banking review 2013 (final print edition)

Monday, March 10, 2014 | www.brecorder.com/br2013

BankingReview2013

BANKING REVIEW 2013 | March 10, 2014

Contents MONEY THAT PRAYS

Ahmed Khizer KhanChief Executive O�icer, Burj BankPAGE 24

BRANCHLESS BANKING SECTIONPAGE 25

MAPPING THE DISPARITY IN BANK BRANCH NETWORK ACROSS PAKISTANPAGE 34

IMPROVING MOBILE BANKINGGROWTH PROSPECTSQasif Shahid and Shamsulhaq NiazPAGE 28

AGRI LENDINGJaveria AnsarPAGE 32

IMPEDIMENTS TO BUILDINGA STRONGER BOND MARKETAbdul Rehman WarraichPAGE 37

BARCLAYS:STRATEGY BY DESIGNShazad DadaChief Executive O�icer, Barclays BankPAGE 30

CITIBANK N.A. CAUTIOUSLYOPTIMISTIC ABOUT PAKISTANNadeem LodhiCountry Manager and Managing Director, Citibank N.A.PAGE 31

BANK OF PUNJAB:EYEING THE UNBANKEDNaeemuddin KhanPresident andChief Executive O�icer,Bank of PunjabPAGE 35

SINDH BANK NO LONGERPROVINCIAL IN CHARACTERBilal SheikhPresident andChief Executive O�icer,Sindh BankPAGE 36

FROM THE EDITOR’S DESKPAGE 4

BANKING BLUESAli Khizar Aslam PAGE 5

PRIVATE SECTOR NO PRIMARY LEVER OF GROWTHSalim RazaPAGE 7

MEEZAN BANK CEO ANTICIPATES A LARGER SHARE OF PIEIrfan SiddiquiFounding President and Chief Executive O�icer, Meezan Bank Ltd.PAGE 23

LOAN DEMAND LOOKSENCOURAGINGAtif BajwaChief Executive O�icer, Bank AlfalahPAGE 8

THE RISE AND FALL OF BANKING SPREADSSobia SaleemPAGE 10

SUMMIT’S PLANS TO TURN ISLAMICHusain LawaiPresident & Chief Executive O�icer, Summit BankPAGE 12

HOW BASEL-III WILL IMPACTPAKISTAN, OTHERSSayem AliPAGE 14

VIEW FROM THE STOCK MARKETRabia LalaniPAGE 16

HABIB METRO EYESGROWTH IN TRADE FINANCESirajuddin AzizPresident and Chief Executive O�icer, Habib Metropolitan BankPAGE 15

BANKING:AN UNCONVENTIONAL VIEWSyed Bakhtiyar KazmiPAGE 17

SAVING MORTGAGE FINANCESidra FarrukhPAGE 18

BANKING AT A GLANCEPAGE 20

Zuhair AbbasiSenior Research Analyst

Sijal FawadResearch Analyst

BR RESEARCHTHE TEAM

Sohaib JamaliEditor Research

Rabia LalaniResearch Analyst

Ali Khizar AslamHead of Research

Murtaza KhaliqCreative Head

Javeria AnsarResearch Analyst

Rabia LalaniResearch Analyst

Zuhair AbbasiSenior Analyst

Hammad HaiderSenior Research Analyst

Sidra FarrukhResearch Analyst

Sobia MuhammadSaleemResearch Analyst

Adil MansoorResearch Analyst

Naseem Waheed

Banking is always important

Editor’s note

04 / Banking Review 2013

The publication of Business Recorder’s Banking Review 2013 has interestingly coincided with the release of State Bank of Pakistan’s latest quarterly review of the country’s economy that covers the period July-September 2013. A fresh central bank outlook, therefore, has thrown up an opportunity for us to make a brief comment on the banking sector in a more cogent and meaningful manner. While defending its decision of a hike policy in rate by 50 basis points to 9.5 percent in September 2013, SBP has argued that policy tightening had become imperative although monetary growth was already subdued as the growth in broad money supply (M2) during Q1-FY14 was only 0.2 percent, compared to 0.7 percent in the corresponding quarter last year. “[T]his trend can primarily be traced to a rise in the external deficit, which reduced the NFA of the banking system by 64.4 percent during the period,” according to SBP. The SBP report, through a footnote, explains that in absolute terms, “the NFA of the banking system declined by Rs 173.2 billion in Q1-FY14, compared to an increase of Rs 11.8 billion in Q1-FY13”. Explaining why NDA, on the other hand, posted an increase of 2.3 percent during the quarter, the central bank holds high budgetary borrowing from the banking system and lower net retirement of private sector credit responsible for the rise. Through another footnote or an additional piece of information printed at the bottom of the page, the bank argues why its decisions on interest rates are not based on the previous data, but on the forecast of macroeconomic variables. The SBP report, indeed, gives one a bigger picture of the country’s financial domain. Having said that, one however needs to admit the fact that a lot of water has flown under the bridges since September 2013 and the present shape of macroeconomic indicators amply explain why central bank policies are sometimes not truly forward-looking or perhaps, do not genuinely provide for the future.

That our active financial institutions deliver significant and unique value to the country’s economy and businesses, investors, and savers is a fact that has found its best expression in the perfor-mance of our banking sector particularly

since 2000. However, there exists a flawed, albeit widely popular, argument that well developed financial markets are correlated with economic development and that a sound and sophisticated financial system promotes the e�iciency of investment and economic growth in an economy by reducing the costs of intermediation and by improving the allocation of risk. Unfortunately, however, in our country well-developed financial markets are conspicuous by their absence; nor do we witness any robust investment and economic growth any more. This argument, therefore, leads to a profound question whether or not the key regulator, i.e., State Bank of Pakistan, has been e�iciently monitoring the functioning of the domestic market with a view to evaluating its impact on the economy. A readily available answer could be that the central bank has been performing its regulatory job towards money market, the forex market as well as the domestic financial market in an e�icient way. But this does not appear to be the most plausible answer because what people generally confront is a reality that shows that the banking sector has been demonstrating an impressive performance but the country’s economy has been witnessing a sluggish growth particularly since 2007. The other question that keeps gnawing one’s mind is that why the banking sector has failed to e�ect in recent years a generous distribution of credit to support SMEs and regions with a view to contributing towards e�orts aimed at broadening and building a sound economic base. These two profound questions have been discerned from the write-ups in this Review. The articles and interviews in this publication address a number of questions and issues relating to econom-ics and finance such as finance, growth and national integration; the rise and fall of banking spreads; mortgage finance; and an unconventional view on banking. Last but not least, branchless banking and Islamic banking seem to be the buzzwords in the world of finance in Pakistan. According to many, these may be more of a solution than buzzwords. Insofar as Islamic banking is concerned,

that has shown an impressive 10 percent growth in a decade, this mode of banking has become an important segment of the global financial markets. In Pakistan, we are witnessing the operations of Islamic banking alongside the conventional banking system. Islamic banks have been anticipating a bigger share of the pie and space in coming months and years. They mainly derive their confidence from Shariah-compliant products that they o�er to a largely conservative Muslim society. The other major reason behind their growing optimism is the fact that already Islamic financial institutions, in one form or another, are operating in over 70 countries. Its huge success in Malaysia, for example, is a strong case in point. But what the proponents of Islamic finance often overlook is the fact that Islamic economics, as argued, for example, by Muhammad Akram Khan in his book What is Wrong with Islamic Economics? Analyzing the Present State and Future Agenda, has failed in part because of its disproportionate focus on issues of finance—both in terms of providing Islamic financial products and institutions to circumvent the perceived prohibition of riba, and in terms of zakah as a tool of public finance. Those who strongly advocate Islamic banking as a substitute for conventional banking are required to make unstinted e�orts towards making Islamic finance a coherent discipline and chart a way forward for that discipline in the country’s economic policymaking. In the end, this newspaper wishes proponents of both conventional banking and Islamic banking a bright present and a brighter future. Business Recorder will always encourage a healthy competition between these two modes of banking in the larger interest of Pakistan, although one must refrain from making a direct comparison between Islamic banking and conventional banking.

Banking ‘blues’Ever since the global financial crisis of 2008 dawned upon us, Pakistan’s banking industry seemed stuck in a limbo. Although the country’s financial industry wasn’t big enough to be affected by the global meltdown, the growing twin deficits (fiscal and external) at home threw up an opportunity for banks to narrow down the choice of banking assets to government borrowing. With the wiping out of some of the credit extended to big ticket corporates and a virtual demise of consumer lending in its nascent stage, banks successfully ventured into branchless banking and mobile banking in collaboration with telecommunication giants. However, the shocks of high toxic assets, especially in SMEs and consumer sector, were too much to be absorbed by technologically advanced ways of banking. To ensure steady profits, banks were forced to become efficient by both reducing the markup and administrative costs. However, in the process they lost the prime focus of financial intermediation. The industry-wide advance-to-deposit ratio (ADR) decreased from a peak of 75 percent in December 2008 to less than 50 percent by September 2013. The obvious reason behind this decline was the government’s financing needs that crowded out private credit as investment-to-deposits ratio (IDR) (primarily due to T-Bills) soared from 34 percent to 52 percent in the past five years. Considering that deposits base almost doubled since 2007, the swings in ADR and IDR are tell-tale signs on their own; though real economic growth remained subdued in the period. Growth in deposits appears impressive as it paced with a nominal GDP growth in a high inflationary era, which is also attributed to over-reliance of fiscal borrowing on banking system. The government’s borrowing stock from the central bank increased almost six fold - from Rs476 billion as of June 2008 to Rs2.77 trillion - as of January 2014. This increase of Rs2.3 trillion explains a two-third increase in bank deposits. Effectively, had it not been for such a huge increase in federal government borrowings, the profitability of commercial banks would have stagnated in the last five years. From Rs73 billion in CY07, commercial banks’ profits nose-dived to Rs43 billion in CY08 before hitting Rs178 billion in CY12. Despite these decent profits, bank penetra-tion continues to remain low as less than 15 percent of people have bank deposits accounts and those who have access to credit are even smaller in number. Even among those who have bank accounts, there are many who have no incentive to maintain their accounts as such. A majority of bank account holders are getting abysmally low return on their savings and the worrisome fact is that the trend has worsened over the past five years. The composition of CASA (current

