The banks are currently flush with liquidity but there are not very many attractive avenues for profitable deployment of cash

Sep 29 - Oct 05, 2003

Changes in world industry and trade are taking place fast due to various internal and external factors, offering opportunities and challenges particularly to the banks and financial institutions. The opportunities might slip away if the banks in Pakistan fail to suitably adapt their products/services required by the customers in the new scenario. Probably in the coming days the customers shall be more selective and closely look at the strengths of different banks before they decide to establish business relationship with a particular bank or banks. As such, the banks have to continuously improve their image as well as the services including cost competitiveness to attract credible customers. This would be possible with merit-based appointments of experienced personnel, adaptation of organizational structure to the modern needs, streamlining of procedures and controls, and improving quality of services achieved through extensive training of the personnel engaged purely on merit. Some of the important action areas essential for sustained profitability and growth of the banks are briefly described below.

Arrangements under World Trade Organization (WTO) would be fully effective from January 1, 2005 when all quotas would be abolished. This event might have direct and indirect implications for the bank operations. Many of the banks might have to face problems in loan recovery. Under the changed scenario, the borrowers now servicing loans on due dates might find it difficult to timely honour the commitments. The banks have to carefully review their loan portfolios now and to take precautionary measures to minimize the potential risk. This review process would not be easy as the banks would be anticipating likely changes and taking measures considered appropriate in the new situation. The process can be handled well if the proceedings of the WTO meetings are carefully followed for likely impact on the banks as well as their borrowers and customers.

The banks are currently flush with liquidity but there are not very many attractive avenues for profitable deployment of cash. The federal finance minister, speaking at the inauguration of the HBL housing scheme, urged the banks to find more profitable avenues including schemes in the area of liability management. The changed situation demands developing new and innovative instruments as well as venturing into avenues not vigorously followed earlier. The Governor State Bank has been alluding to this need for sometime now. To help develop such diversification in bank lending, the government has brought changes in the law, wherever required, for financing house building, general construction, and consumer durables. Fiscal adjustments including significant reduction in applicable taxes have also been introduced through the current budget. The banks are expected to take full advantage of these measures and introduce banking services that are modern, customer-oriented and competitive. Some of the functions they have been doing in the past are still relevant and therefore must also be continued with greater efficiency.

The banks have recently initiated finance for consumer durables and houses purchase / construction. Earlier their housing loans were restricted to the bank staff only. Due to limited experience of the new financing with the general public, some banks have apprehensions of potential high risks. Moreover, the banks presently do not have long-term funds for financing housing construction which is a 15-20 year commitment. The mismatch of the assets and liabilities can be reduced by developing new products for mobilizing long-term deposits for such financing purposes. The foreign banks operating in Pakistan, because of their international operations, are better placed to introduce such products more easily. Their branches in Pakistan can quickly adapt the guidelines/documents to the conditions prevailing in the country and start the financing confidently at a large scale. The local banks with their diligence can neutralize this disadvantage.

Municipal infrastructure offers big financing potential for banks and financial institutions in the country. Every city needs large cash for implementation of projects such as overhead bridges, underpasses, roads, sewage treatment plants, sewerages, water supply and storage, construction and road-building equipment, fire-brigades, etc. These are important civic services and must be financed and provided to the people as soon as feasible. The banks have big opportunities for advisory services as well as for part financing of these projects. Difficult areas including loan security and repayment guarantees can be sorted out by the banks and the local authorities with the concerned provincial and federal authorities. These projects are mostly for the welfare of the people and therefore the government accords priority and in certain cases tax concessions. The banks can also help the local authorities in the developing the financing package for the large infrastructure projects and mobilizing foreign currency funds for meeting part of the capital costs.

The banks, for increased public savings and documentation of the economy, are expected for adapting their products and procedures to better suit the small and medium depositors. Low returns on their deposits recently have pushed these depositors to the wall of despair. Most of them depended on bank profit for running their kitchens. Enhancement of service charges and imposition of fine for failing to maintain the minimum balance has added to their despair. Most of them have started feeling that profit on deposits may not have been determined using fairly. The depositors also feel that that the banks pay lower profits due to large write offs of loans to the borrowers and for which the depositors are being penalized. From this they might conclude that as the banks were not performing well, their deposits might be at risk. This is a very crucial area for the banks and the senior managements must give early attention to introduce transparency and fairness in determining profit on deposits. The banks must have the confidence of the depositors all the time.

With the increased liquidity with the banks in the aftermath of the 9/11 and the ensuing reduction in mark-up rates, the banks were thought to be hard pressed to seek new avenues for gainful deployment of their growing deposits for ensuring profit on their operations and reasonable return to their depositors. In actual, the banks have largely shown for them better profits, it appears largely by offering lower rates of return to the depositors. The SBP might consider introducing transparency and fairness in the determination of profit rate on deposits by the banks and other financial institutions.

The banks must take note that cheap deposits may not be there for all times to come. Cordial service and fair rate of return provided to the depositors are expected to lay the foundation for long-term relationship. The banks at present can devise new products for raising long-term deposits to be able to finance housing and industry without seriously disturbing the matching of assets and liabilities. Due to this, the banks may not opt to raise long-term funds through issuing of TFCs or other similar debt instruments at considerably high cost and effort. Moreover, the government due to socio-economic considerations might not allow mistreatment by the banks of the small depositors. There are already talks of profitably using surplus funds mobilized through NSS by the government in other areas while maintaining profit rates on NSS at reasonable level.

