COMMERCIAL BANKS: NEW CHALLENGES AHEAD
Raising the paid up capital will enable the banks to play their role more efficiently and effectively
By SHABBIR H. KAZMI
June 27 - July 03, 2005
Over the last five years commercial banks operating in Pakistan have emerged stronger. They have not only consolidated their position but intruded into area which remained exclusive domain of foreign banks for a long time. It may be true that after the 9/11 global landscape banking has undergone drastic change, to which Pakistan also has to respond. However, the paradigm shift had started much earlier in Pakistan, to be specific, when the government of Pakistan allowed the private sector to enter into commercial banking business. The private sector acquired two large banks and also established about a dozen banks.
As the ownership of commercial banks was shifting from the public sector to the private sector (under the three tier policy of deregulation, liberalization and privatization) a more vibrant regulatory mechanism has to be put in place. The objective was to protect both the depositors and the shareholders of the banking system. State Bank of Pakistan was given not only the autonomous status but the government also adhered to the policy of least interference, to a large extent. Efforts were also made to monitor and supervise the banks through policy and regulatory framework rather than interfering in day to day affairs.
The results are on record and the credit for transformation of banking system goes to the State Bank of Pakistan, working under the able guidance of Dr. Ishrat Husain. It will not be fair to acknowledge efforts of the government for giving a free hand to Dr. Ishrat. The central bank has achieved the targets fixed before launch of first generation structural reforms. The success gave courage to come up with second generation reforms. It is believed that the central bank will also succeed in achieving the new targets.
It is also necessary to bring it on record that the consultative policy being followed by the central bank is yielding very positive results. Since the rules and regulations are prepared in full consultation with the players the level of resistance is least. The self- regulatory mechanism adopted by the players has helped in the creation of more conducive working environment. Over the next five years, the SBP plans to ensure (i) soundness of the financial sector, (ii) effective monetary management of the economy, (iii) prudent exchange and reserve management, and (iv) efficient and sound payment systems.
To ensure the soundness of the financial sector, the SBP has been focusing on deepening of financial sector, proactive supervision and regulation of financial institutions, strengthening of financial sector, privatization of the public sector banks, divestment of government holding in the privatized banks, and promotion of Islamic banking as a parallel system.
The main targets of the SBP is to ensure an efficient and sound payment systems through implementation of the RTGS, promotion of e-banking, establishment of an electronic clearing house, and development of public key infrastructure and digital certification.
For financial sector deepening and broadening of access, the short to medium term strategic plan is to consolidate and build on the existing initiatives in agriculture finance, SMEs, mortgage and micro finance. The strategy includes strengthening of the exiting micro finance regime and expansion of agriculture credit to small farmers and for livestock. For the SMEs, as an initial step, delivery of credit by banks will be monitored and intermediary/technical support organizations will be encouraged to assist the SMEs in preparing bankable proposals. In the medium term, the staff of the banks will be trained in program lending and the proposed guarantee scheme by the Government of Pakistan (GoP) will be established. To pursue this strategy, there has been close coordination with the Small and Medium Enterprise Development Authority (SMEDA).
The SBP plans to formulate an agile banking crisis resolution mechanism through implementation of prompt corrective action regime and reinforce it with modification in the Banking Companies Ordinance. In the short term the cluster plans to enhance market discipline through adoption of International Accounting Standards, implement IRAF, and enhance the usage of CIB along with the Data Warehouse. IRAF will also be further modified to reflect the risk profile of each banking institution and a standardized template will be developed for this purpose. This risk profile, as assessed by the Banking Desk, will also be taken into account in the final composite rating of each bank.
For achieving consolidated supervision, cooperation with other regulatory bodies, both foreign and local, will be intensified leading to enhanced off-site monitoring and targeted on-site inspections of cross border branches. In the medium to long term a smooth transition from Basel-I to Basel-II and institutionalization of stress testing will strengthen the existing risk management regime.
The SBP has been following appropriate strategies to facilitate the government in privatization and divestment of the public sector banks including the IDBP, SME Bank and Zarai Taraqiati Bank along with divestment of remaining government holding in the already privatized banks. The strategy is to proactively play its role as an advisor and facilitator to the privatization process by bringing improvements in the selection of strategic investors, following due diligence process, and successful completion of the transactions.