account and saving account) increased from 58 percent in CY08 to 65 percent as of September 2013. That’s how banks maintained their high spreads despite assets being skewed towards low risk and low return government papers. Higher spreads may have gotten bankers good profits, but the approach has long term repercussions for bankers as well as consumers. The former are going to face an asset-liability mismatch, once the fiscal house is in order and the government has no dire need of financing from the banking system. On the flipside, the latter is restricted from long-term financing and simultaneously depositor is not getting adequate return on its savings. That partially explains the fall of investment to GDP from 19 percent in FY07 to 14 percent in FY13 and domestic savings to GDP from 12 percent to 8.7 percent in the past six years. Recognizing these pitfalls, the central bank had been pushing the banks to focus on long-term deposits and to increase the return on demand deposits (saving accounts). First the SBP tried moral suasion. That, of course, didn’t work. Then it fixed the minimum deposit rate 5 percent, regardless of the fact policy rate reached as high as 15 percent. But commercial banks remained fixated with cost efficiencies by increasing CASA, to which the bonuses of liability managers were pegged. Later the SBP increased the minimum rate on saving accounts from 5 to 6 percent in 2007 but that was not enough as well. Finally, the central bank put its foot down and linked the deposit rates to the interest rates corridor. The linking of deposit rate is likely to compel commercial banks to look for riskier high return assets to maintain spreads. However, much more is needed to be done to kick off private sector lending. The government has to gradually move away from banking system to give room to private sector. Concurrently, macroeconomic conditions need to be improved to encourage bankers to lend to private sector and to whet a credit appetite among corporates and SMEs. Following the change in political regime, the temporary resolution of circular debt amid a gradual decline in non-performing loans that already began before PML-N took office, confidence has started to return to the credit market and there is an ensuing uptick in private credit off-take. However, its sustainability is contingent upon the resolution of structural impediments, such as reliance of fiscal financing on banks, energy woes and bleak law and order. The good omen is that the government seems focused on improving overall economic conditions. It has aggressive plans on privatiza-tion and corporatization of public sector entities. That not only promises to bring efficiencies in the system but also has the potential to slash fiscal deficit by a good margin.

Ali Khizar

The government also appears committed to resolving the energy woes by installing new capacities in coal and constructing dams. This does not only bode well for other manufactur-ing sectors but also provides a huge opportu-nity for banking system to indulge in long-term financing projects. Plus, Pakistani exporters, especially those in the textile sector, can generate high credit demand in the wake of GSP+. To date textile and power sectors demonstrate improvement in both economic and credit growth. In the backdrop of these improvements, banks ought to sway away from the attitude of lazy banking as gone are the days when banks can generate low cost deposits without much

efforts and heedlessly deploy them to government papers. It is true that not all banks are heavily skewed towards government’s fiscal financing. A few banks have concentrated in the non-core businesses over the period, such as in trade finance. Then, benefitting from their presence around the globe, a few foreign banks have specialized in dealing with multinational clients. Then of course there is the treasury desk which has lately been the most important avenue within the conventional banking domain. In fact, bank treasurer in a few banks is deemed to be more powerful than the president of the bank. However, all these areas are not enough to fill the vacuum that will likely be created once the government loses its credit appetite. Banks ought to explore consumer segments including mortgage financing and have to penetrate SMEs; although it’s easier said than done as in the pre-crisis days the banks that ventured into these businesses suffered big losses and since then the industry has taken a cautious approach to these areas. One of the reasons why banks are reluctant to capture this segment is poor foreclosure and repossession laws. Be that as it may, the good thing is that the SBP is cognizant of the need to develop housing finance as it not only caters to the need of millions of households, but will also boost tens of allied industries by creating economic activities and generating employ-ment. Apart from the foreclosure problems,

asset-liability mismatch makes these products too risky, as mortgage is usually a long-term asset while deposit base has a low maturity. This can be dealt with by creating mortgage finance companies, with long term funding, to extend credit through commercial banks to end users for a tenor of as long as 25 years. Similarly, the central bank needs to facilitate tailor-made lending products to SMEs. This can be done by giving banks the first right on the cash flows of these firms upon default and by virtue of this banks can have the incentive to facilitate small companies to make proper financial statements, budgeting and planning. While the preceding measures can increase credit penetration in society, there is also a concurrent need to bring a large chunk of unbanked population into the banking net as more than 85 percent of population does not have a bank account. Financial inclusion is amongst the key objectives of the SBP and government, as it is imperative for creating a saving culture. A large chunk of population does not have access to banking facilities or uses them merely for checking accounts as they consider conventional banking un-Islamic. To this end, the most successful experiment has been the introduction of Islamic banking. Pakistan’s Islamic banking has grown to 10 percent of total banking size in a decade; it shows an immense potential in an economy where religious beliefs are deeply entrenched. Mind you, in the post-crises world Islamic banking is considered as a safe haven and the

size of Islamic banking has grown at a much faster pace in Islamic countries such as Malaysia, the UAE, and Saudi Arabia. This is exactly why virtually all the big players are aggressively entering into this market segment. MCB is acquiring a majority stake in Burj Bank to open an Islamic banking subsidi-ary; it plans to quadruple the acquired entity’s assets size to over Rs200 billion. Then Summit Bank is transforming itself into an Islamic bank in CY14. Similarly, Islamic windows of Bank Alfalah, Standard Chartered and a few others are widening aggressively. While the gradual uptick in credit off-take, the extension of branchless banking and developments thereof may be seen as the winds of change. The trend towards Islamic banking with almost herd-like following may well bring the biggest tectonic shift in the history of country’s banking.


Continued on next page

The good thing is that the SBP is cognizant of the need to develop housing finance as it not only caters to the need of millions of households and will also boost tens of allied industries by creating economic activities and generating employment.

Ever since the global financial crisis of 2008 dawned upon us, Pakistan’s banking industry seemed stuck in a limbo. Although the country’s financial industry wasn’t big enough to be affected by the global meltdown, the growing twin deficits (fiscal and external) at home threw up an opportunity for banks to narrow down the choice of banking assets to government borrowing. With the wiping out of some of the credit extended to big ticket corporates and a virtual demise of consumer lending in its nascent stage, banks successfully ventured into branchless banking and mobile banking in collaboration with telecommunication giants. However, the shocks of high toxic assets, especially in SMEs and consumer sector, were too much to be absorbed by technologically advanced ways of banking. To ensure steady profits, banks were forced to become efficient by both reducing the markup and administrative costs. However, in the process they lost the prime focus of financial intermediation. The industry-wide advance-to-deposit ratio (ADR) decreased from a peak of 75 percent in December 2008 to less than 50 percent by September 2013. The obvious reason behind this decline was the government’s financing needs that crowded out private credit as investment-to-deposits ratio (IDR) (primarily due to T-Bills) soared from 34 percent to 52 percent in the past five years. Considering that deposits base almost doubled since 2007, the swings in ADR and IDR are tell-tale signs on their own; though real economic growth remained subdued in the period. Growth in deposits appears impressive as it paced with a nominal GDP growth in a high inflationary era, which is also attributed to over-reliance of fiscal borrowing on banking system. The government’s borrowing stock from the central bank increased almost six fold - from Rs476 billion as of June 2008 to Rs2.77 trillion - as of January 2014. This increase of Rs2.3 trillion explains a two-third increase in bank deposits. Effectively, had it not been for such a huge increase in federal government borrowings, the profitability of commercial banks would have stagnated in the last five years. From Rs73 billion in CY07, commercial banks’ profits nose-dived to Rs43 billion in CY08 before hitting Rs178 billion in CY12. Despite these decent profits, bank penetra-tion continues to remain low as less than 15 percent of people have bank deposits accounts and those who have access to credit are even smaller in number. Even among those who have bank accounts, there are many who have no incentive to maintain their accounts as such. A majority of bank account holders are getting abysmally low return on their savings and the worrisome fact is that the trend has worsened over the past five years. The composition of CASA (current

account and saving account) increased from 58 percent in CY08 to 65 percent as of September 2013. That’s how banks maintained their high spreads despite assets being skewed towards low risk and low return government papers. Higher spreads may have gotten bankers good profits, but the approach has long term repercussions for bankers as well as consumers. The former are going to face an asset-liability mismatch, once the fiscal house is in order and the government has no dire need of financing from the banking system. On the flipside, the latter is restricted from long-term financing and simultaneously depositor is not getting adequate return on its savings. That partially explains the fall of investment to GDP from 19 percent in FY07 to 14 percent in FY13 and domestic savings to GDP from 12 percent to 8.7 percent in the past six years. Recognizing these pitfalls, the central bank had been pushing the banks to focus on long-term deposits and to increase the return on demand deposits (saving accounts). First the SBP tried moral suasion. That, of course, didn’t work. Then it fixed the minimum deposit rate 5 percent, regardless of the fact policy rate reached as high as 15 percent. But commercial banks remained fixated with cost efficiencies by increasing CASA, to which the bonuses of liability managers were pegged. Later the SBP increased the minimum rate on saving accounts from 5 to 6 percent in 2007 but that was not enough as well. Finally, the central bank put its foot down and linked the deposit rates to the interest rates corridor. The linking of deposit rate is likely to compel commercial banks to look for riskier high return assets to maintain spreads. However, much more is needed to be done to kick off private sector lending. The government has to gradually move away from banking system to give room to private sector. Concurrently, macroeconomic conditions need to be improved to encourage bankers to lend to private sector and to whet a credit appetite among corporates and SMEs. Following the change in political regime, the temporary resolution of circular debt amid a gradual decline in non-performing loans that already began before PML-N took office, confidence has started to return to the credit market and there is an ensuing uptick in private credit off-take. However, its sustainability is contingent upon the resolution of structural impediments, such as reliance of fiscal financing on banks, energy woes and bleak law and order. The good omen is that the government seems focused on improving overall economic conditions. It has aggressive plans on privatiza-tion and corporatization of public sector entities. That not only promises to bring efficiencies in the system but also has the potential to slash fiscal deficit by a good margin.


