(NO)LAW & (DIS)ORDER THREATS TO BANKING SECTOR
SHAMSUL GHANI (email@example.com)
Jan 05 - 18, 2009
The harm caused to the banking sector by the worsening law and order situation and mounting terrorism appears to be overshadowed by the damage caused to the other sectors of economy, particularly trade and industry. The global financial crisis and our banking sector's capacity to sustain the onslaught have been much in focus and few attempts have been made to assess the extent of damage inflicted by the law and order factor alone. The liquidity crunch ensuing in the face of an unprecedented capital flight put the banks in a tight corner. The capital flight phenomenon generated great demand for dollars which in turn put pressure on banks' rupee deposits. Although SBP tried to control the situation by creating room for supportive liquidity of Rs.270 billion, yet the dent made in banks' sustaining ability was much bigger. However, it is difficult to decide what portion of the huge capital outflow should be attributed to the greed factor rather than the law and order factor. A recent Asia Post article by James Crickton says:
"Billions of dollars flying out of Pakistan, due to growing fears of terrorism and worsening economic situation, came to be a boon for London's slumped property market.
According to property dealers here in London, Pakistani politicians and military officers have been investing in areas around the prestigious Park Lane and Mayfair in central part of the city, which are historically the most sought after areas of the rich and most famous Pakistanis. Shortage of land in these areas has opened up adjoining residential districts, which are now being preferred to by many Pakistanis for investment and development. They feel that investments in the UK are safe bet than putting their money in Pakistan."
It was not London market alone that attracted our opportunistic investors and country's higher-ups, other global investment markets too - particularly the Dubai market - took their share out of Pakistan's meager financial resources. After economy, the major sufferers were Pakistani banks that helplessly saw their kitties emptying in the mad run for safer and high-yield foreign investments. With the inflow of FDI, the banks get flush with liquidity and with its exit they find their operations severely restrained. The deteriorating law and order situation has taken heavy toll on FDI on one hand and triggered domestic money outflow on the other. The banking sector, till 2007, registered tremendous growth besides attracting huge foreign investment. During 2008, the situation changed dramatically when, amidst political instability and uncertainty, foreign investors interested in our banking sector put on hold their investment programs. Investment bank mergers and foreign investors' plans to buy stakes in Pakistani banks couldn't materialize.
Booming trade and industry keep the banks going; a recessionary economy puts them under stress. The overall slump in the economy directly affects the growth of banking sector. According to the perception survey 2008, at least 32 foreign companies are planning to wind up their Pakistan operations, while 122 others may limit their investment programs because of the prevailing law and order situation. According to the same survey, 141 out of 175 member companies registered on OICCI (Overseas Investors Chamber of Commerce and Industry) have shown their dissatisfaction over the government efforts to improve the situation. About 96 per cent of the OICCI members consider the law and order situation as one of the most pressing concerns for the investors. The year 2009 is going to be a difficult year for the banks when the impact of the negative factors - law and order situation, high policy rate, competition with the NSS, dwindling economy and flown-away capital - will be duly factored in. Presently, we are busy singing about the resilience and robustness of our banking sector in the face of a global financial crisis. True, that the banking sector has amassed immense strength during the last 6-7 years. Till 2001, the capital to risk weighted assets ratio of the banks was one of the lowest in the region. This ratio now stands at 13, higher than the standard requirement. During 90s, we saw a mushroom growth in the banking sector when new banks were allowed to open like new Modaraba and leasing companies. Every small (or large) business group vied for a bank of its own. The low capital requirement and lax controls culminated in the failure of a number of banks like Prudential Bank, Indus Bank, Mehran Bank etc. The stricter SBP controls and huge liquidity pouring after 9/11 changed the banks from strugglers to real performers. Huge liquidity, highest ever bank spread, and non-existent competition from without, it was during those 6-7 years when all positive factors combined together to bestow the banks with unparallel financial strength. Unfortunately, all negative factors have now combined together to test the mettle of yesteryears' performers.
Besides drying up of foreign investment, the banking sector during adverse law and order situation faces a number of problems hampering its growth. The terrorism menace is an added negative which threatens nit only the economy but also the very existence of the country. Circumstances have proved that unlike bad law and order situation which restricts itself to the national boundaries, the terrorism threat assumes global dimensions badly tarnishing the country image and bringing the economic growth to an indefinite halt. The country becomes hostage to the global exploitative forces that take full advantage of the situation to advance their respective interests. The recent Mumbai events are an example. Internally, the acts of terrorism, besides badly mauling the masses' confidence, hold the economy in hostage. Investments are withheld, expansions are indefinitely delayed and financial crises are brewed-up. This ultimately transmits to the balance sheets of country's banks that are forced to close down their loss making branches and resort to involuntary layoffs. The adverse law and order situation and the resultant foreign portfolio investment withdrawal send stock market reeling. The equity values are ruthlessly shaved off. This again transmits to the banks' balance sheets as their portfolio investments dilute and shares kept as collaterals diminish in value thereby lowering the quality of risk assets and giving rise to the possibility of loan defaults. This in turn puts further strain on their already dwindling profits as additional provisioning for NPLs becomes imperative.
To sum up, the time for being euphoric about our banking sector's strength is over. The menaces of terrorism and bad law and order situation must be contained before they turn the banks' bottom lines red. A failed banking sector is a prelude to a failed state.