To further strengthen the financial sector, the SBP intends to introduce a safety net through deposit insurance scheme, a phased increase in the regulatory capital requirement, and acting as catalyst in the development of an enabling legal framework for private sector credit bureaus. Modest progress has so far been achieved through consolidation and mergers of financial institutions. The minimum capital requirement has been raised to Rs 2 billion, effective from 31st December 2005. However, this amount of almost US$ 35 million is considered inadequate in comparison with the trends in the global banking markets. The SBP aims to set US$ 100 million as minimum capital by end of 2009, a three-fold increase from the present levels. According to SBP at present, only ten banks have US$ 100 million capital. The higher capital requirements will allow some medium size banks to emerge and attain a capital to assets ratio of 5 percent, enabling these banks to book assets up to US$ 2 billion.
Lately the SBP decided to introduce Islamic banking in parallel with the conventional banking in Pakistan. It has already issued four licences and more are in the pipeline. The central bank has decided, as a policy to issue only Islamic banking licences in the country. The licencing, supervision, regulation, inspection, Shariah Audit, training of personnel of these Islamic banks or branches is done by the Islamic Banking Department of the central bank. A two-pronged approach is being followed i.e. attracting international banks of quality to locate in Pakistan and nurturing a cadre of professional Islamic bankers domestically.
New financial products will be traded in the Money/Bonds market by the introduction of Zero Coupon Yield Curve through the bootstrapping process, Bond Stripping and development of a GoP Bond Index. Recognizing the need for tradable financial instruments for Islamic banking treasury operations, the SBP plans to design and implement these new instruments. The SBP is planning the listing of government securities particularly Pakistan Investment Bonds (PIBs) on the stock exchange. This will broaden the investor base through inclusion of retail/small institutions.
RTGS will be completed by December 2005. To reduce the settlement time significantly and increase cost effectiveness, the SBP plans to establish an electronic clearinghouse. Instead of paper cheques, its image will be forwarded by payee's bank using secured network and the clearing will be done automatically. The SBP also plans to promote accelerated adoption of e-banking and ensure that all banks get networked and connected electronically within the next two years. Security of online payment processing is vital for promotion of e-commerce, and the central bank is playing a key role in the development of a cost effective infrastructure for digital certification.
A number of new areas are emerging where the SBP plans to venture or has already initiated work, like e-banking, deposit insurance scheme, electronic clearing house, PKI, Exim Bank and Digital Certification. The SBP plans to help formulate and strengthen the legal framework governing these areas. Many of the functional strategies listed above encompass either updating/changing the existing legal frameworks or facilitation of enactment of new laws in areas like AML, Private Credit Bureaus, Banking Crisis Resolution, Islamic Banking, Capital Account Liberalization and legislation for Government Securities.
To ensure continuity of critical functions (time sensitive) of the SBP and prevent any major disruption in financial system of the country the SBP plans to establish a technology Disaster Recovery Center to cope with any interruption due to a technology fault or a disaster. The enforcement mechanisms to ensure regular testing and up-dating will be in place by end 2005 and will be coordinated by the Business Continuity Process coordinator with the relevant critical departments.
As stated earlier the policies followed by the central bank are yielding positive results. One may say that return on deposits do not commensurate with the rate of inflation in the country, most of the time these are negative. However, the positive point is that deposits are growing persistently. This growth can be attributed to two factors, growth in remittances received through formal banking system and increase in the usage of ATM/debit cards. Now the account holders normally withdraw only that much amount which is necessary and keep the balance in their accounts.
It is very important to say that deposits kept in Islamic banks have shown a very substantial growth. One may say that these deposits constitute only 1.5 percent of the total banking deposits. However, when compared with other countries it is a very significant achievement. Malaysia took about two decades to reach this level, which Pakistan has attained in less than two years. As stated by Pervez Said, Director, Islamic Banking Department of the SBP, "The creation of parallel Islamic banking in the country provides an option to people for earning the rate of return which is comparable with return being paid by the conventional banks. The real advantage is that the return is Riba-free. Islamic banking is expected to grow at a faster as people develop faith in the system."
There has also been a significant change in the profile of depositors and borrowers. Even in the recent past bulk of the deposits was provided by a large number but the number of borrowers was confined to a very insignificant number. Now the situation has changed to a large extent with the introduction of consumer finance and housing finance. Most of the depositors have become borrowers in one way or the other. The number has not gone up to the desired level only because people have not been able to develop 'profile' with the banks. The largest beneficiaries of consumer finance have been the employees of corporate sector, government servants and autonomous bodies as their salaries are credited to their accounts on a regular basis.
