Market orientation of banking system

Adopting policies leading to liberalization of monetary market have been impressive and praiseworthy;

By Abdul Rahman Batada
Jan 01 - 14, 2001

Monetary Management in the Past: Banking reforms were introduced by the people's party regime in the year 1972 and institutions like National Credit Consultative Council, Industrial Credit Advisory Committee and Agricultural Credit Advisory Committee came into being. The chief aim of monetary and credit policies was then to keep credit expansion in the private sector within reasonable limits and to bring about a more rational allocation of bank credit to encourage inflow of credit for productive and priority purposes.

Further the Banks were nationalized in the year 1974 with the aim to spread Banking facilities all over the country. As such it was felt necessary to open Commercial Banks branches in far-flung areas of the country so as to reach and capture the deposits lying in the hands of small peasants, farmers and landlords. Commercial Banks in fact were given the task of opening accounts of such individuals who have never been to the bank. In order to induce the customers the Banks used to open a saving account with a sum of Rs.5/-only. Resultantly a record number of branches were opened during this era for fetching small deposits at rural as well as urban level. The increase in number of Branches of banks only was considered then a path for progress and success of financial sector by the then Policy framers. It is interesting to note that factors like productivity and profitability of the banks were completely ignored at the time of opening branches of the bank. Opening of Banks branches in excess of their requirement not only affected the banks productivity, profitability and its soundness but also paved way for recruitment of Staff/Officers in such banks on political grounds, which aggravated the position of banking sector in Pakistan. A bank having more and more branches all over the country was then considered to be sound and successful.

In addition to above the financial sector in the country was then brought under direct control in respect of interest rate movement, domestic credit control in the shape of credit ceiling and selective credit allocations etc. The factors like number of branches and number of accounts then played a positive role in determining the credit ceiling allocations.

Moreover these banks were also required to fulfil mandatory target allocated to them for providing credit at subsidized rates to priority sectors viz. Agriculture, small business finance etc.

Impact of above policies on the economy

l) The Commercial Banks were required to accept deposits, but they could not lend as per their will due to fixation of credit ceilings. In addition to above these Commercial banks were also required to provide loans to priority sectors at low rates of interest. This infact created excess liquidity with the commercial banks, which ultimately resulted in decreasing the profitability of the Banks due to nonutilization of funds available with them. The Banks were also required to invest minimum of 5% of their demand and time deposits in non-interest bearing assets as cash reserve requirement.

2) Non-Bank Financial Institutions: NBFI's mobilized a large portion of financial savings during the period as they escaped the supervision of the Central Bank.

3) In order to increase the rate of savings in the country high rates of interest on various Government Savings Scheme were offered than other financial Institutions resulting in segmentation of Financial Market

4) As the profitability of National Commercial Banks had declined it was not possible for them to offer equivalent rates of return to its depositors.

Since the system adopted was not found working in the long run it became absolutely necessary to bring certain fresh reforms in the Financial and Banking Sector.

Main Objectives for Introducing Fresh Reforms

1) Removal of distortion and segmentation of financial Markets.

2) Elimination and abolition of direct and subsidized credit schemes.

3) Switchover to market based interest rate determination through regular auction programme of the Government Borrowing.

4) Allocation of credit according to market forces.

5) Development of secondary market for Govt. Securities.

6) Privatization of Nationalized Commercial Banks.

7) Allowing free entry of private banks in the financial sector.

Financial Sector Reforms -Introduction Of:

Financial Sector Reforms have been introduced in Pakistan in the year 1991. Some of the important points of reforms are given below so as to depict the position at a glance.

1) Nationalized Commercial Banks like Muslim Commercial Bank and Allied Bank of Pakistan has already been privatized. Privatization of other Banks like H.B.L, United Bank Limited is on hand.

2) A number of new Banks viz. Metropolitan Bank, Habib Credit & Exchange Bank, leasing companies and Modarabas has been established.

3) Public Sector Enterprises have been allowed to borrow from any Scheduled Bank in competition with Nationalized Commercial Banks.

4) Credit Ceiling as an instrument of credit control abolished with effect from 1st August 1992.

5) Abolition of Credit Deposit Ratio (CDR) with effect from 30th September 1995 which served as a media of Credit Control.

6) O.M.O (Open Market Operation) is now main instrument of monetary Policy. The relevant Department of State Bank of Pakistan at regular Intervals conduct auction of Government Securities.

7) Non-banks have also been allowed to trade in Government Securities among themselves.

8) Effective from 16th July, 1997 Scheduled Banks and DFIs have been allowed to determine their lending deposit rates.

9) Minimum Lending rate prescribed for the Banks and DFIs stands abolished with effect from 28th July 1997.

10) SLR reduced to 16.5% on 22-6- 1998

11) Non- residents have been permitted to invest in Government Securities including NIT units and they are empowered to repatriate.

12) REPO rate reduced to 13%

13) Auctioning of Government Securities (T.B/F.I.B) introduced in 1991.

14) Attempt to close non-earning branches of Nationalized Commercial Banks undertaken to reduce the fixed cost and to increase the Profitability.

Critical Assessment of Reforms Introduced in 1991:

Positive effects:

1) Results of adopting policies leading to liberalization of monetary market have been impressive and praiseworthy. This has encouraged competitions among the financial institutions.

2) Government can now borrow from market at market rate instead of borrowing from banking sector at a subsidized rate.

3) Restructuring, downsizing, rightsizing of employees in banking sector for reducing the expense/costs has been undertaken by almost all the banks and financial institutions. Further a number of branches of the various banks running in loss have been closed to reduce the cost and increase the profitability of the Banks. A number of Banks have sold assets like guesthouses. etc.

4) Chances of further bad debts, and defaults have been averted and minimized.

Negative Effects:

a) The priority sectors, which used to receive ample funds in the shape of cheap credit under Credit Ceiling criteria, is now likely to remain neglected. They may starve for cheap funds in the years to come.

b) As the Government has reduced the rate of profit on different savings and this process is likely to continue with a view to provide funds to our Industrial Sector and other Sectors of the economy it has and it will adversely affect the small depositor and saver which is not good for a country like Pakistan where saving rate is far below from required rate. Needless to mention that the debacle of Foreign Currency Account in the past has severely shattered the public confidence as such reduction in the rate of profit on Government Schemes may not be better for the economy as a whole.

Moreover the hard earned funds in the shape of Commutation, Gratuity and Provident Fund received on retirement and invested in Government Schemes by the retired employees for earning livelihood may experience severe hardships to meet their day to day expenses.

c) The process of reducing the non-earning branches of the Nationalized Banks undertaken in the year 1996 picked up momentum in the year 1998 and 1999 as is evident from the statistical data's given below:

Scheduled Banks - Pakistan and Foreign

.

Pakistani Banks

Foreign Banks

Total

Year

No. of
Banks

No. of
Banks

No. of
Banks

No. of
Banks

No. of
Banks

No. of
Banks

1990

10

7341

29

67

39

7408

1991

10

7493

26

68

36

7561

1992

18

7583

28

71

46

7654

1993

21

7803

21

71

42

7874

1994

21

7857

20

74

41

7931

1995

25

8326

19

74

44

8400

1996

25

8523

22

83

47

8608

1997

25

8597

21

85

46

8682

1998

25

8049

21

81

46

8130

1999

25

7973

21

21

46

8058

Source:" Pakistan Statistical Year Book 2000 "Federal Bureau of Statistics Statistics Division, Govt. of Pakistan.