Absence of long-term funds leads to mismatch of asset and liability for financial institutions

Aug 02 - 08, 2004





One of the main facets of the government's strategy to ensure sustainable growth is to improve the availability of long-term funds for project financing. Historically, within Pakistan and most of the developing world, this effort has been hampered by the lack of appetite for long-term savings. Absence of long-term funds leads to mismatch of asset and liability for financial institutions. One of the reasons for the paucity of long-term funds is the lack of institutional capacity to mobilize such funds.

According to Ali Farid of AKD Securities, Private Pension Funds (PPFs) has the potentials to overcome this constraint as well as easing the heavy fiscal burden of the state. Examples from all over the globe show the phenomenon success of PPF in countries spread over from as far as Latin America and Eastern Europe to as close as East Asia and even India. In some of the countries like Netherlands, UK, Switzerland and South Africa assets of pension funds are in excess of 100% of their GDP.

The PPFs offer an alternative arrangement for private savings for the individuals. As against public or company pension funds, the PPF offers the freedom to choose desired risk return profile. According to market sources, the existing fragmented institutions offering pension plans cover only 10 percent of the labour force in Pakistan.

The entry of PPFs will provide individuals the freedom to choose. Instead of getting a pension based on a fixed formula, the amount of pension would depend on the return that the investment made on the individual's contribution gets. PPFs can provide a variety of pension plans with varying risk-return characteristics. Individuals could then choose from the menu of pension plans that offer varying risk-return characteristics. Furthermore, private sector asset managers have the incentive to offer long-term financial planning services to private savers, a practically unheard of concept in Pakistan today.



The incentive of double tax exemption proposal of the Task Force constituted by Securities and Exchange Commission of Pakistan (SECP) is the most attractive incentive likely to be offered by the GoP. According to Mr. Nasim Beg, Member of SECP Task Force, the proposed tax structure would provide dual tax holiday. Not only will the wealth in the pension fund be exempted from tax but also income tax will be levied only on the wage left after making the contribution to the fund. This would provide people incentive to increase their savings. The link between higher savings and higher investment and growth is well established.

According to Dr. Tariq Hassan, Chairman of SECP, such funds would be especially beneficial for those people who shift jobs. In the existing social security system, pensions depend on the number of years a person has worked for a particular employer. This, along with the threat of losing pension when switching jobs, limits labour mobility. Introduction of PPF would improve the dynamics of the labour market and would help workers make job transitions.

The existing institutions like Employees Old-age Benefit Institution (EOBI), company managed provident funds, and life insurance companies only cover 10% of the labour force. EOBI only provides coverage to the blue-collar workers and the vast informal sector along with the self-employed and small entrepreneurs have no access to any social security system. PPFs could cater for that 90% of the market and fill the vacuum that exists currently.

There is also a need to revitalize EOBI. This institution has been in existence for decades but the coverage provides to the people, as a percentage of total work force, is still very limited. Though, all the employers are required to provide this coverage, but the failure has been only because the EOBI either does not bother or prefers to keep the eyes closed. According to the some analysts the situation also prevails because the employers know that labour supply exceeds demand and in case of an accident leading to permanent disability or death of a worker there is a big queue of people standing outside.