The financial sector in Pakistan has emerged
stronger and exhibits an increased resilience to shock. In the early
nineties it was dominated by state-owned banking system that has been
transformed in to one that is predominantly under the control of the
private sector. The legislative framework and the State Bank of
Pakistan's supervisory capacity have been improved substantially. The
banks have learnt that by broadening their client base, adding new
products to their portfolio and offering new types of services, they
can diversify their risks as well as earn higher returns.
The economies of scale and economies of scope make
these goals quite feasible. However, it is necessary to remember the
words of Dr. Ishrat Husain. He was right is saying that only those who
have imagination, agility and capability will be successful while
others will fail. Reckless lending or optimistic forecasting that the
current low interest rate environment will remain unchanged in times
to come is bound to get their institutions into deep trouble. He urged
them to be enterprising but prudent, strategic but not risk averse and
flexible but not too indulgent in reaching out to the small farmers,
small firms or individuals with microfinance or consumer financing
Financial sector has been paying adequate attention
on developing new products on the asset side but neglecting the savers
and depositors. It is myopic approach to follow one-sided approach as
it is the savers and depositors who provide the wherewithal for the
industry to perform its basic function of intermediation. The banks
and non-bank institutions have to come up with innovative solutions
tailored to the needs of millions of depositors and savers. It is a
wake-up time to begin looking after the interest of this vast majority
of small savers and mobilize and utilize their savings in a much
better way than the way it has been done in the past. Development of
new liability products should be on the top of the agenda.
At the national level the biggest opportunity is to
integrate into international financial market. Entry of foreign
investors in the banking industry of Pakistan is very important as
they bring not only the precious foreign exchange but also the skills
and techniques of modern banking system, innovative products and
services and networking into global chain. As the competition in
domestic banking system has become fierce and the profit margins on
traditional modes of Corporate and trade financing are under pressure
the banks are moving into new business areas — Consumer loans,
mortgage financing, SME financing and agriculture lending.
These new areas require expertise, systems and
procedures, controls, technology and risk management technique. The
banks have to strike a balance between prudent lending and a rapid
build up of risky portfolio. The gradual transition from prudential
regulations to a guideline driven framework would require in-house
risk management capacity within the banks and further elimination of
weaker banks from the system. But creating awareness, educating the
counter parties, building up local expertise, introducing proper
controls and disclosures standards are some of the pre-requisites that
have to be put in place.
With foreign exchange regime being gradually
liberalized and partial capital account convertibility has been
achieved further measures need to be undertaken to open up the market
for cross-boarder risk products to private wealth managers and well
established corporate houses.
Capital requirements of the banking sector have to
be adequate in relation to the risk weighted assets and conform to the
Basel Accord. To further strengthen their competitive ability, both
domestically and internationally and to encourage the economies of
scale, the minimum paid-up capital requirements of the banks have been
raised. The banks were required to increase their paid-up capital from
one billion rupees to one and a half billion rupees by this year end
and to further enhance to two billion rupees by end of 2005.
Otherwise, they will no longer be allowed to carry out full banking
activities as scheduled banks. This is expected to lead to mergers and
acquisitions for consolidation and weeding out of weaker players.
The State Bank has removed restrictions imposed on
nationalized commercial banks for consumer financing. The positive
experience of auto financing gives a lot of hope that the middle class
of this country will be able to access consumer durables through
banks. This will at the same time boost the manufacturing of TVs,
air-conditioners, VCRs, washing and drying machines, deep freezers
etc. in the country.
A number of incentives have been provided to
encourage mortgage financing by the banks. The upper limit has been
raised and tax deduction on interest payments on mortgage has been
allowed. The new recovery law is also aimed at expediting repossession
of property by the banks. The banks have been allowed to raise
long-term funds through rated and listed debt instruments like TFCs to
match their long-term mortgage assets with their liabilities.
A complete revamping of agriculture credit scheme
has been done recently with the help of commercial banks. The scope of
the scheme which was limited to production loans for inputs has been
broadened to the whole value chain of agriculture sector. The SBP has
included financing for silos, godowns, refrigerated vans, agro
processing and distribution under the cover of this scheme. This
broadening of the scope as well the removal of other restrictions has
enabled the commercial banks to increase their lending for
agriculture. Unlike the previous years when they were prepared to pay
penalties for under performance they have set up higher targets for
this year. The private commercial banks have also agreed to step in
and increase their lending to agriculture.