Lending to the agriculture sector is also on the rise. It is on record that in the past a number of banks preferred to pay penalty rather than disbursing the target amount fixed by the central bank. As opposed to this, commercial banks would be disbursing about Rs 100 before the current financial year closes. It is believed that banks have chosen to extend such credits only because they have discovered the real potential. With the improved income of farm workers and government's priority to the agriculture the earnings prospects are getting brighter. However, some of the critics still say that bulk of such lending is going to landlords rather than the farm workers. They also apprehend that in case of default the blame would go to small farmers, whereas the actual beneficiaries are the feudal lords.
There are apprehensions about the interest rate hike. Rising rates are expected to improve earnings of banks but are expected to adversely affect fresh borrowing. It is also being said that the worst hit will be the small borrowers as they have acquired the funds on floating rates. There was a news also that about 13,000 cars leased to individuals would come back to auto financier because it is getting difficult for the people to make timely payment. If this happens it would be bad omen for the auto financier as well as the automotive assemblers.
In the rising interest rates scenario the financial institutions are getting anxious to lock more and more funds. The newspapers are filled with advertisements of banks soliciting deposits at very high rates. However, most of the time an asterisk is attached with the rate, which is disguising. A lot of depositors may be willing to lock their money at the indicative rates but not get the same ultimately. The situation has arisen only due to the fact that bulk of the banking deposits is for less than one year tenure. It seems that depositors are not willing to commit their funds for longer tenure. Previously it was said that the tendency was due to lack of confidence in the banking system, but the same attitude at present is beyond comprehension.
It may be unfortunate but also a fact that country still lacks DFIs. In this scenario it is often said that commercial banks should undertake medium and long term funding. Theoretically, proving long term funding is not the mandate of commercial banks. Therefore, they should not indulge in this activity. However, some of the analysts are of the view that banks should allocate 10 to 15 percent of their deposits for long term lending. They should extend such loans through syndication. However, there is another suggestion that banks should extend loans generously to the leasing companies and modarabas, which are already in the business of providing medium term financing. It will help the banks in deploying their surplus funds and earn profit and ensuring availability of funds to medium term financiers.
Privatization of commercial banks has yielded positive results. These entities have emerged stronger with the passage of time. Privatization of Allied Bank of Pakistan was a bad scar. However, sale of its shares to private sector is expected to bring a complete turnaround. Investors are also benefiting from divestment of shares of National Bank of Pakistan. The bank is working exceptionally well under the able leadership of Syed Ali Raza. The bank has improved in terms of quality of its services and more importantly playing a very proactive role.
Taking an inspiration from the public offer of Kot Addu Power Company, the government decided to offer shares of United Bank to general public. However, the public offering was undersubscribed. According to the analysts this happened due to incorrect timing, higher price and above all reducing lot size to 200 shares only. Even the lot size would have not mattered had the government not said that applications for larger lots would not be accepted. Let us accept the fact, with an open heart, that it was a bad decision. Nations learn from their past mistakes and Pakistan's policy makers will also learn a lesson.
As a policy the government has decided to list all the commercial banks on the local stock exchanges. However, Habib Bank and Allied Bank are not listed as yet. It will be appropriate to list these banks at the earliest and also offer their shares to general public. Saying this, it is also necessary to say that the government should not offer the shares of these banks in the lot of 200 shares.
In the past SBP has allowed the banks to float term finance certificates to improve their capital adequacy. However, it was not a good proposition, simply because there is no secondary market of TFCs in the country.
Last but not the least; the SBP must announce the final schedule for raising capital of banks to Rs 6 billion. PAGE has suggested in the past that banks should be asked to raise capital only through issue of right shares. This will help in raising the free float and also broaden the shareholders' base.
FINANCIAL HIGHLIGHTS OF COMMERCIAL BANKS
(JULY 2004 — MARCH 2005)
(RUPEES IN 000)
NAME OF BANK
SHARE HOLDER'S EQUITY
PROFIT AFTER TAX
National Bank of Pakistan*
PICIC Commercial Bank
* Dec 2004
NATIONAL BANK OF PAKISTAN
FIVE YEAR PERFORMANCE AT A GLANCE
(Rs. in Million)