Dec 21 - 27, 2009

During last one decade, Pakistani banking system has gradually evolved from a weak state-owned system to a slightly healthier and active private sector driven system. The private sector controls nearly 80 percent of the system assets, as opposed to the early 1990s when 90 percent of the system assets were controlled by the government. The State Bank of Pakistan has shifted entire load of oil import bills on commercial banks from December 14. The country's banking sector has the potential to grow further and its expansion is crucial for national economy. The sector however needs a continuous improvement in monitoring, surveillance and supervision.

According to one estimate, banking system in Pakistan is made up of 53 banks, which includes 30 commercial banks, four specialized banks, six Islamic banks, seven development financial institutions and six micro-finance banks. The four largest commercial banks account for 44.2 percent of system assets, while eight second-tier banks account for a further 35 percent indicating moderate concentration. Foreign banks were less in number, but their presence has substantially increased. The estimated share of foreign banks in the banking industry of Pakistan has reached 13 per cent. In terms of assets, foreign investors possess about 42 per cent banking assets of the country.

The country's banking system grew at a compounded annual growth rate (CAGR) of 17.8 percent between fiscal year 2001 to 2006, supported by relatively strong growth in the domestic economy, with the underlying liability growth driven by both an influx of private and institutional capital, as well as inter-governmental receipts. Loans too grew at a strong CAGR of 24.2 percent during the same period, before slowing down to only 2 percent during the first nine months of 2007 amidst greater political uncertainty, which in turn affected economic sentiment.

The existing foreign banks have by and large enhanced their presence and stake in Pakistan along with new foreign banks that have entered the domestic market for the first time. For example, Standard Chartered Bank has acquired Union Bank, ABN-Amro has acquired Prime Bank, Tamasek of Singapore has established NIB Bank. There are other transactions, which are in the pipeline and reflect the robustness and profitability of banking sector in Pakistan.

The central bank's decision has given the banks an important oil role, as the $10 billion annual oil payment is significantly heavy amount for private sector while it attracts speculative forces to benefit from the floating and fluctuating exchange rates. The commercial banks have about $3.5 billion in their accounts which means the inter-bank heavily relies on continuous inflow of dollars to meet the new requirement of approximately $10 billion. Local currency is predicted by market pundits to remain under pressure, as excessive volatility is possible in managing foreign exchange market.

The State Bank was caught in a difficult situation from the mid of 2008 when oil prices shot up and touched $147 per barrel. This massive increase in petroleum prices siphoned off country's reserves, which fell to just about $6.5 billion causing serious threat of balance of payment. The first agreement with the IMF in November 2008 emphasized that the central would get rid of making payment of oil import bills by February 2010. The bank first shifted the payment of furnace oil bill from Feb 1, 2008 to the private sector, which accounted for 20 per cent of the total imports. On July 15, the central bank instructed banks to make all purchases of foreign exchange from inter-bank market related to the import of POL products except that for crude oil.

Last month, the central bank lowered its benchmark interest rate by 50 basis points to 12.5 percent from 13 percent for a third time this year to spur economic growth in the strife-torn country. The central bank cut the key policy rate as inflation eased to a 22-month low of 8.9 per cent year-on-year in October, and as various macroeconomic indicators showed improvements. The central bank kept its discount rate unchanged at 13 per cent on Sept. 29 after a cut in August of 100 basis points. The slowing inflation has enabled the central bank to reduce interest rates. The analysts believe that the Gross Domestic Product (GDP) growth has declined due to economic slowdown following the tight monetary policy, as irrationally high interest rates are holding back the growth. They contend that significant reduction in discount rate bringing it down to single digit is essential to rescue the ailing industry.

Some bankers however believe that lower interest rate will hurt inflows of dollars in the country and inflate the already inflated economy. They believe that the possible discouraging effects on foreign inflows need to be considered before reducing the interest rates. The higher return has increased the inflows through remittances by 19 per cent. On the other hand, the open and inter-bank market has witnessed some stability due to the unregistered dollar inflows.

The decline in growth rate and decreasing currency value has led people to expect more inflation and massive increase in the joblessness. The soaring power and gas tariffs are likely to put additional burden on the industry and squeeze the gross margins of the industry. The local manufacturers forecast more industrial closures and job losses over the next one year. The middle-class income group is slipping fast into the poor class while vulnerability of the lower classes has further aggravated.

Many analysts believe that cutting interest rates to single digit level will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports and generate more tax revenue for the government.

Last year, Fitch Ratings noted that Pakistan's banks have historically enjoyed low cost of funds as a result of their large low cost deposit base resulting in some banks enjoying interest spreads of around 7.5 to 8.5 percent. Asset quality that constrained banks' performance in the 1990s has since improved with the reported gross NPL ratio declining to 7.7 percent at end of the nine moths of 2007, from a staggering 23.5 percent at fiscal year 2000. Capitalization as measured by the reported equity to total assets ratio improved sharply to 10.2 percent from 4.5 percent at fiscal year 2000 due to greater earnings retention and new equity infusions.