The banks are adopting electronic banking as a
norm. There is a big surge among the banks including NCBs to upgrade
their technology and on-line banking services. In the recent past a
large expansion in the ATMs number has been witnessed and the number
is increasing at a very fast pace.
The decision mandating the banks to join one of
either two ATM switches available in the country has provided further
boost. Progress in creating automated or on-line branches of banks has
been quite significant so far and it is expected that by 2004 a
majority of the bank branches will be on-line or automated. Utility
bills payment and remittances would be handled through ATMs, Kiosks or
Personal Computers reducing both time and cost. Investment in
information technology is being undertaken by the banks to enhance
efficiency, reduce transaction costs and promote e-commerce. It has
been estimated that a banking transaction through ATM costs one fourth
as much a transaction conducted over the counter in a traditional
branch — and the similar transaction over the Internet costs a mere
fraction of the traditional teller costs.
The banking supervision and regulatory capacity of
the central bank has been strengthened. Merit-based recruitment,
competency-enhancing training, performance-linked promotion,
technology-driven process, induction of skilled human resources and
greater emphasis on values such as integrity, trust, team work have
brought about a structural transformation in the character of the
institution. The responsibility for supervision of non-bank finance
companies has been separated and transferred to Securities and
Exchange Commission. The SBP itself has been divided into two parts
— one looking after central banking and the other after retail
banking for the government.
The banking sector, which was fully dominated by
state-owned entities, has been opened up to the private sector. Four
out of five largest NCBs have been privatized. While the ownership and
management of the banks by private sector is one pillar of the
reforms, the other pillar is a strong regulatory environment. The
private banks are prone to taking excessive risks in their lending as
their own capital is much lower in relation to the depositors' money.
They can realize the large upside potential from high-risk assets
while the defaults and losses in event of downside scenario are borne
disproportionately by the depositors.
It is the responsibility of the central bank as a
regulator to be extremely vigilant and take prompt timely action to
prevent the bank managers and owners from assuming excessive risks.
The central bank has strengthened its capacity by acquiring new
skills, upgrading the quality of the existing human resources base,
adopting technology and re-engineering business processes. The banking
regulation and supervision are risk-based and are fully compliant with
the international standards and codes prescribed by Basel Committee.
The risk management practices are being modified to conform to Basel
II rules. The financial soundness indicators show a healthy and sound
banking system with high degree of financial stability.
The banking sector has now diversified its product
base and carried out a lot of innovation. They have expanded their
reach to agriculture, SMEs, mortgage financing and consumer financing.
Not only that this diversified lending portfolio mitigates risks but
it also raises the purchasing power of a large segment of population
that was completely shut out from credit markets. Pakistan's auto
industry has expanded its car production by a multiple of five times
in the last four years as auto financing enabled a vast number of
middle class income earners to purchase the cars on monthly
The affordability of these new products by the
middle class became possible as the prudent fiscal and monetary
policies pursued by the Government left a lot of liquidity in the
banking system. The healthy competition among banks, lower taxation
and reduction in non-performing loans brought about a lowering of
average interest rates. The Government, by reducing its fiscal deficit
and public sector enterprises by making cash profits, freed up
loan-able funds for the use of the private sector. The central bank by
pursuing an accommodating monetary policy did not mop up excess
liquidity and helped the businesses and consumers to access funds at
historically record low levels.
Pricing and remuneration for most of the financial
services are now determined by banks on a competitive basis. There are
no directions or interventions by the State Bank of Pakistan or the
Government. Prior to the reforms, there were subsidized lending rates
for priority sectors and the rate paid by the Government on its
borrowing through banking system was artificially pegged at below
market rates. Banks and other financial institutions are free to set
their own lending and deposit rates. Government and public sector
enterprises have to pay market-based interest rates on debt raised
through the banking system.
The State Bank of Pakistan has adopted a new system
of monitoring, surveillance and supervision of banks and development
finance institutions. The system formally known as 'Institutional Risk
Assessment Framework' (IRAF) is aimed at ensuring continuous and
proactive monitoring of these entities.