The writer is Head ofResearch at BusinessRecorder. He can bereached at:[email protected]

Government’s borrowing stock from the central bank

Rs476 billion

as of June 2008 as of January 2014

Rs2.77 trillion

Rs2.3 trillion

increase

The government also appears committed to resolving the energy woes by installing new capacities in coal and constructing dams. This does not only bode well for other manufactur-ing sectors but also provides a huge opportu-nity for banking system to indulge in long-term financing projects. Plus, Pakistani exporters, especially those in the textile sector, can generate high credit demand in the wake of GSP+. To date textile and power sectors demonstrate improvement in both economic and credit growth. In the backdrop of these improvements, banks ought to sway away from the attitude of lazy banking as gone are the days when banks can generate low cost deposits without much

efforts and heedlessly deploy them to government papers. It is true that not all banks are heavily skewed towards government’s fiscal financing. A few banks have concentrated in the non-core businesses over the period, such as in trade finance. Then, benefitting from their presence around the globe, a few foreign banks have specialized in dealing with multinational clients. Then of course there is the treasury desk which has lately been the most important avenue within the conventional banking domain. In fact, bank treasurer in a few banks is deemed to be more powerful than the president of the bank. However, all these areas are not enough to fill the vacuum that will likely be created once the government loses its credit appetite. Banks ought to explore consumer segments including mortgage financing and have to penetrate SMEs; although it’s easier said than done as in the pre-crisis days the banks that ventured into these businesses suffered big losses and since then the industry has taken a cautious approach to these areas. One of the reasons why banks are reluctant to capture this segment is poor foreclosure and repossession laws. Be that as it may, the good thing is that the SBP is cognizant of the need to develop housing finance as it not only caters to the need of millions of households, but will also boost tens of allied industries by creating economic activities and generating employ-ment. Apart from the foreclosure problems,

asset-liability mismatch makes these products too risky, as mortgage is usually a long-term asset while deposit base has a low maturity. This can be dealt with by creating mortgage finance companies, with long term funding, to extend credit through commercial banks to end users for a tenor of as long as 25 years. Similarly, the central bank needs to facilitate tailor-made lending products to SMEs. This can be done by giving banks the first right on the cash flows of these firms upon default and by virtue of this banks can have the incentive to facilitate small companies to make proper financial statements, budgeting and planning. While the preceding measures can increase credit penetration in society, there is also a concurrent need to bring a large chunk of unbanked population into the banking net as more than 85 percent of population does not have a bank account. Financial inclusion is amongst the key objectives of the SBP and government, as it is imperative for creating a saving culture. A large chunk of population does not have access to banking facilities or uses them merely for checking accounts as they consider conventional banking un-Islamic. To this end, the most successful experiment has been the introduction of Islamic banking. Pakistan’s Islamic banking has grown to 10 percent of total banking size in a decade; it shows an immense potential in an economy where religious beliefs are deeply entrenched. Mind you, in the post-crises world Islamic banking is considered as a safe haven and the

size of Islamic banking has grown at a much faster pace in Islamic countries such as Malaysia, the UAE, and Saudi Arabia. This is exactly why virtually all the big players are aggressively entering into this market segment. MCB is acquiring a majority stake in Burj Bank to open an Islamic banking subsidi-ary; it plans to quadruple the acquired entity’s assets size to over Rs200 billion. Then Summit Bank is transforming itself into an Islamic bank in CY14. Similarly, Islamic windows of Bank Alfalah, Standard Chartered and a few others are widening aggressively. While the gradual uptick in credit off-take, the extension of branchless banking and developments thereof may be seen as the winds of change. The trend towards Islamic banking with almost herd-like following may well bring the biggest tectonic shift in the history of country’s banking.

Continued from previous page


Private sector no primarylever of growthIf Pakistan’s economy continues to grow at the pace it has in the last five years, it will take the country 80 long years to double its per capita income. India, by comparison, will take 11 years, Bangladesh, 14 years, and Sri Lanka, 12 years. This begs the question as to what is the prognosis for Pakistan recovering to the 7 percent GDP growth needed to match Bangladesh’s pace for doubling GDP. Our weakened growth capacity today is owed to the deepening of policy and market failures over time. Without addressing these, improve-ments in the external business environment – such as remedying power shortages, and stimulating regional trade – cannot provide the much needed growth dynamism.

Policy and market failureThe central ‘policy’ failure is fiscal, i.e., the persistence of a state devouring public debt to survive – owing to its distorted fiscal principles, which ordain that ‘only the little people pay taxes’ – the deeply embedded droit du seigneur of our political culture. This can be easily addressed, if the political will to challenge powerful plutocratic interest exists. ‘Market’ failure lies in increasingly ineffective economic governance. The state’s regulatory institutions have been politically ‘enveloped’, and development institutions, wound down. A complacent belief persists that the primary lever of growth will be the private sector. But that belief has proved delusionary. Our LSM and financial services sectors have, in effect, jettisoned any ambition to take up the leadership role in development. The investment-to-GDP ratio has declined to 13 percent. Within this, LSM has declined the fastest, in current terms from Rs350 billion to Rs 198 billion – or by 40 percent (or 60%, in constant FY06 Rupees). The banking sector – while it has greatly improved efficiency and convenience - has not grown over the last decade, relative to GDP: still stands around 33 percent. The private sector now takes only 48 percent (from 67% in FY06) of bank loans and investments, with the government taking 52 percent. Crowding out is becoming as marked as was under the government-owned banking regime – when a basic rationale for banks’ privatization was that they would divert lending to the private-sector. Borrowing by the SMEs – the largest national employer – is down to 6.5 percent of bank credit, from 17 percent in FY06. And regional participation in credit – essential for political stability that is catalytic to growth – has withered on the vine. Loans by banks in Khyber Pakhtunkhwa have slipped to 9 percent of their total deposits in KP, down from 12 percent in FY06; in Baluchistan, to 7 percent from 9 percent; and the figure for AJK has remained at around 4 percent. The comparable figures for Sindh and Punjab are 66 percent and 51 percent respectively (the reciprocal represents

investment in government securities). In value, this comes to Rs800bn being transferred from the smaller to the larger provinces. Access to finance creates broad-based growth. With general access constrained, wealth creation in Pakistan has consolidated around a small number of large business houses, and in particular regions, mainly central Punjab and Karachi. Inequality has grown sharply, inimical alike to creating demand, which is the other side of sustainable growth, and to political stability. Where we stand, until the state’s forfeited role in institutionalizing growth is understood, identified and powerfully vitalized, we will continue to drift.

Focus on localized credit supplyElsewhere, over history, the state has played a strong role in building the economic base through distribution of credit to support SMEs and regions. During their development stage, from the mid 19th century onwards, banking systems in Europe and the US were tied structurally into this objective. Thus, banking licenses in the US restricted banks to operations within individual states, and sometimes, to single towns. The objective was to mobilise local savings for job-creation and growth within the communities. State governments fostered SMEs by requiring that state awarded contracts ensure a minimum component of inputs from the SME, usually 25-40 percent. Where suitable, states invested in small businesses, and guaranteed their loans. At the federal level, the Washington-based Small Business Association was created to facilitate legal and operational issues pertaining to SMEs, and to provide financial assistance by guaranteeing part of their borrowings. The German states (Landers) set up their own banks, the ‘Landesbanken’ that financed business and projects within the states, and are the apex banks’ (the Sparkassens) regional savings banks. Some 40 percent of Germany‘s banking system falls within this structure even today. Another strata of banks are the cooperatives, spread across the country. The original objective for all these institutions was again redeployment of local savings within the region. Regional banks were the funding sources for Germany’s famed ‘Mittlestand’, mainly family owned businesses that are today the backbone of German industry. In today’s leading emerging markets, the state has played the distributional role in a different way. While banking in most emerging markets started with large metropolitan banks, the state either retained ownership of the banking system, or directed lending to ensure that SMEs and the regions were adequately supported. Where banks are dominantly government-owned, as in China (90%) and India (70%), the state banks operate along strictly-defined priorities for lending. In countries such as Brazil

and Turkey, where more than 40% of the commercial banking system is government-owned, there are special government-owned development banks, focusing on agriculture, SME, and infrastructure finance.

Provinces must take the initiativeFor Pakistan today, the ‘fast-track’ route to galvanizing SME lending, which in itself is regionally distributed, would be if the provincial-owned banks (BOP, BOK, Sindh Bank) were re-chartered to work exclusively on the SME sector within their domain – the raison d’être for provincial banks was regional development, but all three provincial lenders now mimic national business strategies of the commercial banks. With provincial banks dedicated to the SMEs, SMEDA should be embedded into their operations; cross-reference of experience and information would make SMEDA a more effective development organization. Legal, bureaucratic and infrastructural impediments faced by SMEs would be redressed faster by provincial governments if remedial recommen-dations were filtered through the provincial banks and SMEDA – rather than put to provincial governments directly by the myriad small business associations. Also, given the rapid job-creation that a vibrantly growing SME segment brings, it is likely that provincial governments will come to see the provincial banks as important agencies for their own political success, and ensure high quality of professionalism and governance. To support this momentum, the federal government should set up a venture capital fund, with the participation of major commer-cial banks, to invest in individual SMEs with innovative business plans. The board should have a dominantly private sector composition, and appoint the CEO. Venture capital funding, and strategic and technical oversight should help develop successful transactions, highlighting the entrepreneurial potential latent in SMEs. This should provide the SMEs more reliable access to funding from banks. Progressively, the opportunity will develop for IPOs via the creation of a stock-market window for small companies, such as Alternative Investment Market for smaller growing businesses in the UK. Finally, another valuable support would be if government project contracts required the lead contractor subcontract or procure a percentage of the project value, a minimum of 25 percent from regional SMEs, as is the case in the US, and elsewhere. In short, the state needs to play a much stronger role in stimulating the development of the broad-base of the national economic pyramid. Together, the initiatives suggested will stimulate smaller businesses across the regions, create new jobs, and hasten national economic integration.

Salim Raza

The writer is a former governor of State Bank of Pakistan.

While banking in most emerging markets started with large metropolitan banks, the state either retained ownership of the banking system, or directed lending to ensure that SMEs and the regions were adequately supported

“Loan demand looks encouraging”

BR Research: How do you see the new government’s performance so far and how has it impacted overall confidence?

Atif Bajwa: We are optimistic about the future. I believe that there is a plan, and, hopefully, 2014 will move on a fast and positive track. The intention from the government is right. On the power issue, we already see improvements and I expect further development in the near future. However, I suspect that the bigger impact of initiatives will take some time as supply side bottlenecks have to be removed. Businesses are willing to invest in capacity and equipment modernisation. The big concern in the short run, though, is the balance-of-payments situation. The government is looking to raise sovereign bonds and trade finance facilities, whilst also seeking support from multilateral agencies. All of these e�orts will start bearing fruit hopefully in the first half of this year.

BRR: Will these e�orts and improvement in business confidence help boost banking sector income?

AB: As long as business confidence is backed by improved economic fundamen-tals and stability in the foreign exchange environment, it will be very good for the economy. It is not necessary that banks will make money o� these developments in the short term. However, in the medium to longer term, stability and growth will lead to profitable results.

BRR: Has demand started pouring in from the textile sector surrounding the GSP Plus scenario?

AB: The numbers for loan demand are looking slightly more encouraging, but these may need to be adjusted for cyclicality of borrowing needs. Some clients are beginning to talk about expan-sion. There is interest in power projects and there are some enquiries about setting up alternate biogas and coal plants. But this will only translate into reality over the next few quarters.

I wouldn’t say that there is a lot of activity at the moment. A key development has been that the bigger textile companies de-leveraged over the years, helping them in a volatile environment. As a result, these companies are doing well and their balance sheets are strong, and they are well positioned now to take advantage of lending facilities o�ered by banks.

