Pakistan’s Financial sector

1. Pakistan’s Financial sector Lecture: 12 Mahreen Mahmud

2. Reading • Sustainable Growth in the Financial Sector of Pakistan - Ishrat Hussain, April 2005

3. Financial Reforms • It is pertinent to ask whether the reforms brought about in the financial sector of Pakistan will persist generating sustainable growth in the sector or quickly dissipate. • Eight factors that attest the sustainability of growth in the financial sector • Analysis assumes stability, continuity of good policies and good governance

4. First • Capital base of the banks has been strengthened by raising the minimum capital requirements • Capital adequacy ratio which reflects the amount of capital to finance the risk weighted assets • As the banks mainly use the depositors’ money to take risks they should also have their shareholders’ money at stake too. • High capital adequacy ensures that the bank management exercise caution and prudence in granting of loans.

5. Second Quality of assets has improved • Gross Non performing loans to Gross advances for the commercial banks have come down from 25% to less than 10 % • The flow of NPLs has dwindled to less than 5 percent that means that 95 percent of the loans in banks’ portfolio are being fully serviced on time.

6. Third • Earnings of the commercial banks have risen because healthy competition and restructuring have resulted in efficiency gains. • Spreads between the deposit and lending rates now range between 3.5 to 4.5 percent compared to 7.5 to 8 percent five years ago.

7. Third • The spreads have declined because the drag of NPLs has disappeared • Corporate tax rates on the profits of the banks have been lowered • Excess labor has been eased out through golden handshake schemes in the three major banks – NPB, HBL and UBL. • Cost – Income ratios have therefore fallen

8. Fourth • Access to banking services broadened to middle and lower middle income groups. • SME financing, mortgage loans, automobile leasing, personal loans etc. • Khushhali Bank, and other microfinance institutions will reach out to half a million households providing them small unsecured loans ranging between Rs. 5,000 to Rs. 25,000

9. Fourth • Salaried classes have also begun to leverage their incomes by receiving personal loans the installments of which are deducted from their monthly pay checks. • Diversifies the risk for the banks and allows them to earn a decent return on their loan products. • Enhanced purchasing power -> stimulates aggregate demand -> expansion of production of manufactured goods -> higher growth of the economy.

10. Fifth • With privatization of nationalized commercial banks the role of the regulatory and supervisory authorities has also changed. • The SBP has laid down fit and proper criteria for the appointment of the Boards of Directors, Chief Executives and Senior management of the banks.

11. Sixth Apprehensions expressed about the risks to which the banks have been exposed or will be exposed in the future in light of the rising interest rates. Two criticisms: 1. More defaults on consumer loans as interest rates go up. • Last five years the banks have been asked to earmark reserves of 1.5 percent against their secured consumer loans and 3 percent against unsecured loans in their portfolios.

12. Sixth • Pool of money will enable the banks to deal with in the event they are stuck with higher defaults. • Repossession laws have been strengthened and repossession of automobiles or houses has become much easier for the banks and liquidate their collaterals against which the loans have been given.

13. Sixth 2. Banks are fuelling the speculative activities such as stock market share trading • The banks have been restricted by the SBP and their total exposure to shares cannot exceed 20% of their equity.

14. Seventh • Human resource base of the banking system is being upgraded. • New breed of bankers will be infused with professional skills. • Industry wide standards for training, promotion, compensation and benefits, severance and continuing professional education.

15. Eight Technology up gradation project • ATMs and online banking. • The Real Time Gross Settlement System (RTGS) will allow inter-bank transfer of funds from any place in the country • Cost savings will result in further efficiency of the banking system and increased volume of business. • It is estimated that the average cost of processing a cheque is around Rs. 50 while that of ATM withdrawal is Rs. 15

16. Reading • Pakistan's financial Sector - A future Perspective - Dr. Shamshad Akhtar, June 2006

17. The economic turnaround owes its origin to two principal factors: 1. Persistent political and macroeconomic stability which has helped restore investor confidence and attracted domestic and foreign capital

18. 2. The ongoing financial sector development and transformation which has helped meet the growing financing requirements of the productive sectors, while generating consumption demand that turned out to be the main driver of economic growth.

19. Pakistan’s financial sector’s scope and scale • The liberalization and deregulation of the financial sector has helped transfer the banking sector’s majority ownership to the private sector. • There has been exceptional growth in the profitability and efficiency of the financial services industry.

20. Pakistan’s financial sector’s scope and scale • Induced a degree of institutional diversification as evident from: (i) the growth of equity markets that, given their high returns, has attracted foreign portfolio flows; and

21. Pakistan’s financial sector’s scope and scale (ii) proliferation of a wide array of non-bank financial institutions which provide a range of financial services such as leasing, investment banking and fund management, and offer Islamic instruments such as modarabas and musharikas.

22. Issues - 1 • Large segments of the economy, population and geography remain under served by the formal financial system. • There is a need to extend the reach of the financial system and better serve small entrepreneurs and households, especially in the SME, agriculture and service sectors, which account for most of the country’s GDP and employment generation but presently receive a relatively small share of total credit.

23. Issues - 2 • The recent global financial market turmoil and the current privately-owned structure of the domestic banking system, highlight the need for a financial safety net to deal with contagion and systemic risks. • This includes: • depositor protection, • Liquidity • Lender of Last Resort facilities in the SBP, an exit framework to deal effectively with inevitable bank failures in ways that will strengthen rather that weaken the banking sector as a whole • improved coordination mechanisms with the GOP in cases of systemic problems.

24. Issues - 3 • The financial sector is too bank-centered and needs to become more diversified in order to meet the country’s future financing needs. • New issues of shares have been very limited

25. Issues - 4 • The privatization of the banking system made it more dynamic and competitive but it still has some way to go. • New products have been developed, especially in consumer lending. • But competition is impeded • by lack of transparency in the pricing of deposit-takingskewed by the dominance of a few large banks with vast branch networks • Most deposit rates have remained steeply negative in real terms, while bank margins have remained high.

26. Enormous potential for future financial sector growth in Pakistan • The financial sector in Pakistan would have to double in size to reach the level implied by the GDP ratios for India (202%) or the average for all EMCs worldwide (216%). This would mean a doubling in nominal terms. Such a doubling would imply a massive increase of financial intermediation, i.e., financial savings and credit flows in the economy

27. Enormous potential for future financial sector growth in Pakistan • The vision for Pakistan that one can draw from the data is that future financial sector growth and deepening should be based on: • private sector intermediation, including banking, equities and especially private debt markets. • This would allow resources to be channeled to the private sector, both for private investment and consumption, which are the key drivers of growth in the economy.