The first generation of reforms in the financial
sector of Pakistan is about to be completed successfully and we have to
lay down the proposals for eliciting wide discussion on the second
generation of reforms. The reforms should be implemented in the next
five years, although they have to be reviewed continuously to adapt them
according to the changing circumstances both domestically and
The objective of the second-generation reforms is to
further deepen the financial sector and integrate it into the global
economy. Before we lay down the proposed road map, let me recapitulate
briefly as to what we have learnt from our experience so far and what we
have accomplished so far.
First, financial sector functions effectively and
efficiently only if the macroeconomic situation is favourable and
stable. The need to maintain macroeconomic stability will thus remain
imperative for the coming period too.
Second, reforms can be successfully implemented only
if there is consultation, involvement and consensus building among all
the stakeholders throughout the process. An institutionalized mechanism
for this interaction and collaboration has to remain in place.
Third, there has to be an active champion for
conceptualizing, formulating, sequencing, implementing and monitoring
reforms. In the absence of such a champion, there is a serious risk of
derailment, reversal or abandonment.
Fourth, application of technology, intensive use of
human resource competencies and managerial skills are the key tools for
achieving results and have to be carefully nurtured and upgraded
continuously. Fifth, the regulators have the responsibility to
communicate and explain the rationale, progress and outcomes of their
policies and keep the market players fully informed.
markets in Pakistan have been liberalized and have become competitive
and relatively efficient but still remain shallow.
(b) The array
of financial instruments available for various types of transactions in
the market has widened but the evolution of new instruments has to
remain on track.
infrastructure has been strengthened but the legal system is still too
time consuming and costly for the ordinary market participants.
environment has improved and the capacity of regulators to oversee and
monitor is much better today but the enforcement and prompt corrective
action capabilities need to be further enhanced.
soundness indicators of the system show an upward moving trend in almost
all dimensions but there are weaknesses and vulnerabilities that require
to be fixed.
governance rules have been clarified and conform to best international
practices but their consistent application and voluntary adoption by the
industry remain uneven.
sector is opening up to the middle and lower income groups but the
commitment and mindset of the providers are still out of sync with the
It can be seen from the above catalogue of
accomplishments that we have made a lot of progress but, at the same
time, challenges ahead of us are quite formidable, the agenda for action
is a lot more complex and the need for remaining alert and agile is even
more pressing. The industry and regulators cannot afford to become
complacent on our achievements but strive to work harder and together to
move forward on the road we have set for ourselves.
WHAT NEEDS TO BE DONE?
The second generation of reforms should be built on
the strengths of the financial system, work on removing the weaknesses
and gaps and agree upon the speed, contents and phasing of these
reforms. In my humble view, there are at least ten areas in which these
reforms will produce promising results.
(a) BROADENING ACCESS TO MIDDLE AND LOWER INCOME
The banks have learnt that by broadening their client
base, adding new products to their portfolio and offering new types of
services, they can not only diversify their risks but also earn higher
returns. We should continue to move along these lines and aim to reach
out to at least three million households in agriculture sector and two
million small, medium and micro enterprises in the next five years. The
economies of scale and economies of scope make these goals quite
feasible but I must also warn 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
your institutions into deep trouble. I would urge you 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 needs.
(b) NEW LIABILITY PRODUCTS:
The industry has paid adequate attention so far on
developing new products on the asset side but neglected the savers and
depositors. It is myopic for us to have such 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 28 million depositors and savers of Pakistan. The Government
has made the playing field level for you by removing the preferential
returns in the National Savings Scheme, which has hurt the scheme
holders badly. It is a wake-up time for all of us 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 we have done so far.
Development of new liability products should be on the top of the agenda
for the next five years. This is a serious weakness that we cannot
afford to live with any more.
(c) CORPORATE RESTRUCTURING:
Financial Sector Reforms in absence of corporate
sector restructuring i.e. pruning costs, reducing debt and increasing
efficiency will have only short-term beneficial effects. The ratio of
total corporate debt to GDP should be lowered, capacity has to be
expanded and labour productivity needs to be raised. Firms have to be in
better shape and invest in productive activities while new firms have to
enter credit markets.
Firms will fail in their businesses for a variety of
reasons. Bankruptcy law will provide a mechanism for an orderly
settlement of obligations. Bankruptcy separates bad managers from
potentially valuable assets, lifts debts from shoulders that cannot
support them and preserve value that alternatives such as liquidation
(d) INFRASTRUCTURE FINANCING:
The traditional mode of financing infrastructure
projects only through Public Sector Development Programme has resulted
in congestions, shortages and bottlenecks. The experiment with the
independent power producer types of arrangements in the private sector
has not proved satisfactory from the viewpoint of the consumer. We have,
therefore, to find some other ways of fostering private-public
partnership in the areas of infrastructure development, and like other
countries, the banks and capital markets have to take the lead.
You should look at the successful experiences in
other emerging markets and adapt them to our conditions. The State Bank
of Pakistan (SBP) is prepared to work with you and we plan to hold a
conference next year in which we will bring all the stakeholders
together to ponder over this issue and come up with some practical
course of action.
It is gratifying to note that a lot of progress has
been made in establishing the platform for Electronic banking. With the
deregulation of telecommmunication sector in Pakistan, the opportunities
for further value-added services to underpin banking transactions have
multiplied manifold. While small and medium banks can now offer on-line
services to their customers, the large banks have to move more
expeditiously so that the E-Banking network can be utilized optimally.
