Apr 20 - 26, 2009

Although the banking and financial sectors in Pakistan has successfully withstood the global economic turmoil and financial sector's meltdown during the last year, it is still not out of hot water as it is faced with many challenges. According to the latest statistics of the last two quarters, the two major worrying factors are the widening advance-deposit gap and alarming rise in the amount of non performing loans. The profitability of the sector has also declined.

Banks made record advances during 2008 which was highest since 2002. Advances grew to Rs457 billion during the calendar year 2008 as against Rs280 billion during 2007 which is 61% than last year. Deposit of the commercial banks fell by about 60% during this period coming down to Rs226 billion compared to Rs590 billion during the previous calendar year. The fall in deposit growth vastly impacted the banking industry and destabilized the entire system while small banks were hit by the poor growth. The banks and financial institutions have added a whopping sum of over Rs100 billion to their combine non-performing loans in the year 2008 bringing the total to over Rs325 billion highest in the banking history of Pakistan.

Experts are of the view that banks advances mainly increased because of circular debt. "Banks provide debt on government guarantees for public sector enterprises which attracted a good sum of money from commercial banks," said an analyst. The circular debt is a new phenomenon in the country. When a company does not clear its debt to other company, it creates a chain of debt or circular debt and the process goes on. When the government assures banks that it will return the debt, banks once again lend to indebted companies. The circular debt accumulated to around Rs220 billion. Public sector advances in just five months reached over Rs60 billion, an obvious reason for higher advances of banks. On the other hand, banks investment, mainly on security papers and stocks, fell by 52 per cent during the year.

Since banks are not investing in security papers, the government had to borrow a record sum of Rs688 billion from the State Bank during the fiscal year 2007-08 which escalated inflation to 24%. The State Bank accelerated its effort to attract banks investment and gradually started increasing policy interest rate which reached as high as 15 per cent in November 2008. According to the data, banks made an investment of Rs220 billion during 2008 compared to Rs416.5 billion in 2007. However, most shocking is the sharp decline in deposit growth during 2008, which is reflecting the real cause of liquidity crunch in the banking sector.

Unprecedented rise in the NPLs is attributed to economic slowdown due to higher interest rates, high cost of production, and power breakdown apart from global economic recession. "The NLPs of the banks had been declining during the six years from CY2001 to CY2006, they started surging in 2007, and the trend continued during CY 2008. During the CY2007, NPLs rose by Rs 30 billion, or 17 percent to Rs 206.1 billion from Rs 175.5 billion. Sources said that a surge of about 52 percent was witnessed in overall banks NPLs during CY2008 to a record level of Rs 313.657 billion on December 31, 2008 from Rs 206.1 billion on December 31, 2007. It was a record increase in the history of banking industry, which never had been witnessed in the past in a single year. The NPLs stood at Rs 240 billion in CY2000, Rs 244.1 billion in CY2001, Rs 231.5 billion in CY2002, Rs 211.3 billion in CY2003, Rs 199.8 billion in CY2004, Rs 177.4 billion in CY2005, and Rs 175.3 billion in CY2006.

Out of total NPLs, the commercial banks saw an increase of 64 percent during CY2008, which rose by Rs 111.015 billion to Rs 284.515 billion in 2008 from Rs 173.5 billion in 2007. In the case of public sector banks the NPLs increased by Rs 33.5 billion from Rs 44.1 billion to Rs 77.6 billion at the end of December 2008. However, the specialized banks presented better performance, whose NPLs declined by Rs 3.35 billion to Rs 29.143 billion from Rs 32.5 billion. With an increase of 114 percent, the NPLs of foreign bank reached Rs 3.003 billion in December 2008 from Rs 1.4 billion in December 2007.

After making easy and unchecked profits during the last five years (2002-2007) commercial banks in Pakistan are now faced with multifaceted challenges that threaten their profitability. The banking sector fully exploited pro-rich and pro-elite economic policies followed during the last 7/8 years of Musharraf/Shaukat Aziz Government, rapidly making rich richer and poor poorer. Rate of profits in National Saving Schemes operated under Government control mainly for retired and elderly persons was reduced significantly by the former Government.

Following the trend, the Government as well as private commercial banks, through a clandestine collusion, reduced the rate of profit on saving accounts drastically (bringing it down to about 3 to 4 percent ) leaving the depositor in perplexing situation. For years the spread between what banks were paying to their depositor and what they were charging form their borrowers ranged between 8 to 9 percent against normal and internationally accepted standard of 2 to 3 percent. In the process, banks swelled their profits to a level unprecedented in the baking history. This continued for years under protection of the Government and the regulator of the banking sector in Pakistan. This scenario changed with the beginning of the current fiscal year and the credit goes to the newly established Competition Commission of Pakistan (CCP) which took notice of this cartel like behavior of the banks that are depriving depositors of their due share. The CCP imposed heavy fines of Rs.25 million each on seven banks, Rs.30 million on Pakistan Banking Association for being the main player in the game.

The Banking system of Pakistan 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 five largest commercial banks account for 55% of system assets, while eight second-tier banks account for a further 35% indicating moderate concentration. However, the banking sector has witnessed huge investments, mergers and acquisitions during FY2007-08. The most highlighted investment during FY2007-8 is the entry of Barclays in Pakistan as it will not only strengthen the baking system of the country but will also bring a significant amount of foreign direct investment and technology to launch innovative financial products.

The banking industry is still facing multi-faceted challenges as a consequence of ever tightening monetary stances by the central bank, high level of defaults with the two best customers i.e. textile and consumers, huge write-offs, and colossal raise in salaries and perquisites of the directors of the banks. The efficiency of the banks was actually veiled in making record profits at the cost of depositor's money.