BRR: The lending to SMEs has largely been to the medium ones, with smaller ones often neglected. Do you see the trend shifting?

AB: SME is a slightly tricky area. The banking sector’s exposure to SME has indicated a tilt towards larger sized enterprises. And that is only because a lot of banks have had their fingers burnt in SME lending in the past. Hence, it is only fair that they will all be a little more cautious. However, at Bank Alfalah, we have decided that we simply cannot ignore this sector, despite the fact that it has led to higher NPLs. That doesn’t mean we will blindly start pursuing avenues of lending in the SME arena. The fact is that the SME sector has su�ered from a chronic lack of capacity. Their own understanding of business management seems inadequate. The sector has su�ered from persistent power outages and a lack of access to markets as well, since Pakistan has become somewhat of a pariah. These are genuine issues that cannot be easily dismissed or neglected. Banks will have to abandon formula lending and develop a well thought-out model for SME Bbanking. At Bank Alfalah, we are already working on this and have restructured our SME approach with the help of IFC’s advisory service. We have developed a model that views SME operations holistically, instead of solely focusing on the lending part. Everything from their cash flows to their non-core operations will be thoroughly explored and understood. We also intend to help smaller businesses with their capacity building by providing them access to non-financial advisory services. Seemingly small aspects are important,

such as how to manage accounts, how to set up a basic supply chain, educating them about requirements by banks, etc. And a little handholding goes a long way in improving compliance and performance of smaller units. To this end, we are, in fact, just launching an SME Toolkit in collabora-tion with IFC - this is an online portal which provides value-added resources including business advice, local and global best practices, opportunities and challenges to both existing and potential SMEs in the country. Such resources will play an important role in the long term, sustainable development of the SME sector.

BRR: Do you have any new consumer products in the o�ing?

AB: We are looking to introduce new products whilst refining some of our existing product portfolio, increasing our range of credit cards, introducing corpo-rate cards and better defining the tailored segmentation of products available for individual customers. We remain the largest issuer and acquirer of credit cards in the country and these initiatives should augment our e�orts to retain that ranking. In addition to our mainstream financial solutions, we have also added a host of doorstep banking options including branchless, mobile and internet banking, and cash management to our suite. One of the key areas of focus for us this year is wealth management – we are keen to penetrate this domain but want to ensure that we base it on a comprehensive needs analysis of the market, so as to provide bespoke solutions to this segment. Not many banks have succeeded in Pakistan with their priority banking model, therefore, we want to take our time but try and do it right.

BRR: How do you see CY14 in terms of deposit growth?

AB: I wouldn’t forecast a dramatic improvement. The industry average in deposit growth is 13-15 percent, and that is mainly driven by money supply growth. The only real question is how much of that can be deployed in fresh lending. If you

look at lending growth, the industry average has typically hovered between 8-9 percent. While our bank outstripped the market last year by growing at 18 percent, at an industry level, deposit growth will stay ahead of lending. We are hoping to build upon this momentum and keep up with last year’s performance.

BRR: What is the major impediment your Islamic banking window faces?

AB: We are the second largest Islamic o�ering in the country. Our Islamic deposits currently comprise 16 percent of the bank’s total deposits. From an industry perspective, Islamic banking is still the fastest growing area in banking. However, whilst deposits keep growing, the issue is more on the assets side. Islamic assets are very di�icult to find, as there are not enough Sukuks or other such Islamic products. If you look at Islamic banks, their ADR is closer to 35 percent on average – the key reason for this is that they cannot find Sharia-compliant structured assets. The government could help by rolling out local and foreign currency Shariah-compliant Sukuks.

BRR: Since you’ve been expanding with such aggression, your cost-to-income ratio is higher than your peers. How are you going to manage the human resource side of the expansion, whilst trying to keep a lid on costs?

AB: Relative to the market, our sta�-to- branch ratio is high as the size of our branches is bigger; hence the cost of maintaining a branch is higher.Our future growth strategy is robust; we are currently at 574 branches and plan to continue expanding our footprint by redeploying employees from our existing talent pool. Hence if you look at our figures, while our branches have gone up in number over the last 2-3 years, the head count remains flat. This also helps our e�orts to provide our sta� with cross-functional job rotations and opportunities in new roles within the bank.

Interview by Ali Khizar

Atif BajwaChief Executive O�icer, Bank Alfalah



The rise and fall of banking spreads One of the gravest problems nailed to Pakistan’s banking system since the inception of financial liberalization reforms in early 1990s is the fact that depositors are not paid an adequate return on their savings. The removal of the ceiling on lending rates in March 1995, followed by the withdrawal of SBP’s instructions on payment of returns to investors and depositors in June 1998, had a profound impact on the interest rate structure of the financial sector. In early 1980s, banks were advised to declare profit rates on saving deposits after obtaining clearance from the SBP on the proposed profit rates. However, after the financial liberalization, banks were asked to determine the returns payable on funds mobilized from investors and depositors on the basis of the profits and losses incurred by them, and the requirement to seek approval from the SBP on proposed profit rates was dispensed with. While the linkage of lending and deposit rates with the policy rate was a bona fide move that helped the objective of monetary transmission, it also led to a gradual increase in banking spread. The movement of weighted average lending and deposit rates of the banking system over the years gives an obvious impression that while the lending rates moved quite in tandem with the policy rate, charging adequate risk premium over and above, deposit rates lagged far behind. The widened gap between savings and deposit rates, also known as net interest rate spreads, that discouraged savings culture in the country on one hand, proved to be the engine of banking sector’s robust financial performance in the recent years. The fact that the banking sector didn’t share its fortunes with the depositors, who are the major financier to the banks, led to a depressed pace of deposit mobilization. This is well evident by the fact that deposits nosedived to less than 27 percent of GDP by FY13 compared to over 60 percent in India and around 52 percent in Bangladesh. In contrast to deposits, the currency-in-circulation in Pakistan is hovering around 31 percent of the deposits. Growing currency-in-circulation implies depletion of deposits, and vice versa. SBP Research Bulletin titled “The Behavior and Determinants of the Currency Deposit Ratio in Pakistan” reveals that a rise in currency-in-circulation results in lesser deposits and hence lesser loanable funds available with the banks.

This restricts banks’ ability to meet private sector credit demand and in turn impairs economic growth. To put things in perspective, the banks had focused on private-sector lending before the crisis of 2008. Private sector lending was one of the dominant contributors of the mushrooming

interest rate spreads. As of June 2008, the stock of government securities was only 16.4 percent, while lending to the private sector was 52.4 percent of their total assets. Post 2008 financial crisis, however, banks were hit by huge levels of non-performing loans (NPLs), following which they juggled around with

their asset-mix and turned their gaze from risky advances to low-yielding government securities in the pursuit of cleaning their balance sheets from the scars of financial crisis. The risk averse strategy assumed by the banking sector had a propensity of dealing a death blow to its bulging spreads. Besides, the SBP also imposed the minimum deposit rate (MDR) of 5 percent per annum on all categories of saving/PLS deposits with effect from June 2008. But the banks tactfully diluted the negative impact of balance sheet shift and MDR on the spreads by playing with the other variable of the equation – deposits. A breakup of total banking sector deposits indicates that the share of fixed deposits has dropped from 35 percent in 2008 to 27 percent in June 2013. Conversely, current accounts grew from 27 percent to 30 percent of total deposits whereas saving deposits grew from 37 percent to 41 percent of the total deposits over the same period. The change in deposit mix of the banking sector lowered its maturity profile, creating further incentive for the banks to park their funds in government securities; the government’s domestic debt maturity averages less than two years, which matches the asset-liability maturity profiles. In the process, banks’ pace of deposit mobilization was also hindered: average year-on-year growth in

Sobia Saleem

deposits eased to 13 percent in the five years after the 2008 crisis, vis-à-vis an average growth of 19 percent in the five years before. Besides, over the years the banking sector has significantly diversified its sources of income. Non-markup income as a proportion of gross banking income has grown significantly in the recent years, which also helps buttress their bottomline. This created a win-win situation for the banks whereby they kept NPLs at a bay by ignoring the private sector credit yet sacrificing little on the earnings front. Connecting the dots, the MDR imposed by the central bank back in 2008 could neither trigger banks to recompose their asset portfolios in favor of private sector lending; nor did it encourage savings culture as the banks started mobilizing low cost, low maturity deposits. Bear in mind that in 2008, the SBP was determined to taper the spreads to boost the savings culture and to compensate the depositors well. However, in the current backdrop, as banks are negligent of their core duty, keeping a check on spreads could serve the dual purpose of boosting deposits as well as private sector credit off-take. The monetary easing of 500 basis points between FY12-FY13 coupled with the increase in MDR from 5 percent to 6 percent in 2HFY12 and change in the profit calculation methodology from minimum monthly balance to average balance appears to be a nail right in the head, as it narrowed the spreads from 5.54 percent in FY12 to 4.86 percent in FY13, a level unseen since FY05.

While the banks were expecting the monetary tightening to create a breathing space for their spreads, the central bank adopted the principle of “the worse, the better”. With the rate hike of 50 basis points in September 2013, the SBP did not only raise the MDR to 6.5 percent, but it also pegged it to SBP repo rate, leaving a margin of 50 basis points between MDR and SBP repo rate (SBP repo rate is 250 basis points less than the policy rate). With the second hike of 50 basis points in November 2013, MDR clocks in at 7.5 percent with banking spreads hitting another 9-year low of 4.5 percent in December 2013. The banks appear flexing muscles to combat the current level of spreads by mobilizing current accounts and shunning saving deposits. Private sector lending also showed notable improvements during 1HFY14, which grew by 9.95 percent vis-à-vis a growth of 5.77 percent during the similar period last year. Some attribute this growth to be the long-awaited revival in banks‘ asset portfolios while others attribute it to banks’ lackluster participation in government securities auctions in 1QFY14 because of uncertainty on the discount rate front. Whether or not the private sector credit growth in 1HFY14 is the revival of banks’ appetite for risky lending, one thing is for sure: if the risk free lending avenue is unavailable or becomes unattractive to the banks or is shared with a diversified investor base other than banks, banks will definitely look for avenues to park their surplus funds. That’s exactly what happened in 1HFY14.

The listing of government securities on the local bourses is also a positive development on this front. The move would take time to reap its desired results; but it would definitely cause a dent on the banks’ asset portfolios by sharing the pie of government securities with retail investors. The idea is that merely squeezing the banking spreads to trigger private sector lending or to instill a savings culture in the economy would lead to nowhere. Banks are smart enough. Sooner or later, they will play with other variables of the spread equation and end up making attractive profits. The way to go forward is directed lending or priority sector lending to boost availability of credit to the private sector. A similar tool is adopted by the Reserve Bank of India whereby all

public, private and foreign banks with 20 and more branches have to lend 40 percent of their adjusted net bank credit to six priority sectors defined by the central bank. The same strategy is also employed in different forms and shapes by South Korea, Japan, China, Brazil, Thailand etc. Still at the end of the day, twisting the banks’ arms are structural issues such as power shortages, security issues and above all banking courts, which must be improved to turn the tables and reap the true benefits of shaved margins.