The banks and the DFIs are exposed to major risks such as credit, market, liquidity, operational, etc. which if not adequately managed might cause losses and in worst case make impossible for the institutions to remain in business. Risk Management Guidelines, prepared and circulated by the SBP for compliance, are designed to provide an overview of actions the banks/DFIs may take for identifying, measuring, monitoring, and mitigating/controlling the risks inherent in the business of banking. According to the SBP guidelines, the basic principles relating to risk management that are applicable to every financial institution, irrespective of its size and complexity, include: (i) Overall responsibility of risk management vests in the Board of Directors, which shall formulate policies in various areas of operations of the bank. The senior management is interalia, responsible for devising risk management strategy and well-defined policies and procedures for mitigating/controlling risks, which should be duly approved by the Board. The senior management is also responsible for the dissemination, implementation, and compliance of approved policies and procedures; (ii) At operational level, risk assessment may be made on portfolio or business line basis; however, at the top level the management needs to adopt a holistic approach in assessing and managing risk profile of the bank; (iii) Irrespective of a separate risk review or management function individuals heading various business lines or units are also accountable for the risk they are taking; (iv) The risk review function should be independent of those who approve and take risk; and (v) the banks should have contingency plans for any unexpected or worst case scenarios.

The measures taken by the banks for implementation of the risk guidelines will be communicated to SBP's Banking Supervision Department in the form of a half yearly progress report within 30 days from the end of each calendar half year i.e. 30th June and 31st December of each year. The first such report shall be submitted for the half year ending 31st December 2003. The State Bank's inspection team shall conduct on-site verification of the progress so reported during their routine inspection. The banks are expected to make required organizational changes and to take measure for effective implementations of the risk guidelines. For the first report, the banks shall have to work really hard as they would be switching from somewhat conventional banking to modern banking.

The Board of Directors of the banks would appoint competent management, monitor its performance and hold it accountable for problems. Once the men or women agree to be directors they have to find time for supervision of bank operations and take responsibility for the results including full compliance with the regulatory requirements. It is felt that they need to be paid handsomely for the big responsibility and the time and efforts they would require now to put in for welfare of the banks. Until a better way out is found to adequately compensate the directors, their meeting fee might be enhanced many times. This should induce the directors to take more care of the banks by devising better policies and through extensive monitoring of the performance of the senior management.

The DFIs currently regulated by the SBP already have separate Chairman of the Boards and the Chief Executives. The nationalized commercial banks and many private local banks have one person who is the Chairman of the Board as well as the Chief Executive. This might have to be changed in the new scenario by hiring a new Chairman or the Chief Executive.

The Borrowers are now becoming more sophisticated. Chances are they would be noting down carefully the lapses made be the banks in the processing and disbursement of loans to the customers. In case they feel they suffered losses due to lapses/mistakes of the bank staff or were obliged to forego profitable opportunities, they might not hesitate to enforce lenders' liability and claim damages from the banks through the law courts. The bank personnel have to be aware of these risks as well and always be covering their tracks through efficient operations and transparent procedures.

Local banks have been facing tough competition from foreign banks as they are maintaining better project teams and proactively pick the better projects and customers for financing. As a result they earn higher profits and they are exposed to lesser loan defaults and write offs. Local financial institutions have to develop their project teams better and pay them market salaries to be able to successfully compete with the foreign teams. Data bank and training are the two key areas for maintaining the expertise levels high and therefore more funds and patronage of the senior management to these activities is required. Advisory fees are an important source of income and it could be enhanced many times provided the project teams developed by the banks have the reputation of being one of the top teams in the country, capable of helping the customers in various areas and situations. This dream would only be realized if the bank personnel are highly qualified, experienced in project finance and known to be of high integrity. The banks have to develop such teams who would also help improve overall image of the bank.

The banks and DFIs need better personnel now than ever. The directors must be knowledgeable, senior management be experienced and committed, other personnel to be competent and well trained. This might require fresh recruitment of professionals at middle and lower levels, who should be given extensive on the job training.

Many banks show in their equity considerable amount of Reserves for Revaluation of Securities. This jacks up the overall equity and the capacity for mobilizing of deposits. In case there are slumps in the stock exchanges, the values of securities shall plummet and expose the banks seriously in more than one way. The banks should endeavour to raise fresh paid up capital by cash injection and thus improve the magnitude and quality of the equity components.

The banks have to be always on the right side of the regulators through strict compliance of the prescribed rules, regulations and controls. The Governor, SBP and the Chairman, SECP have recently resolved to work in close cooperation to build up a strong and effective regulatory framework in the country. Corporate sector providing major business to the banks is regulated by the SECP. The SBP has recently issued instructions to the effect that the external auditors of the banks shall share their audit findings with the SBP inspectors. This is part of the tightening of the regulation process and the banks have to remain in compliance of the regulatory requirements. The banks' personnel, for improving monitoring of their borrowers, must also remain aware of the SECP regulations and see that the borrower companies are always in full compliance.