Sep 26 - Oct 2, 20

Banks have the power to destroy an economy, a nation, and of course themselves.

Their destructive power comes from their ability to effect monetary expansion through credit creation. The central bank with the mandate to print currency notes can join hands with the banks to hasten the process of destruction.

Niall Ferguson, while tracing the history of banking, writes in his book The Ascent of Money: The Amsterdam Exchange Bank (Wisselbank) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces...By allowing merchants to set up accounts denominated in a standardized currency, the Exchange Bank pioneered the system of cheques and direct debits and transfers that we take for granted today...The limitation on this system was simply that the Exchange Bank maintained something close to a 100 percent ratio between its deposits and its reserves of precious metal and coin...This made the bank secure, no doubt, but it prevented it performing what would now be seen as the defining characteristic of a bank, credit creation."

Lenin's fellow Bolshevik Yevgeny Preobrazhensky described the banknote-printing press as 'that machine-gun of the Commissariat of Finance which poured fire into the rear of the bourgeois system.'

Monetary expansion, by itself, is not injurious to an economy. It is so only when used as a tool to create higher income-inequalities. Productive use of the wealth created through banking system boosts economy, generates employment, and raises standard of living of the common person. The central bank is responsible for monitoring the growth of money supply and (with the help of the banking system) tracking the flow of paper wealth created through credit and currency printing.

While State bank of Pakistan (SBP) has failed to check the freefall of the economy, the banking sector has been guilty of fishing in troubled waters.

Pakistani banks survived the onslaught of global financial crisis mainly for two reasons: their minimal integration with the global financial markets, and the strength of their balance sheets developed during the first decade of this millennium.

Sadly, their strong balance sheets were not the result of honest banking practices. Unusually, high banking spreads under the dormant SBP vigilance and risk-free lending to the government bodies contributed to the ill-acquired strength.


Total banking assets 3,660 4,353 5,172 5,628 6,516 7,190 7,157
Total banks' deposits 2,662 3,000 3,566 3,801 4,325 5,124 5,365
Total banks' advances 2,044 2,409 2,651 3,141 3,272 3,494 3,412
Total banks' investments 730 770 1,211 981 1,645 2,102 2,657
Advances to deposits ratio 76.8 80.3 74.3 82.6 75.7 68.2 63.6
Investments to deposits ratio 27.4 25.7 34.0 25.8 38.0 41.0 49.5

Banks are supposed to support the economy, businesses, and industry. Fair return system ensures welfare of the depositors.

Pakistan's banking sector has failed on each of the two accounts. According to an IMF report, Pakistan's is the worst economy in the region.

How can "the worst economy" have a sound banking industry? There is definitely something wrong, both with the banking system and our economic policy framework. State bank's failure to provide level playing field to all banks has given rise to unfair competition rendering smaller banks uncompetitive and therefore at a marked disadvantage.

The big five banks rule the roost and skim off major portion of the entire industry profit in 2010; they accounted for 95 percent of the industry profit. These banks have reported a 24 percent growth in cumulative profits during first half of the current calendar year. The State bank too has reported a 20 percent growth in its half-yearly profits.

SBP and the top commercial banks are thriving on increased interest income accruing from zero-risk lending to the government and its affiliated bodies.

This is happening at the cost of the private sector and the economy. The private sector has found a way out - migration to the business-friendly lands.

The economy has no such options. In addition, it has been saddled with the damaging consequences of the private sector migration. The private sector continues to unload its past borrowings to allow the greedy banks (and their indolent monitor - the SBP) to increase their government-loans portfolio, and hence their profitability. Whatever fresh borrowing the private sector enters into is working-capital-oriented. Therefore, no capital formation and no capacity enhancement can be envisaged in the years to come.


INDICATORS 2005 2006 2007 2008 2009 JUN-10 SEP-10
Risk weighted CAR* 11.3 12.7 12.3 12.2 14.0 13.9 13.8
Capital to total assets 7.9 9.4 10.5 10.0 10.1 9.9 9.9
NPLs** to total loans 8.3 6.9 7.6 10.5 12.6 12.9 14.0
Net NPLs to net loans 2.1 1.6 1.1 3.4 4.1 3.8 4.5
Net NPLs to capital 14.3 5.7 5.6 15.4 20.4 18.4 21.8
Return on assets (before tax) 2.8 3.1 2.2 1.2 1.3 1.8 1.6
Return on equity (after tax) 25.8 23.8 15.4 7.8 8.9 10.9 9.9
Cost / Income ratio 41.5 40.3 43.2 50.1 51.2 52.6 53.6
Liquid assets to total assets 33.7 31.9 33.6 28.2 32.7 34.2 33.6
Liquid assets to total deposits 43.5 42.7 45.1 37.7 44.5 45.3 44.4
*Capital Adequacy Ratio ** Non Performing Loans

The current scenario spells doom for the already battered economy. The State bank, instead of taking to task the banks who have reneged on their core responsibility of mobilizing deposits and lending to the business and industry, has colluded with them in the shady deal of earning illegitimate profits.

A high policy rate gives the banks a reason to ignore the task of deposit mobilization and take to the option of risk-free government lending. This drastically cuts nation's savings rate, which has come down to less than 10 percent.

Low savings mean low investment, and therefore, low growth. Who will save the economy from the troika of the government, the State bank, and the banking cartel?