Interest rate spread Lending rate Deposit rate

Trends in lending and deposit rates

-

2

4

6

8

10

12

14

16

Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

%

Source: BR Research calculations based on SBP data

Negative correlation between currency in circulation and deposit growth

5%

10%

15%

20%

25%

30%

Jan -07 Jul -07 Jan -08 Jul -08 Jan -09 Jul -09 Jan -10 Jul -10 Jan -11 Jul -11 Jan -12 Jul -12 Jan -13 Jul -13

Source: BR Research calculations based on SBP data

Deposit (YoY Growth) Currency in circulation (YoY Growth)

One of the gravest problems nailed to Pakistan’s banking system since the inception of financial liberalization reforms in early 1990s is the fact that depositors are not paid an adequate return on their savings. The removal of the ceiling on lending rates in March 1995, followed by the withdrawal of SBP’s instructions on payment of returns to investors and depositors in June 1998, had a profound impact on the interest rate structure of the financial sector. In early 1980s, banks were advised to declare profit rates on saving deposits after obtaining clearance from the SBP on the proposed profit rates. However, after the financial liberalization, banks were asked to determine the returns payable on funds mobilized from investors and depositors on the basis of the profits and losses incurred by them, and the requirement to seek approval from the SBP on proposed profit rates was dispensed with. While the linkage of lending and deposit rates with the policy rate was a bona fide move that helped the objective of monetary transmission, it also led to a gradual increase in banking spread. The movement of weighted average lending and deposit rates of the banking system over the years gives an obvious impression that while the lending rates moved quite in tandem with the policy rate, charging adequate risk premium over and above, deposit rates lagged far behind. The widened gap between savings and deposit rates, also known as net interest rate spreads, that discouraged savings culture in the country on one hand, proved to be the engine of banking sector’s robust financial performance in the recent years. The fact that the banking sector didn’t share its fortunes with the depositors, who are the major financier to the banks, led to a depressed pace of deposit mobilization. This is well evident by the fact that deposits nosedived to less than 27 percent of GDP by FY13 compared to over 60 percent in India and around 52 percent in Bangladesh. In contrast to deposits, the currency-in-circulation in Pakistan is hovering around 31 percent of the deposits. Growing currency-in-circulation implies depletion of deposits, and vice versa. SBP Research Bulletin titled “The Behavior and Determinants of the Currency Deposit Ratio in Pakistan” reveals that a rise in currency-in-circulation results in lesser deposits and hence lesser loanable funds available with the banks.

This restricts banks’ ability to meet private sector credit demand and in turn impairs economic growth. To put things in perspective, the banks had focused on private-sector lending before the crisis of 2008. Private sector lending was one of the dominant contributors of the mushrooming

interest rate spreads. As of June 2008, the stock of government securities was only 16.4 percent, while lending to the private sector was 52.4 percent of their total assets. Post 2008 financial crisis, however, banks were hit by huge levels of non-performing loans (NPLs), following which they juggled around with

their asset-mix and turned their gaze from risky advances to low-yielding government securities in the pursuit of cleaning their balance sheets from the scars of financial crisis. The risk averse strategy assumed by the banking sector had a propensity of dealing a death blow to its bulging spreads. Besides, the SBP also imposed the minimum deposit rate (MDR) of 5 percent per annum on all categories of saving/PLS deposits with effect from June 2008. But the banks tactfully diluted the negative impact of balance sheet shift and MDR on the spreads by playing with the other variable of the equation – deposits. A breakup of total banking sector deposits indicates that the share of fixed deposits has dropped from 35 percent in 2008 to 27 percent in June 2013. Conversely, current accounts grew from 27 percent to 30 percent of total deposits whereas saving deposits grew from 37 percent to 41 percent of the total deposits over the same period. The change in deposit mix of the banking sector lowered its maturity profile, creating further incentive for the banks to park their funds in government securities; the government’s domestic debt maturity averages less than two years, which matches the asset-liability maturity profiles. In the process, banks’ pace of deposit mobilization was also hindered: average year-on-year growth in


deposits eased to 13 percent in the five years after the 2008 crisis, vis-à-vis an average growth of 19 percent in the five years before. Besides, over the years the banking sector has significantly diversified its sources of income. Non-markup income as a proportion of gross banking income has grown significantly in the recent years, which also helps buttress their bottomline. This created a win-win situation for the banks whereby they kept NPLs at a bay by ignoring the private sector credit yet sacrificing little on the earnings front. Connecting the dots, the MDR imposed by the central bank back in 2008 could neither trigger banks to recompose their asset portfolios in favor of private sector lending; nor did it encourage savings culture as the banks started mobilizing low cost, low maturity deposits. Bear in mind that in 2008, the SBP was determined to taper the spreads to boost the savings culture and to compensate the depositors well. However, in the current backdrop, as banks are negligent of their core duty, keeping a check on spreads could serve the dual purpose of boosting deposits as well as private sector credit off-take. The monetary easing of 500 basis points between FY12-FY13 coupled with the increase in MDR from 5 percent to 6 percent in 2HFY12 and change in the profit calculation methodology from minimum monthly balance to average balance appears to be a nail right in the head, as it narrowed the spreads from 5.54 percent in FY12 to 4.86 percent in FY13, a level unseen since FY05.

While the banks were expecting the monetary tightening to create a breathing space for their spreads, the central bank adopted the principle of “the worse, the better”. With the rate hike of 50 basis points in September 2013, the SBP did not only raise the MDR to 6.5 percent, but it also pegged it to SBP repo rate, leaving a margin of 50 basis points between MDR and SBP repo rate (SBP repo rate is 250 basis points less than the policy rate). With the second hike of 50 basis points in November 2013, MDR clocks in at 7.5 percent with banking spreads hitting another 9-year low of 4.5 percent in December 2013. The banks appear flexing muscles to combat the current level of spreads by mobilizing current accounts and shunning saving deposits. Private sector lending also showed notable improvements during 1HFY14, which grew by 9.95 percent vis-à-vis a growth of 5.77 percent during the similar period last year. Some attribute this growth to be the long-awaited revival in banks‘ asset portfolios while others attribute it to banks’ lackluster participation in government securities auctions in 1QFY14 because of uncertainty on the discount rate front. Whether or not the private sector credit growth in 1HFY14 is the revival of banks’ appetite for risky lending, one thing is for sure: if the risk free lending avenue is unavailable or becomes unattractive to the banks or is shared with a diversified investor base other than banks, banks will definitely look for avenues to park their surplus funds. That’s exactly what happened in 1HFY14.

The listing of government securities on the local bourses is also a positive development on this front. The move would take time to reap its desired results; but it would definitely cause a dent on the banks’ asset portfolios by sharing the pie of government securities with retail investors. The idea is that merely squeezing the banking spreads to trigger private sector lending or to instill a savings culture in the economy would lead to nowhere. Banks are smart enough. Sooner or later, they will play with other variables of the spread equation and end up making attractive profits. The way to go forward is directed lending or priority sector lending to boost availability of credit to the private sector. A similar tool is adopted by the Reserve Bank of India whereby all

public, private and foreign banks with 20 and more branches have to lend 40 percent of their adjusted net bank credit to six priority sectors defined by the central bank. The same strategy is also employed in different forms and shapes by South Korea, Japan, China, Brazil, Thailand etc. Still at the end of the day, twisting the banks’ arms are structural issues such as power shortages, security issues and above all banking courts, which must be improved to turn the tables and reap the true benefits of shaved margins.

The writer works as Research Analyst at Business Recorder. She can be reached [email protected]

20

30

40

50

60

70

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

%

Source: BR Research, Federal ReserveBank of St. Louis

Deposit-to-GDP ratio

India Bangladesh Pakistan

Summit’s plans to turn IslamicHusain Lawai is a seasoned banker who has worked both in Pakistan and the Middle East. Currently, he is serving as the President and the CEO of Summit Bank. In this interview with BR Research, Lawai talks about the bank’s plans to raise capital to meet its capital adequacy requirements as well as its plans of conversion to Islamic bank.

Below is the edited transcript.

Husain LawaiPresident andChief Executive O�icer, Summit Bank

BR Research: Let’s take it from the top. Your equity is as low as Rs3.2 billion. How do you plan to restore financial stability?Husain Lawai: We have given a commit-ment to the central bank that we will be capital compliant by September 2014. We have already appointed a financial advisor in Abu Dhabi. We have also informed the arrangement to SBP that as a first step, we are o�ering $50 million additional capital, which will hopefully be raised by end of March 2014.

BRR: Who is providing this amount?HL: We are receiving it from 4-5 investors. An in-principle commitment of $35 million has been made from one investor based in Abu Dhabi. One is from Bahrain, one is from Kuwait, two are from Malaysia and one is from Qatar. These are high net worth individuals. Our sponsors will be funding $11.5 million and if there is any shortfall in capital in September, our sponsors will subscribe it. The expected shortfall will be $10 million, which will be injected by our sponsors.

BRR: When do expect the bank to start posting profits?HL: Over the next two to three quarters.

BRR: If we look at the classification of your NPLs, most of the NPLs are in loss category. Is it because of full provisions?HL: Yes, for those NPLs no further provision is required. But although certain NPLs have been fully provided for, we expect to book full reversals for it. We expect more reversals in 2014. BRR: What is the biggest stumbling block in recovering bad loans?HL: Unfortunately, in Pakistan the judicial system favors the defaulter as opposed to the lender. It takes as long as 15 years to recover the amount as the defaulters want to exhaust all the appeals and judicial process. Such long delays in recovery of defaulted amount are detrimental for the banking sector.

BRR: What is your view on the corporate rehabilitation act?HL: I am in favor of the act, but not in its present shape. We have already suggested a number of changes. The corporate system should be aligned

with what is happening around the globe. We should give the borrower a reasonable time, say of 6 to 8 weeks, to submit remedial plan for rehabilitation of the project. The bank should give time, of say 11 months, to implement the rehabilitation plan and monitor key performance criteria. If the borrower fails in implementing its plan, then the bank should take over and dispose o� the project or business. This should all happen with the support of high court or banking court.

BRR: Can we safely say that the worst is over for Summit Bank?HL: Yes. The last quarter of 2013 was the turning point. We can assume that the economy will also be doing better. I am positive as long as the government goes for structural reforms rather than going for cosmetic measures.

