FOZIA AROOJ (fozia.arooj@hotmail.com)
June 02 - 08, 2008

The entire banking industry is facing multifaceted challenges as a consequence of ever tightening monetary stances by the central bank, high level of defaults with the two best customers textile and consumers, huge write offs, colossal raise in salaries and perquisites of the directors of the banks. Exorbitantly high spread and negative return to the depositors have fallen short to further elevate the profitability of the banks. The efficiency of the banks was actually veiled in making record profits at the cost of depositor's money.

State Bank of Pakistan (SBP) has recently announced raise in discount rate by 1.5 % which not only jolted the foundations of the banking system but also took its toll on already deteriorating capital markets. Hike in Cash Reserve Ratio and Statutory Liquidity Ratio and fixation of minimum slab for rate of return on deposits have nudged the whole financial market. The interim monetary policy is likely to reduce banks profit by 20-30% resultantly draining a total liquidity of Rs62 billion out of the banking channels. In addition a lethal blow will be experienced as low credit growth in the wake of high interest rates which would reduce interest income of banks.



The Non-Performing Loans (NPLs) kept mounting and rose to Rs170 billion in 2007 compared to Rs141 billion in 2006, hence showing an increase of over 20% during the year ended on December 31, 2007. Conventionally the bad debts used to be denoted as the outcome of the influential political hands during 1970s to 1980s. But now that 90% of the banks are being operated in private sector this plight clearly reveals the inefficiency of banks to channelise deposits and maximize depositor's return.

Textile is considered the leading industrial sector and life blood of the economy. It is the largest borrower with total advances of Rs565 billion at the end of 2007. This sector has come up with huge non payments and sudden collapse with largest contribution of 30% in the overall NPLs. The textile sector added Rs10.4 billion in NPL's during 2007. After witnessing astonishing growth the consumer financing has also started losing its luster at the time of maturity of the payments. In consumer finance total NPLs are Rs.18.6 billion in 2007 as compared to Rs. 8.8 billion in 2006 thereby exhibiting an upsurge of 111%. Auto sector has been the major contributor amongst these defaults. It is generally believed that higher lending rates to the consumer sector are causing massive defaults and the banks would see more defaults in this sector.


The deposit base experienced record growth of over 19 % during 2007 which was in the backdrop of high growth in money supply and strong foreign inflows. But with the start of 2008 the deposit growth has also slowed down and in first quarter it slid down to just 1.8% with total deposits reaching Rs 3.63 trillion (or $57.9 billion). Main reason behind slow growth in deposits can be attributed to money supply growth, which increased by just Rs 79.9 billion or1.9% in first quarter of 2008.


The profitability of the banks was hurt during 2007 primarily because of lesser non interest income caused by slower growth in advances. Banking sector's advances depicted a growth of 6.1 percent in first quarter (Jan-Mar) 2008. This is mainly attributable to government's heavy borrowing from banks. During 2007, the banking sector's advances growth of 17% was lower than the last 4 year average of 28% Growth in banks advances fell by 60% in 2007 compared to average growth of last four years reflecting slowdown in economy. This slower growth was actually a fall out of the recession in the economy. In order to curb inflation SBP has also attempted to curtail credit circulation ignoring the fact that during last four years the high growth of advances was accompanied by the boost in economy and both complemented each other. As a consequence the investment poured in and the GDP growth rate flew to reach at 7%.

SBP should also take into account the fact that Pakistani banking sector is one of the highly under- penetrated sectors when it comes to advances. Credit penetration in Pakistan is calculated at 28% of the GDP, which is one of the lowest in emerging and Asian countries like India, China, Turkey, South Africa, Malaysia, Korea and Brazil.


The Pakistani banking system is made up of 53 banks, which include 30 commercial banks, four specialized banks, six Islamic banks, seven development financial institutions and six micro-finance banks. The 5 largest commercial banks account for 55% of system assets, while eight second-tier banks account for a further 35 percent indicating moderate concentration. According to an estimate these banks are paying around 2-2.5% on deposits in real terms which is shocking. Now that the SBP has attempted to fix minimum 5% return on deposits these banks are hit the hardest. At the same time, the cost of fund has substantially increased and it may reduce the entire banking sector profits by 20-30%. The increase in deposit rates on saving accounts (approximately 43% of total banking deposits) to a minimum of 5% is likely to increase cost of deposits for the industry by 125bps to 4.26% from previous 3%.

As a matter of fact banks would face double negative impact as decline of high cost credit would bring low interest income for banks. Calculations showed that the SBP would suck up Rs62bn from the banking system with the increase of 1% CRR and SLR.

In future the investment avenue for banks is also not diversified as historically the banks have not been investing for any long-term projects, though the corporate sector is still the largest borrower. This shortcoming has limited the options for banks. Either they are investing in risk-free government papers, including Treasury bills or advancing for consumer financing. The trend in the banking sector is more visible through the fact that in 2001 banks advances for consumer sector were just 2.1%, which has now reached 14%.

Reducing inflation through credit crunch has been a part of the State Bank's stance but the inflation kept on moving up mainly on account of high oil and food prices. At the same time, the slower penetration of credit in the economy has slowed down the economic activity.