With the privatization of Habib Bank almost 80
percent of banking has been placed in the hands of private sector.
Therefore, the central bank has to step up its vigilance and watchdog
functions in order to protect the interests of the depositors, prevent
possible emergence of systemic problems in the financial sector,
discourage private banks from taking excessive and unmanageable risks
and take timely remedial measures. The previous system of monitoring
and supervision served its purpose well when the banks were owned by
the government but market based transactions, promotion of healthy
competition and, improving the efficiency and services to customers
require a different and new approach.
Under the new system, the central bank has to
follow a cohesive supervisory approach whereby the findings from
on-site inspection, periodic reports from off-site surveillance and
market information will be integrated to produce a comprehensive
assessment and composite internal risk rating of each banking
institution. The banks which have low ratings or show high probability
of deterioration in financial soundness will then be taken up for
prompt corrective action.
In this regard one of the major moves has been the
change of ownership of Allied Bank of Pakistan. The Ibrahim Group,
which has injected Rs.14.2 billion into capital of the Allied Bank of
Pakistan (ABL) for acquiring its 325 million additional shares,
assumed the control of the Bank. Speaking on the occasion, the SBP
Governor has termed the successful reconstruction of ABL as beneficial
both for the organization as well as for the banking industry. He
expressed the hope that the transfer of the management of ABL to a
strategic investor will turnaround the bank and usher in a new era of
growth and stability in the banking sector. The Ibrahim Group were the
successful bidder as they offered the highest bid of Rs.14.2 billion
for acquiring these additional shares, which constitute 75.35% of the
revised capital of ABL.
Yet another move to facilitate masses in borrowing
from the organized system has been the establishment of micro finance
institutions in the country. The State Bank of Pakistan has issued a
licence to Rozgar Micro Finance Bank to undertake the business of
micro financing in Karachi. The licence of this new micro finance bank
was handed over to Mr. Badr-ud-Din Khan, Chairman, Rozgar Micro
Finance Bank in Karachi recently. This is the fourth Micro Finance
Bank, licensed by the Central Bank. Out of the three already licensed
micro finance banks, Khushhali Bank and First Micro Finance Bank have
a nationwide operations network whereas Network Microfinance Bank and
Rozgar Micro Finance Bank are district based.
The story will be incomplete without talking about
Islamic banking initiative of the central bank that is fully supported
by the government. The latest addition to the list of conventional
banks opening up designated Islamic banking branches is Bank Al Habib.
With the issuance of this licence, the total number of conventional
banks that are having stand-alone Islamic Banking branches has
increased to six (6). Five other banks that have been issued licences
for Islamic Banking Branches include Muslim Commercial Bank (3
branches), Bank Alfalah (7 branches) and one branch each of Habib Bank
AG Zurich, Bank of Khyber and Standard Chartered Bank. One
full-fledged Islamic Bank, viz. Meezan Bank with licence for 14
branches is already operating since March, 2002. Yet another bank,
Bank Islami is expected to commence its operation by next year.
The central bank is now issuing licences for
setting up of Islamic Banks, Islamic Banking subsidiaries and Islamic
banking branches. The addition of new players in the market will
ensure better services to the customers of Islamic Banking. The future
of Islamic Banking industry in Pakistan is extremely promising due to
growing demand from the customers. It is heartening to note that the
State Bank in promoting Islamic Banking in the country is following a
Commercial banks in Pakistan are emerging stronger.
However, the growth also poses challenges. As a whole, Pakistan's
financial sector has to scale up its activities in catering to the
needs of the middle and poor income groups. The broad direction in
which the sector need to move are:
client base has to expand from 2 million to at least 5 million
borrowers in the next five years.
products have to be introduced particularly for consumer, SME and
3) Loans for
education and health, both at the individual level as well as for
providers of services, have to be stepped up.
Infrastructure loans to District and Union Council levels will fill in
the community needs at the grassroots level.
and modaraba companies have to extend their geographical coverage to
rural and peri-urban areas.
Widespread use of electronic and mobile banking channels will reduce
the transaction costs while extending the outreach to a large segment