BRR: Do you think the linking of minimum deposit rate with discount rate is a positive development?HL: In the long run, yes. In the short run, however, some banks will feel a pinch.

BRR: Why are banks not penetrating into the lower end of the market? HL: It is because the cost of opening branch has gotten very high. It costs roughly Rs15 million; setting up an IT system, installing and providing the branch infrastructure, etc. We are in conversation with the central bank, to build something which is between a booth and a branch with only a three person sta�. Using a satellite we can provide services of paying utility bills, collecting home remittance, etc, to our customers in areas where there is no branch. If they want to open an account one person can assist over there and the rest of the processing can be carried out from the branch.

BRR: What kind of innovative lending products are you thinking to launch?HL: We plan to go for small tickets which give better return. We have launched a scheme called “Sonay Pe Sohaga”, where we will allocate some funds to our consum-ers which will be guaranteed by the companies they are employed in. They will not be just plain vanilla consumer loans;

they will be pegged by corporate guaran-tees. We have already entered into arrangements with leading corporate companies. Apart from that we are negotiating with prospective customers.

BRR: There is a lot of talk about Summit’s full-fledged transition to Islamic banking. What is the actual plan?HL: In March 2013, our board of directors announced that this transition from conventional banking to Islamic banking should be carried out in the next 5 years. But now we are planning to do it in 3 years. This is because if we compare the conventional and Islamic banking sectors, Islamic seems to be growing at a faster rate in Pakistan. Moreover, our Chairman Mr. Naseer Lootha was the pioneer of Islamic banking in the world when they launched Dubai Islamic Bank. Hence, from the time when he took over Summit, he has been eager to pursue Islamic banking. The merger of three banks was a good learning experi-ence for us and in the next three years, we look forward to operate as an Islamic bank.

BRR: What is the reason behind this shift from conventional to Islamic banking?HL: There are three reasons for this. One, growth potential is significantly higher for Islamic banks. The other reason is that if we continue to function as a conventional bank we will not be able to sustain as a major player in the sub-sector of the banking sector. On the flipside, if we shift to Islamic banking, we will be among the top three. The third reason is that there is a lot of gap in the Islamic banking market. In my view Islamic banks in Pakistan are not o�ering true Islamic products; they just change the label.

BRR: Do you think your customers will switch from conventional to Islamic banking? HL: Actually, we conducted research regarding this last year. Earlier we were of the view that we should maintain conven-tional as well. After the survey, however, we concluded that 95 percent of the customers – that include both depositors and borrowers - were willing to switch to Islamic banking. In addition we also look forward to attracting new customers. BRR: What kind of products do you plan to

o�er as an Islamic bank and what will make them stand out from other Islamic products being o�ered by other banks?HL: Our main thrust would be on two products, Mudaraba and Musharaka. When I was the president of MCB we introduced Musharaka; we o�ered it to some textile units and steel mills. This was carried out after conducting extensive research on these industries and the returns were greater than the interests received earlier. BRR: What is the structural plan for conversion over the three years? HL: We will be starting from March 7 this year; we have already received the approval from central bank to conduct Islamic banking. We are starting from the conversion of one branch, which is the one on I.I. Chundrigar Road, Karachi. The customers associated with this branch will be informed about the changes. Of those the ones who wish to continue with Summit will be o�ered Mudaraba,Musharaka and Ijarah later. The process of converting branches will continue, and we hope to achieve complete transformation in the next three years.

BRR: How many new branches are you going to open in 2014?HL: We did not apply for branches in October 2013, but we hope to take our decision about it in March 2014. A maximum number of 10 branches will be opened during 2014. Instead we plan to improve the performance of existing network. At our national conference this year we plan to address the area managers and regional managers and discuss ways to improve the productivity and e�iciency of each branch and each employee rather than opening new branches. We will give more attention to those branches that are not doing well and then we might shift them or take some other measures.

Interview by Ali Khizar and Sobia Saleem



How Basel-III will impact Pakistan, othersThe Basel-III regulations have come into effect from January this year. These regulatory changes are to ensure that history doesn’t repeat itself in the form of another 2008-like financial crisis. The changes to banking capital requirements will have a wide-ranging impact on bank lending practices and credit availability to the private sector over the next five years. State Bank of Pakistan’s circular, issued on August 15, highlights the Basel-III reforms agenda and implementation timeline. The major changes pertain to the raising Capital Adequacy Ratio (CAR) to 12.5 percent in a phased manner by end of 2019, up from 10 percent today under the Basel-II framework. The additional capital requirement is part of the Basel Committee on Banking Supervision's recommendation to introduce an additional 2.5 percent Capital Conservation Buffer (CCB) on the banks. It is important to note that the SBP is implementing the Basel-III capital ratios at 2 percent above the Basel Committee's recommendations of 10.5 percent (8% of total capital + 2.5% conservation buffer) to act as a buffer for the additional capital that may be required because of modelling shortfalls. The Basel-III regime includes several elements that will be phased in between 2013 and 2019: a capital conservation buffer (2.5%), a countercyclical capital buffer (0-2.5%, depend-ing on conditions), and a buffer for global systemically important banks (1% for each). Under the Basel-III regime, there are also limitations that will be imposed on bank lending in case CAR falls below the 12.5 percent requirement. In particular, banks will need to reduce lending against its CE (Common Equity) Tier I of CAR. The changes in Basel-III are expected to lead even well capitalized banks in EU, US and emerging markets to find it hard to be compliant. Pakistani banks are well capitalized with CAR of 15.6 percent (September 2013), with Tier 1 capital making up over 13.4 percent. Hence, even with Basel-III implementation most of the banks will easily meet CAR requirements. According to SBP’s estimates, the CAR of banks would drop to 14 percent under Basel-III regulations – still above the prescribed limits. However, there will be some crowding out of smaller banks, which will support mergers & acquisitions in the financial sector. Within the emerging Asian markets, Indian banks are likely to be more capital-constrained than peers. The Reserve Bank of India estimated in its annual report (August 2012) that Indian banks face an equity shortfall of $35 billion on account of Basel-III implementation. Banks in China have the next-highest capital requirement

of $14.5 billion, largely driven by high nominal GDP growth. US and European banks face an uphill challenge and may be the most significantly impacted as a result of Basel-III. In May 2012, Fitch Ratings published a study on potential pressures on 29 Global Systemi-cally Important Financial Institutions (G-SIFIs – the ‘too big to fail’ banking giants) arising from Basel-III. According to Fitch, the average G-SIFI bank would have to raise $9.5 billion of common equity to comply with Basel-III rules. The aggregate amount for the 29 banks would be a whopping $566 billion. This shortfall would be met by a combination of earnings retention, equity issuance and reduction of risk weighted assets. Maintaining higher capital levels over the longer term under Basel-III is likely to lower banks Return on equity (ROE) as they face higher capital costs. According to a Fitch study, large banks globally would see an average ROE decline of 20 percent as a result of Basel-III implementation. Another study, conducted by McKinsey at end-2010 for European banks, estimated the ROE impact on European banks at 30 percent. If banks are unable to raise the equity required under Basel-III (and necessitated by its second-round impacts and by European bank deleveraging), they are likely to curtail lending to corporates, creating a financing gap. Our estimates suggest an aggregate shortfall in corporate lending from banks at over $340 billion over the next five years. In Pakistan, a combination of tighter lending requirements and crowding out of private sector credit are already driving corporates to raise funds from debt & equity markets. As growth picks up and credit demand grows stronger, one can see significant new TFC floated in the markets over the next few years. Pakistan’s corporate bond market is very small at around an estimated Rs350 billion, which is around 1.5 percent of GDP, and only a tenth in size of the total government bond markets. Traditionally, banks have been the primary funding source for corporate in emerging Asian markets. However, the composition of corpo-rate funding is likely to change over the next decade. While some of this expected shift will be structural as the region’s bond and alternative funding markets develop, it is likely to be largely driven by constraints on bank funding. Basel-III and deleveraging by European banks are likely to cause a structural shift in the composition of corporate funding; prompting more corporates (especially higher-rated ones) to access bond markets directly rather than borrow from banks. This is likely to increase the size of the regions corporate bond markets over the medium term.

The shift is already under way as big corporates turn to the bond market for longer-term (and, arguably, less covenant-heavy) funding. In 2011, Pakistan saw two large corporate giants Engro and KESC raised Rs4 billion and Rs2 billion respectively through issues of Term Finance Certificates in 2011. Standard Chartered Pakistan successfully closed a ten-year Rs2.5 billion TFC, marking the largest offering in Pakistan by any financial institution in 2012. The key question is that will there be enough demand for all the corporate bonds likely to be issued in Asia? In our view, while international investment is likely to rise, a large part of the incremental demand will come from local investors. If Asian government bond markets are any indicator, international investors own less than 25 percent of the local-currency bond markets, while domestic financial institutions own close to 60 percent. In Pakistan, the foreign investment in government bonds is less than 5 percent; nearly 95 percent is from domestic investors led by banks. Local currency bond markets in Asia are currently fragmented and very local. If they need to grow exponentially in the next decade to fill the gap left by reduced bank lending, greater cross-border mobility and intra-regional fund flows will be required. The local markets are at varying stages of development. Some are still trying to establish a sovereign yield curve, whereas others have well-developed corporate bond markets as deep as those in the US or Europe, with corporates issuing bonds across the maturity and rating spectrum. The dominance of quasi-sovereign issuers and financial institutions is another concern. Issuance from the private sector is still dominated by highly rated corporates (AA and above on the local scale), with access to BBB-negative and lower rated issuers heavily restricted. The strong role of the states in these econo-mies is one reason for this; but it also reflects the early stage of development of corporate bond markets and the risk-seeking behaviour of local investors. Lower-credit quality borrowers need to be able to access the bond markets in order to fill the gap, much as in the larger and more vibrant US high-yield bond markets.

Sayem Ali

The writer has worked as economist Middle East, Pakistan, and North Africa at Standard Chartered Bank. His views do not necessarily represent those of the organisation.

If banks are unable to raise the equity required under Basel-III (and necessitated by its second-round impacts and by European bank deleveraging), they are likely to curtail lending to corporates, creating a financing gap.

HabibMetro eyes growth in trade finance

Sirajuddin Aziz is currently associated with Habib Metropolitan Bank as its President & CEO. During his 35-year banking career with international as well as local banks, he held several senior management positions in various countries including Pakistan, the UK, the UAE, Nigeria, Hong Kong and China. During his career, Aziz has contributed to various professional bodies including Pakistan Banks’ Association as Chairman. He has been a regular speaker on credit, trade and foreign exchange at “The Institute of Bankers Pakistan” and other prestigious institutions. Aziz also frequently contributes articles to newspapers on various subjects.

