improvements have to be brought in.

The key objective of the central bank's efforts is to develop a market oriented, predominantly privately owned financial sector performing efficient financial intermediation through innovative products and allowing fair return to all stakeholders for promoting sustainable and equitable growth in Pakistan. The actions which have been completed so far are: 1) Shift to market based monetary and credit management, 2) Liberalization of foreign exchange regime, 3) Rationalization of interest rate structure and pricing of products, 4) Promoting competition and privatization of NCBs Strengthening the central bank's capacity for supervision and prudential regulations, 6) Improving corporate governance, disclosure and transparency and 7) Strengthening of capital base.

The medium-term strategy of financial sector reforms now focuses: 1) Transition to Islamic banking system, 2) Privatization of NCBs, 3) Foreign exchange market unification, 4) Dealing with non-performing loans, 5) Restructuring of NBFIs, 6) Restructuring and reorganization of DFIs, 7) Consolidation and merger of small private banks, 8) Strengthening of legal infrastructure, 9) Payment and settlement system reform, 10) Developing long-term capital instruments and markets, 11) dealing with foreign banks, 12) Deposit insurance, 13) Financial services exports and Promoting housing finance.

The long-term strategy include: 1) Ensuring self-sustained and commercially viable financial institutions, 2) Minimizing GoP's role to creating regulatory environment based on incentives regime. Where GoP's assistance in equity becomes necessary it may participate without any involvement in the management, 4) ensuring financial discipline 5) and 6) introducing a three tier structure of the financial system.

All the efforts are aimed at developing a strong financial sector in the country to facilitate the private sector in the revival of the economy and poverty alleviation. It is true that Pakistan's financial sector did not face the crises experienced by other Asian countries but has experienced server hemorrhages due to weak internal controls and sluggish performance of regulators. All the efforts are aimed to minimize such weaknesses to make financial institutions sufficiently strong. A strong financial sector can only support the economic revival plan of the GoP.