The credit of making local banks prudent and efficient goes to Dr. Ishrat Husain and his team

Jan 23 - 29, 2006

The year 2005 ended on a positive note for the banking sector, where highest ever growth was witnessed both in advances and deposits. During the year a major achievement was meeting the minimum capital requirement and decision to raise the limit to Rs 6 billion, in phases, by 2009. To get the true picture it is necessary to look at three indicators, i.e. deposits, advances and investment. Total deposits of the scheduled banks grew by 23% during 2005, from Rs 2,161 billion to Rs 2,662 billion, showing an increase of Rs 501 billion. This is the highest ever growth in deposits, higher by 36% from last year's deposit growth of Rs 368 billion, deposit growth in December alone amounted to Rs 178 billion. The deposit growth was mainly driven by growth in Net Domestic Assets, because Net Foreign Assets witnessed erosion.

With consumer financing gaining further momentum, the banking sector continued its tremendous growth in advances during the year. Advances of scheduled banks increased by 29% or Rs 454 billion in 2005 from Rs 1,590 billion to Rs 2,044 billion, also crossing the two trillion rupee mark at the end of the year. This is also the highest ever increase in advances in absolute rupee terms, and higher by 8.2% than the increase in 2004 of Rs 420 billion (36%). In percentage terms it looks lower due to the higher base effect. Advances/Deposit Ratio (ADR) also improved from 71.0% at end 2004 to 76.8% at end 2005. Main contributors to the growth in advances this year were the manufacturing and construction sectors, along with major contribution by consumer financing, which doubled as compared to 2004.

After taking a dip of 16% in 2004, investments of the banking sector gained momentum in 2005. However, total investments of the banking sector are still lower than the level achieved in 2003. Banking sector investments closed the year at Rs 730 billion, up from Rs 626 billion by 17%. Throughout the year, investments of the banking sector saw rising trend as return on short term papers became attractive and attracted reasonable amounts towards it.

In his speech at the 49th Annual General Meeting of the Institute of Bankers on 25th March 2000, Dr. Ishrat Husain, the then Governor, State bank of Pakistan talked about the rationale behind financial sector reforms. He said, "To avoid failure of small banks and to strengthen their balance sheets, serious consideration would need to be given to enhancing the minimum capital requirements together with necessary amendments in banking laws". He also said, "The present number, functions, human and capital base of the financial institutions are neither conducive to positioning Pakistan in the global financial markets nor helpful for efficient intermediation within Pakistan". To bring a positive change he sought help of the participants and all the stakeholders. The outcome was 'Roadmap 2005-10 and the evidence of the success of the strategy is a completely overhauled and refurbished financial system. Banks have grown and become stronger and fueling economic development of the country. At the same time, regulatory system has become more efficient and no financial scam has been unearthed. Despite growth in advances, percentage of non-performing loans (NPLs) is on the decline.

Some of Dr. Ishrat's critics did not appreciate his desire to bring down number of financial institutions, particularly commercial banks. Some cynics were also opposed to the idea of allowing private sector to establish and operate commercial banks. The fact is that at present more than 80% assets of banks are with private domestic banks. Many local banks and sponsors have acquired Pakistan operations of foreign banks. The point to remember is that the foreign banks did not leave Pakistan because of adverse economic fundamentals but only after having realized that they could not compete and/or retain their market share. The growth of private domestic banks also proved the critics wrong. However, the credit of making local banks prudent and efficient goes to Dr. Ishrat Husain and his team. Another positive and worth mentioning point is during his regime prudential rules were not introduced or amended unilaterally but only after extensive and intensive consultation with all the stakeholders.

The strategy of strengthening commercial banks, through enhancing minimum paid-up capital requirement, has yielded very positive results. These private banks had started their operations with Rs 200 million paid-up capital base and as of 31st December 2005 the limit was raised to Rs 2 billion. In the years to come this amount would be raised to Rs 6 billion. Over the years, management/ownership of some of the banks has changed, only to meet the minimum paid-up capital requirement. The hike in minimum capital is aimed at achieving twin objectives, strengthening capital base of the banks and enabling them to play a major role in the economic development of the country. The enhancement of capital has added to the depth of equities market and also provided attractive return to the investors.

Over the years banks have been catering to the needs of government and corporate clients. However, lately their entry in consumer finance in a big way and manifold increase in agriculture credit have widened their outreach as well as provision of services to those, who were grossly ignored in the past. This on one hand has opened new vistas for the banks but more importantly contributing to improvement of the lifestyle of a large percentage pf population. For example auto loans are contributing towards exceptional growth of automobile industry. Similarly, agriculture credit is helping in achieving higher production and yields of various crops as well as bringing down poverty level in the rural areas.