Sirajuddin AzizPresident and Chief Executive O�icer, Habib Metropolitan Bank

When it comes to the economy at large Aziz minces no words in expressing his concerns. “Pakistan’s tax-to-GDP remains one of the key economic variables in the current economic environment, which can be described as sluggish at best.” He adds that “FBR’s tax collection numbers bear evidence of the rampant mindset of not paying taxes,” hoping that the current government would augment revenue by introducing tax reforms. Linking the fiscal discipline with banking sector, Aziz said that while banks are doing well in terms of growth and profitability, the risk free borrowing environment has a�ected the strategy of the overall sector. “The presence of risk- free borrowers impacts the lending spectrum – and consequently the portfo-lio of advances; banks shy away from extending credit to the relatively riskier private sector alternate,” he said. Aziz is hopeful that with interest rates back on an upward trajectory, banks can be expected to post higher topline growth. He expects the industry to strategize towards core advances as “banks cannot sustain their books solely on government securities.” Contrary to popular opinion, Aziz is of the view that banks are now better poised to revisit consumer financing. “At the moment, banks enjoy a competitive spirit among them and are faced by a discern-ing customer base.” HabibMetro has stayed abreast of the industry growth curve. The bank is currently operating on the strategy of organic growth and is penetrating new locations with its presence. From 183 branches in 2012, out of which 100 were in Karachi, HabibMetro’s branch network has grown to 214 branches, spread across 49 cities, as of the end of 2013.

“We are one of the leading trade finance banks, which handles a significant share of Pakistan’s total trade business. One of the practices and strategies that has enabled the bank to capture this ever-growing market share is transactional integration, whereby we handle both legs of the transaction,” says Aziz. Trade finance will continue to be the business segment of interest for HabibMetro according to Aziz, since in addition to its viable self-liquidating nature it o�ers derivative products which increase its appeal versus other business segments. Addressing the passive lending preva-lent in the banking sector, Aziz said that “large banks enjoy the inherent advantage of low cost deposits and can indulge in this risk-averse practice.” However, he believes that lending opportunities will widen with economic growth and devel-opment that is complemented by improvement in law & order and resolu-tion of energy issues. However, he points out that resource generation will prove to be challenging for the banking sector, with the products o�ered by di�erent banks being more or less the same. In this competitive environ-ment, HabibMetro’s advanced technologi-cal platform provides a competitive advantage by o�ering fast pace banking solutions at the push of a button. “HabibMetro has been a trade finance bank since its inception, and hence its credit business is significantly greater compared to other similar sized banks,” said Aziz before emphasizing the viability of trade for any developed or developing country. Being a trade finance bank, the lender has had its share of NPLs emerging out of the global financial crises of 2008, onwards. Briefing about the NPLs, Aziz explains that a close examination of the

entire banking sector NPLs would show that most NPLs were a result of export finance, where the buyer of Pakistani goods, defaulted. However, Aziz maintains that HabibMetro’s NPLs were on a decline and in control. On the subject of deposit mix, Aziz believes that saving deposits are stickier and in that respect cost e�icient, which is why they form a notable quantum of HabibMetro’s deposit base. However, he is not very enthusiastic about the decision to peg deposit rates with the discount rate and asks for it to be reviewed for the sake of financial viability. Commenting on the diversification in HabibMetro’s exposure and composition of advances; Aziz says that high concen-tration of credit exposure in the textile sector earlier has now taken the form of well diversified exposure across a number of sectors. He adds that due to expectations of greater economic and business activity, the trade-oriented bank’s lending – and hence ADR - is expected to witness an increase against a trade-o� with the IDR, which is expected to decline. “By Decem-ber 2014 we can expect HabibMetro’s ADR to mark at 55-58 percent,” adds Aziz. Praising the State Bank, Aziz said it is “the best regulator in the region”. “They have been extremely proactive in regulat-ing the market and have dealt with the financial crisis of 2008 proficiently, preventing the banking industry from being aggressive. The regulator’s mecha-nism of inspection, which was transaction-oriented earlier, has also exhibited remarkable improvement and is now more risk-based. With major opera-tional transformation, the SBP now serves as a model for local and international banks,” he concludes.

Interview by Ali Khizar & Sobia Saleem

By December 2014 we can expect HabibMetro’s ADR to mark at 55-58 percent



Rabia Lalani

View from the stock market

For a year that saw benchmark Karachi Stock Exchange grow by 49 percent, 2013 saw banking stocks underperform the market by 17 percent. This was both a result of macroeconomic conditions in the country that kept private sector credit in check and bank-unfriendly initiatives taken by SBP during the year. To jog down the memory lane, the SBP increased minimum deposit rate on savings account from 5 percent to 6 percent during the year. Later, it linked minimum deposit rate (MDR) with the repo rate, thus limiting banks’ merry-go-round sessions. Linking MDR in times of monetary tightening, however, proved difficult for banks, especially for those which had higher savings deposits as percentage of total deposits. This prompted banks to alter their deposit mix to lower their costs. In the meanwhile, the exemption of Islamic banks from this regulation gave them a reason to cheer about.

On the flipside, a major boost for banks came from improved asset quality. Although increase in discount rates prompted banks to focus on investment in risk-free government securities than on private sector credit, leading to improvement in non-performing loans and robust coverage ratios. Looking ahead there is some level of optimism in the banking sector which is expected to outperform in 2014 as the dynamics are changing. According to Ujala Adnan, a banking analyst at Elixir Securities, Islamic banking, branchless banking and cost-rationalization are the key areas that banks are drumming on to these days. She asserts that as asset quality of the banks has improved considerably, private sector credit off-take is likely to shoot up going forward. Contrary to this, Iqbal Dinani, a sector observer at BMA Capital, is a bit cautious on banking sector. He believes that margins might

not increase substantially as banks have heavily invested in risk free government securities where margins are quite narrow. However, Dinani considers that focusing on increasing advancing activities will help the performance of banks to come on track. Higher coverage ratio and lower NPLs are the key strengths of banking sector at this stage. He says the banks may start lending prudently during 2014 while aggressive lending is likely to start from 2015 and onwards. In this context, BR Research conducted a survey of equity fund managers of leading asset management companies regarding their outlook of banking sector. The survey represents nearly 77 percent of the entire fund size of the mutual fund industry. The survey reveals that fund managers deem banking sector at this stage as a “defensive” play, terming macro-economic concerns particularly depressed private sector credit off-take and

compressed margins as the culprits at the back of muted performance of banks. Most fund managers say that dividend payout announcements and further monetary tightening can help pick up the performance of banking stocks on the local bourse, provided uptick in business activities and increase in credit off-take bring this sector back in limelight. In short, the consensus stance on banking sector is weighted as “neutral” in the short-term, whereas any improvements at the macro-economic level may act as a trigger and lift the stance from “neutral” to “positive”.


Bank

Habib Bank LimitedNational Bank of PakistanMCB Bank LimitedUnited Bank LimitedBank AlfalahAllied Bank LimitedBank AlHabibMeezan Bank LimitedBankIslami PakistanAskari Bank

Stance

Market weightMarket weightUnder weightMarket weightOver weightMarket weightOver weightOver weightOver weightMarket weight

M.P

25-Feb-13

158.6957.35266.77133.5127.9888.7939.5137.488.9613.37

T.P

147.9254.24249.63137.4029.0190.6146.0744.0013.0014.00

Highlighting Traits

Improvement in CASA and NIMsSignificant reduction in CASA and focus on islamic bankingAttractive NIMs and strong recoveriesImprovement in asset quality and attractive NIMsDeposit growth due to branch addtions and improvement in CASA mixStrong non-interest income and strong equity portfolioImproved asset quality, fast NIM growth and attractive coverage ratioPioneer of Islamic banking, strong brand equityTremendous deposit growth and lower cost of fundsDeclining NIMs, with huge NPLs

* Calculated on average market prices

Valutation Summary of Banking Sector Stocks

Source: Average estimates of following brokerage houses:

AKD Securities, Global Securities Pakistan Ltd, Topline Securities, Taurus Securities Ltd, JS Global, Foundation Securities Ltd, BMA Capital, KASB Securities, Optimus Capital Management, Elixir Securities Ltd

2012*

6.295.288.654.864.716.035.506.9711.979.36

2013*

7.949.4211.627.055.955.246.398.4026.09N/A

2014

8.247.6711.218.166.727.846.567.356.3516.92

P/E

2012*

1.110.561.611.020.711.281.251.480.880.60

2013*

1.220.692.361.370.841.281.311.800.661.30

2014

1.350.782.321.581.081.401.411.770.771.09

P/BV

2012*

6.6%14.4%7.4%11.8%13.7%8.6%10.1%5.5%0.0%0.0%

2013*

6.4%8.5%5.6%9.0%9.6%7.1%9.2%4.6%0.0%0.0%

2014

5.9%10.3%5.8%7.3%8.6%7.0%8.5%5.3%0.0%0.0%

Dividend Yield

SWOT analysis of the banking sectorStrengths:

Stringent regulatory frameworkRobust risk management practicesSignificant growth in deposit baseMinimum capital requirements adequately satisfied by all but five smaller banks Sufficient branch networkIncreasing focus on non mark-up income

Weaknesses:Lack of innovative lending productsHigh dependence on spreadsIncreased investment in government securities resulting in depressed private sector credit off-takeHigh percentage of savings deposits as a percentage of total deposits

Continued monetary tightening, which may hamper the growth in credit off-takeListing of government securities and corporate SukuksAttractive rates on national savings schemes

Fresh private sector credit off-takeIncrease in market share through internet and mobile banking, which can reduce operational costs over timeIntroduction of new products, such as branchless banking

Opportunities:

Threats:


