July 20 - 26, 2009

The policy of keeping interest rates high has virtually crippled Pakistan's economy. Higher rates have forced entrepreneurs to postpone creation of new productive facilities, eroded competitiveness of the local manufacturers and above all weakened the balance sheet of commercial banks. Weakening of the financial sector poses one of the biggest threats because rising delinquency is eroding profitability of the financial institutions.

Ideally, commercial banks are involved in three major activities i.e. providing short-term working capital loans, investment in government securities and shares of listed companies. However, over the last 18 months all the segments have come under pressure. With the economic slowdown, private sector's appetite for funds has reduced substantially. However, inability of the government to mobilize revenue to support its extravaganza has been draining out liquidity from the market. On top of this, bearish sentiments engulfing the equities market has not only resulted in heavy impairment but also turned 'other income' negative.

Lately, consumer finance was contributing significantly towards the total income of financial institutions, particularly commercial banks. However, the borrowers have to face double-edged sword. On the one hand, their purchasing power reduced due to inflation and on the other hand banks also started following very stringent credit appraisal procedure.

With banks following stringent credit appraisal procedure and also demanding higher interest rate, the size of consumer finance also shrank. This phenomenon is most visible when one looks at car sales data. During FY09, car sales reduced to nearly half of the volume achieved a year ago. Similarly, financial institutions faced difficulties in collecting the rentals. While repossession of assets was a problem, disposal posed even bigger problem.

Textile sector, the biggest borrower also came under stress. While those units indulging in heavy borrowing found debt ser servicing a key problem, the agony was compounded because they could not compete in the global markets.

Financial institutions are also the biggest investors in the equities market i.e. as promoter of mutual funds, financier, and above all having huge investment portfolio. In the past there has been a move to contain exposure of commercial banks in the stock market, not only the move fizzled out but market participants succeeded in convincing the central bank to allow them to play a bigger role. In India, banks have up to 5% exposure in stocks whereas in Pakistan their stake is as high as 20% of the shareholdersí equity.

One of the segments of financial sector, leasing companies got the worst jolt of higher interest rate. As the banks came under pressure, they stopped extending credit to leasing companies. According to source privy to leasing sector at one stage at least half a dozen leasing companies and a few investment banks were at the verge of bankruptcy. Although, these institutions have been rescued the scars are still evident in the shape of huge accumulated losses.

Another segment coming under tremendous pressure is holders of credit cards. At one stage, banks were distributing credit cards indiscriminately and all and sundry took the advantage. Since most of the people stand no chance of getting any sort of credit from the banks credit card was a blessing in disguise. It was often used as the last option. However, with the diminishing job opportunities, declining purchasing power and also hike in credit role over cost people are in a fix. While, most of the borrowers continue to pay minimum charges the debt burden is growing.

People interested in acquiring housing finance are the worst hit. To begin with, acquiring credit is almost impossible because 1) demand exceeds supply, 2) financing charges are prohibitively high and 3) financial institutions are not willing to extend credit for more than ten years. Ideally, the repayment of housing finance should be more than twenty years but hardly any institution is willing to take such an exposure.

Blaming the banks for all the ills is too easy but one must also explore the reasons for high interest rates in the country. The top most and worst reason is the stubbornness of the policy planners, who still believe that higher interest rates can help in containing inflation. It was a wrong approach and has caused the worst damage to the economy of the country.

Another reason for high lending rates is 'too high administrative cost'. In case of some of the banks, the cost per rupee mobilized exceeds the revenue generated. On top of this is the high human cost. It is not because employees are paid 'too good salary' but because of inefficiencies due to overstaffing and appointments made due to political pressure.

The fact that less than 5% people of Pakistan have access to formal banking should be an eye opener for the policy planners. It is regrettable that only a couple of million people have acquired bulk of the credit. Most of the branches and ATMs are located in urban areas and in some of the cities/areas, there are too many branches.

In an attempt to further jack up their income, commercial banks have been charging ridiculously high service charges. As stated by one of the accountholder, "When I wanted to draw cash using online facility the bank took Rs 55 as service charge. I fail to understand the benefit of online banking if one has to pay such a fabulous price. It seems that quality is going from bad to worse but service charges are skyrocketing."