Focus on small and medium enterprises (SMEs) is not only providing impetus to the manufacturing sector but also helping in boosting exports from Pakistan. Rising imports of plant and machinery and raw materials indicate creation of new productive facilities. Banks are playing most important role as the providers of credit. The diversified lending portfolio helps in mitigating risk as well as raises purchasing power of a large segment of population that was completely ignored in the past.

The prudent and monetary and fiscal policies being followed by the government has helped in making the new financial products affordable for the middle income group. The healthy competition among the banks, a lower taxation and reduction in non-performing loans brought about a lowering of average interest rate. The government, by reducing its fiscal and public enterprises by making cash profits, freed up loan-able funds for the use of the private sector. Following of an accommodating policy by the central bank and not mopping up excess liquidity and helped the end consumers in acquiring funds at historically low interest rates.

Pricing and remuneration for most of the financial services are now determined by the banks on a competitive basis. There are no directions or interventions by the central bank or the government. In the past 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 now free to set their own lending and deposit rates. Even government and public sector enterprises have to pay market based interest rates on debt credit being acquired from the banking system.

Pakistan is among the few developing countries where the public sector banks have gone under the management of private sector in a very short span of time. In fact now only National Bank of Pakistan is under public sector. Almost 80% of the assets of the banking sector are under the management of private sector. In the past there were also complaints about the attitude employees of public sector banks. As against this now management reviews the performance of each and every employee very critically and those meeting the minimum standard could be fired. This change is there because the working environment has reserved from sellers market to buyers market.


With the sale of National Investment Trust (NIT), the public sector open-ended mutual fund, the available free float in the market will be greatly enhanced and trading activity will increase. In addition, proceeds from the sale of NIT estimated at Rs 4.5-6 billion, will lead to one-time income for its current shareholders. The fund is extremely diversified, with exposure in 430 companies out of a total of 662 listed companies. NIT is expected to be broken up into 6 parts. Approximately 36% of the funds under management have been provided by 3 banks- National Bank, Bank of Punjab and Faysal Bank. Each of these banks is expected to be given a part of the fund, in proportion to its current NIT exposure, to manage as its own fund.

With the economy booming, the banking sector is expected to grow on the back of increased private sector credit off-take along with the newly discovered consumer financing. Increase in the international trade and other non-fee based income the financial sector is also expected to post significant returns. Deposits are believed to grow mainly on the back of Net Domestic Assets, with additional help from Net Foreign Assets in 2006, due to expected dollar inflow. Advances of the banking sector are expected to grow by almost the same quantum as that of 2005.

Large commercial banks are expected to continue to dominate domestic banking industry and keep the competition fierce for the smaller banks. According to some estimates 10 top banks account for more than 80% of total deposits and advances. The remaining two dozen banks are struggling to find a share for themselves within the balance. Consolidation in the sector is expected to emerge as a major phenomenon in 2006 and onwards as the minimum paid up capital requirement continues to go up with every year. Loan book expansion is likely to continue with the ongoing expansion in the industrial sector. However, maintaining deposit growth to continue to fuel loan book expansion will emerge as a major challenge, which may also prove to be another reason for the consolidation. Spreads are likely to come under pressure as return on deposits has to be comparable with the lending rates.

Dr. Ishrat Husain had publicly expressed his desire to bring down the number of commercial banks operating in the country, through mergers and acquisitions.

Analysts believe that the sector is likely to see about a dozen merger and acquisition transactions over the next two to three years. While initially the need to acquire or merge will be dependent upon the relative advantages of merger or acquisition, it will gradually translate into the need to raise quick deposits. The need of mergers/acquisitions also arises from the fact that the top 10 banks control almost 80% of the total assets of the banking sector. In case sponsors do not opt for mergers and acquisitions, some of the smaller banks could face serious problems and many face bankruptcy. This would be bad for the sector, for the economy and above all worst for the country.

Successful completion of the first phase of reforms and initiation of second generation reforms have brought in competition within the system, improved internal efficiency, reduced lending rates significantly and broadened access to a larger percentage of population. While the results may be very encouraging, a lot more remains to be done. The point of satisfaction is that the new Governor of the State Bank of Pakistan has expressed her commitment to continue the policies initiated by Dr. Ishrat Husain. However, it is also expected that she will give attention to some of the issues, which may be smaller irritants, but certainly affect the perception about Pakistan's robust banking system.