FOZIA AROOJ (fozia.arooj@hotmail.com)
Sep 15 - 21, 2008

Banks in Pakistan have seen a mushroom growth in the past decade. They are taking undue advantage of the weak regulatory framework by behaving like a cartel and earning windfall profits within the policy space provided to them by the State Bank. This dilemma has emerged and reinforced due to the opening of many small banks with limited capital base and other resources like managerial capability. It is becoming cumbersome for the front line regulator to conduct and supervise activities of mid tier and small sized banks. For the last five years the State Bank has been following a policy to reduce number of banks with a vision of consolidation of banking in the country. It is in the air that in future the Minimum Capital Requirement (MCR) will be increased to $300 million for both conventional and Islamic banks. The MCR was previously set at $100 million. A number of small banks failed to achieve the target of $100 million or they opted to remain far behind the target and their fates were sealed by selling them to big banks. Most of the small banks were sold to giant foreign banks, which increased their share in the banking industry of Pakistan .

The banks have turned into a cartel and exploiting the industry in many ways leaving the State Bank toothless and ineffective. Primary factors which highlight the bank's control and command over matters are as follows:


Pakistan has one of the highest interest rate spreads in the world. Earlier this year despite a slow off-take of credits, banking spread was still highest in the region though it lost some weight during the first six months of FY08. The net margin has been vacillating between 5.95% and 9.58% during the period from 1990 to 2005. In recent years, the spread has exceeded 7% on an average. The six-month average banking spread of year 2007 was 7.39%. The high interest rate spread reflects that competitiveness in the banking sector in Pakistan is either absent or very poor. SBP has powers to control the spread through monetary policy therefore this issue is largely attributed to weak regulation of interest rates. However after the shedding of 53 basis points earlier this year analysts are expecting spreads to float in the range of 6.6 to 6.8 per cent during the second half of 2008.

In other countries where spread is high with similar circumstances non-operating loans and high administrative costs could be considered as major reasons in countries . But these elements can't be held responsible in Pakistan because banks are earning huge profits at the cost of savings of depositors. High interest rate spread is damaging the competitiveness in the economy in general and in the financial sector in particular. The banking sector is earning record profits by charging unrealistic and exceptionally high interest rates. As a result, despite considerable ratio of non-performing loans, the annual profitability of banks has reached 76% on an annual basis over the past few years. This is evident from the pre-tax annual profit of all banks, which was Rs7 billion in 2000, but jumped to Rs123.4 billion in 2006. In recent months, deceleration trends are on the rise in consumer financing due to increasing loan default and use of credit worthiness information by the banks.


Another critical issue surfacing gradually is that almost all consumer loans are on the basis of variable mark-up, which has reduced the loan-servicing capacity of borrowers due to progressive increase in the rates. These variable rates have provided banks with a moral ground to charge elevated mark up. Another malpractice seen on part of the banks was the conversion of terms and conditions after execution and disbursements of loan. In this regard thousands of fixed rate loans were subject to a new rate at the discretion of the bank. This change was associated with the increased cost of funds due to tightening of monetary policy by the SBP. There is mounting evidence that debt repayment capacity of consumer is deteriorating due to high spread and variable interest rates on loans. Depositors are not getting due returns because of the high difference between lending and deposit interest rates.


Acquisition of easy bank credit by household consumers has urged the demand for many essential and luxury items. Ultimately this factor has created demand pull inflation, resulted in escalated prices of essential items and has also stimulated hoarding and black-marketing.


As the consumer financing portfolio is increasing, quality of related banking services is becoming a serious issue. The volume of consumer complaints is rising day by day due to processing delays, service inefficiencies, hidden charges, poor disclosure practices unauthorized debits and non-compliance with requirement of providing monthly bank statements are few examples of poor quality of banking services. For example, in the first eight months of the operation of banking ombudsman in 2005, about 40% complaints filed with the ombudsman related to consumer products, 30% of which were related to credit cards alone.


General public has dearth of knowledge regarding bank's rules and regulations and little capacity to observe and protect their basic rights. This problem of consumer education on banking terms and conditions, policies, rules and regulations is also a critical factor in securing financial rights.


The State Bank should exercise its powers to tighten the regulatory framework and determine a reasonable rate of returns for banks as well as depositors. As a matter of priority, the interest rate spread should be reduced, at least, to the level of average spread in the South Asian region. In addition, there has to be a substantial and concrete plan to decide upon the extent of disbursement of credit to a certain sector of economy so as to avoid undesirable consequences like we are facing in consumer finance.