Transaction costs will become lower and customer service will improve. A
variety of new services can then be offered. Our ATM penetration ratio
is still quite low and we should expand ATMs more aggressively while
maintaining them in good stead.
(f) PRIVATE EQUITY, PENSION AND PROVIDENT FUNDS:
There is still a mismatch between the growing
appetite of institutional and contractual saving institutions for
long-term investment vehicles and the demand for long gestation
mortgage, infrastructure, real estate and project financing. Private
equity and venture capital funds, private pension and provident funds
and insurance companies can play an important role in filling in this
market segment. I would very much urge those who are always so keen to
obtain a traditional banking licence to exploit the vast potential by
setting up these new types of funds which are almost non-existent in the
country but are badly needed. I can assure you, on the part of the SECP
and SBP, that we will render all possible assistance to those who wish
to move into the fields of private equity funds, venture capital funds,
private pension and provident funds, real estate investment trusts and
similar other vehicles.
(g) INVESTMENT BANKING:
The role of investment banking in Pakistan has
remained quite murky so far. The spread of universal banking model in
the country has led to a certain degree of ambiguity as far as the
market niche in which investment banks can operate. In my view, the
corporates will always require investment banks to render services such
as investment advisory, corporate restructuring, distressed assets
acquisition and disposal, mergers and acquisitions, equity and debt
financing. The investment banks have to get away from their aspiration
to mimic commercial banks and build up their capabilities in the areas,
which are begging for help. Commercial banks will never be able to
compete with them either on costs or customer satisfaction even if they
all profess that they can provide total banking solutions to all the
clients needs. Several investment banks have merged into commercial
banks but those who are serious players in this field should re-examine
their strategies and direction and build up their human resource
(h) HUMAN RESOURCE DEVELOPMENT:
I wish to thank all the Chief Executives of banks who
have put in place transparent and merit based system of recruitment of
entry-level bankers. The next step in this value chain of human resource
development is the continuing education, training, testing and
progression of in-service employees and identification of future
managers of the financial industry. Recently, I had a very productive
meeting with the Human Resource Heads of some of your institutions at
the IBP and we have agreed that this area needs your personal attention
and commitment. We, at the SBP, have gained some experience in this
endeavour and we are willing to share that with you. The IBP has been
given a much larger mandate, the NIBAF facilities have been opened up to
the whole industry and the five large banks have offered to upgrade the
quality of their training institutions which can then be available to
other banks, leasing companies, etc. I attach a lot of importance to
this particular area of work and I will take personal interest in
developing a cadre of professional bankers in Pakistan who are of
international standards and can move into multinational banks without
(i) RISK MANAGEMENT:
The advent of Basel II regime in a couple of years
imposes a sense of urgency on both the regulators as well as the
financial industry to put their act together as far as risk management
is concerned. I have very little doubt that the foreign banks operating
in Pakistan will have any serious problems in making the transition
successfully but I remain very much worried about our domestic banks —
large, medium and small. Although we all have been talking about Basle
II for sometime, our response in preparing ourselves have been at best
patchy. The SBP has installed capacity for risk management within the
institution and we intend to keep on expanding this capacity but I see
that our large banks have not yet woken up to attract the human resource
of the right kind, set up the internal rating systems and the supporting
technology. We have started the training courses in real earnest and I
have asked the IBP to give priority to this area but we need trainable
material from the banks. I hope that the Pakistan Banks Association (PBA)
will form an internal working group to bring their member institutions
to reach minimum standards by certain timelines.
(j) PROMOTION OF ISLAMIC BANKING:
I have been very much encouraged by the enthusiastic
response to the setting up of Islamic banks and branches in the country.
This is an extremely positive development as it brings into the fold of
formal financial sector those who have remained outside because of their
faith and beliefs. From my interactions, I can tell you that their
numbers are in millions and not in hundreds of thousands. That is why we
have a highly liberal licencing policy for opening Islamic banks,
subsidiaries or branches. But I must caution you that we do not wish to
transform this into another facade by moving too quickly and too
imprudently. You should have all the ingredients in place — Shariah
Advisors and Auditors, credit appraisers and marketing specialists,
product development capacity, systems and technology — before you
approach the SBP. Merry-go-around a few experienced individuals in this
field by offering them attractive compensation packages will soon out
price Islamic banking products from the market. This is not in our
long-term interest that such kind of reckless actions put the future of
Islamic banking in Pakistan at risk.
Ladies and gentlemen, there are many more tasks we
have to do but I thought if I had too many items on the platter it would
not be possible for us to manage it within the timeframe of the next
five years. But, as I said earlier, these are only some proposals and
suggestions for your consideration, critical review and scrutiny. You
may have some other priorities in mind which may make better sense.
Please feel free to articulate them as I do not have any pretensions of
having monopoly on wisdom.
My purpose is to initiate discussion, debate and
dialogue as to what we ought to be doing together in the next five
years. I hope that all of you will come back to me with your feedback
and ideas and then we can arrive at a consensual roadmap.
In the end, I wish to thank each one of you for your
support, cooperation and assistance to my colleagues at the State Bank
of Pakistan and myself. Without your active collaboration we could not
have achieved what we have done so far and we look forward to even
better relationships in the future to meet these difficult challenges
Keynote address delivered by Dr Ishrat Husain at the
54th Annual General Meeting of the Institute of Bankers, Pakistan held
in Karachi on October 14, 2004.