Banking: An unconventional viewBanks are the overseers of a nation’s premier asset, its savings deposits; unless of course that nation is blessed with surplus oil reserves in which case the government could care less about monetary shenanigans. Frankly, oil rich autocracies, which are the rule by the way, need neither indulge in brilliance of conception nor excellence of execution, petrodollars buy everything. Economists, the forbearers of doom, have even managed to showcase oil wealth as a disease and coined a phrase for it. Still, all nations dream of being compared with the Dutch, and for good reason too. Empirical evidence clearly establishes that booms are sweeter for oil rich nations and recessions avoid them like the plague! Pakistan’s dreams for oil elephants are far from fruition; accordingly the nation, by default, has to ensure efficient utilization of all other resources, if it ever expects to be elevated to the ranks of developed nations. The standard formula for development of an agricultural economy is through an industrial revolution, which requires investment of its savings in projects that create employment and increase productivity. Banks can play a pivotal role in channelling precious resources either towards self sustainability or funding wasteful consumer choices leading to abject dependence; or worse. The evolution of banking remains dependent on the mischief of money and ever since the invention of fiat money, the business of banking is potentially riskier than an invasion force armed to the teeth with WMD; sub-prime and euro debt crises are proof of the carnage and chaos banks are capable off. For a long time preceding the crises, it was actually believed that money and its ilk had actually moderated, or was it tamed, the business cycle; a clever idea down the drain. Business cycles rule supreme, unchallenged; what fools these mortals be! Governments were always cognizant of these associated hazards, if not their ferocity, and have endeavoured to establish a foolproof regulatory regime for banking; unfortunately never succeeding. The events of 2008 have effectively exposed the inability of the latest banking standards established under the Basel Accord to identify a storm, let alone prevent it. If Basel-II had been remotely effective, the

double jeopardy should have been prevented, so why invest in Basel-III? Rationally, prescient and sincere legislation would have kept banking simple; why approve complex derivatives contracts in the garb of innovation, which nobody understands, not even their inventors. Nonetheless, and irrespective of the tenacity of the fraudsters to dream up innovative and unfathomable schemes to regularly and repeatedly defraud the public out of their deposits, banking remains the only vehicle to mediate between savers and investors. So while the cat and mouse game continues between the bankers and their regulators, what matters most is the scorecard. Has the banking sector of the nation succeeded in efficiently deploying the monetary resources of the nation? Notice that the profitability of individual banks or profitability of the banking sector as a whole were not included in the scorecard statement, in fact they don’t even merit a footnote. Surprised? Conventional wisdom dictates that a strong and growing banking sector is a barometer of a nation’s economic prosperity. As of now, all the banks in Pakistan are profitable, and in fact some are doing exceptionally well for a number of years. This prosperity, if the idea had been on the money, should have translated into, a booming national economy, a strengthening rupee, low inflation, a reducing trade imbalance, increasing foreign reserves, a depleting national debt and full employment; which obviously it hasn’t. Another clever idea down the drain! A small clarification at this point; this is neither the forum nor is there sufficient space to get into a protracted critique of western dogmas; logical conclusions will have to suffice. On the other hand the simplicity of the preceding deductions stands witness to their authenticity, if the objective had been deceit and fabrication, complex and muddled articulation would have been the preferred option. Frankly, the propensity of domestic intelligentsia to readily accept any theory stamped “Made by Gora”, without independent thought, is remarkable.

Once again, where is Pakistan on the scorecard?

The economy is hardly booming, sectors in desperate need of funding are seemingly

denied credit. Other than debatable power projects there has been hardly any project investment that merits a special mention, unemployment has reached epidemic proportions and the situation of the rupee, foreign currency reserves, trade deficit and rising national debt are regular “breaking news” on the electronic media. Except that the banks are making money! Ignoring that the “spread”, the difference between interest rates, which the banks pay their depositors and what they charge their lenders, is quite judicious in Pakistan, if the real economy is reeling, why are the banks allowed to make money? Puzzling indeed! Don’t forget the foundations of banking business are built upon monopoly rent and banks are protected by stringent entry barriers; establishing a bank requires a government license which is not easily forthcoming. Apparently banks are lending the savings of the nation back to the government and earn a spread thereon, and there is nothing illegal about that. Admittedly, the big banks were privatized to circumvent government hegemony on banking credit, but in an uncertain and highly-charged environment, the banks cannot be blamed for choosing the less- risky option, lending to the government rather than to the private sector, especially when the spread remains high. Another avenue for deployment of banks’ funds is the equity market. Considering the frequent debacles, it is a wonder that like direct investment in property, stock are not on the regulator’s restricted list. Especially when funds diverted towards equities cannot be utilized for projects in the real economy. Once again, theories on the importance of the stock market are sidestepped; the dotcom of the late 90s should be sufficient evidence of their veracity. “It is said that the world is in a state of bankruptcy, that the world owes the world more than the world can pay,” Ralph Waldo Emerson. Brilliant articulation which can easily be broken down into its sub-sets, simply substitute the word “World” with “Pakistan”, or most any nation today, for that matter! Globally, banks were bailed out and remain hugely profitable, the stock markets are again booming, property prices are again reaching bubbling heights, governments continue to borrow unfettered and all this courtesy central

banks, who continue to ease money supply. Everyone making money is fine but what about the populace? Before moving towards a conclusion, a few statistics, which the editor informs, are apparently necessary to establish credibility; which is rather amazing since hardly anyone understands them. Broad money, M2, increased from Rs8.39 trillion in May 2013 to Rs8.93 trillion in Novem-ber 2013, which establishes that easing is progressing with ease. Most of this money ended up in the form of deposits with banks that at December 2013 have invested or lent Rs4.1 trillion to the government as compared to Rs3.1 trillion to the private sector, although there is an increase in private sector credit since June 2013. How much exposure that banks have in the stock market requires an in depth analysis, which would hardly improve the basic premise, and hence the particular enterprise was not embarked upon. With that out of the way, it is fashionable to be a Keynesian again! Even more curiously nudging investment towards growth sector by governments is not considered a taboo anymore. Will wonders never cease? In conclusion it is imperative that the government utilizes the nation’s savings in projects of national importance, which are necessary for economic growth, creation of employment and export substitution; even, if required, through provision of cheaper credit. Unless the real economy thrives, prosperity within the financial sector will remain at risk and will largely be a mirage.

A healthy banking sector and a healthy industrial sector are both equally important.

Syed Bakhtiyar Kazmi

The writer is a Chartered Accountant based in Islamabad.


Saving mortgage financeHome ownership is often used as a proxy for achieving prosperity like that in the US. While living an American dream might not be a priority for Pakistanis, owning a house is a major component of social infrastructure in the country. The need for a housing policy is quite apparent given its socio-economic benefits and its impact on the real sector and thereby on macro-economic variables. Cognizant of this fact, the State Bank of Pakistan has time and again also emphasized its fiscal benefits for the government. Yet the country continues to face a dearth of housing units especially for low and middle income groups. Today, with a rising population, the country is fraught with limited access to housing and mortgage loans characterised by absent long-term finance and property rights. The underdeveloped house finance market contributes less than one percent to the country’s GDP as per the latest available SBP data, while elsewhere in the world, mortgage loans make up a sizeable chunk of the economic output. Take for instance India,which is way ahead when it comes to financial maturity. Not only is house finance a priority sector in India due to rapid urbanisation and economic growth, mortgages are also the largest components of its banking sector’s retail side.

A major growth driver for house finance in the South Asian goliath is its National Housing Bank; the regulatory body provides institutional framework and long term loans to low and middle income segments. Though, House Building Finance Company is one specialized housing bank in Pakistan with a mandate to provide loans lower-middle and a low-income group, its share in total house finance has reduced in absolute terms over the years. House finance has become expensive in Pakistan and is still restricted to higher-income populations.

Challenges One could easily overestimate the maturity of mortgage lending in the country after going through the strategic goals for house finance by the Infrastructure and Housing Finance Department of SBP. The reality is still far behind from what’s on paper. Of the major challenges that shroud the domestic mortgage based financing, experts speak of the lack of a regulatory framework, absence of secondary mortgage market and long-term fixed interest rates as the prime ones. Also, the reluctance in mortgage lending by the banking sector is due to poor tenancy, possession and foreclosure laws and weak enforcement. This can indeed be seen from the declining trend in real estate exposure by the

banks in the total credit to the non-government sector. The average annual cumulative real estate exposure of the banking sector has toppled from an already miniscule 5.6 percent in CY08 to a dreary 3.9 percent in CY13. Then, of course, the unprecedented rise in property prices, driven primarily by the rising demand, cost of land and construction material, urbanisation and speculative activity in real estate, has continued to impair affordability for those seeking housing. This has adversely impacted the mortgage financing in the country. Experts reckon that when it comes to financing solutions for the middle and low income segments, the awareness and acceptability of the products are marred by mistrust and uncertainty. And let’s not forget, the acceptability of an interest-based financial system has been a restricting factor for the conventional banking industry. Islamic banking industry can take the lead here, especially in the significantly untapped lower-middle class segment, which is in dire need of shelter. Already, Islamic banking has made strides into the mortgage market with around 25 percent share in the country’s house finance. According to the SBP data, the formal financial sector accounts for only one to two percent of total housing transactions in the country, while the informal lending caters to around 10 to 12 percent of the total. Whereas, the rest of the housing finance is arranged through personal resources, showing a tiny share of mortgage-based lending in the country.

What needs to be done?First things first, market oriented housing reforms are the need of the hour. Though, the law for property registration and transfers exists, inefficiencies within the system make the process cumbersome.The key lies in strengthening the institutional framework which includes land administrative procedures, property titling and legal provisions. Improvement in house finance is also contingent upon the introduction and enforcement of foreclosure laws to ensure effective recovery of loans from the defaulters. Also, introducing new housing development and finance-related products is mandatory that caters to the needs of the neglected: the middle and low income segment. While the recent cap on real estate exposure by SBP might be seen as a restrictive attempt

by some, others call it secondary to the main challenges like the lack of foreclosure and tenancy laws. The argument holds weight as it will take some time for the financial sectors’ exposure in mortgage financing to shoot from a dismal three percent to 10 percent. However, reformist attempts are crucial especially after the apex court‘s decision to strike down Section 15 of the Financial Institutions Ordinance 2001, which empow-ered financial institutions to sell mortgaged property without recourse to the court. Though a step in the right direction that gave lenders undue power over the borrowers, experts also fear the decision will not only increase banks’ resistance to extend mortgage loans but also make them hold back lending to private businesses in future. All in all, the work to salvage house finance should pick up immediately by improving the regulatory environment, before the rising interest rate scenario and rising property prices do away with what’s left of mortgage-based lending.

Sidra Farrukh

Source: SBP, House Finance Review 2005-11

80%

86%

India

China

Korea

1%

2%

3%

7%

12%

17%

26%

29%

32%

41%

Mortgage as a percentage of GDP

Pakistan

Indonesia

Bangladesh

Thailand

Malaysia

Singapore

Hong Kong

USA

UK

Declining real estate exposure in total credit to non-govt sector

Total Credit to Non Govt.Sector (LHS) Share of Real estate exposure (RHS)

Source: SBP, Economic Data

1%

2%

3%

4%

5%

6%

7%

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000Rs(bn)

Jun06

Feb07

Oct07

Oct09

Oct11

Oct13

Jun08

Jun09

Jun12

Feb09

Feb11

Feb13


900

2,100

3,300

4,500

5,700

6,900

50%

55%

60%

65%

70%

CY08 CY09 CY10 CY11 CY12 Jun-13

Rs(bn)

Improving CASADeposits (RHS) CASA

20

25

30

35

40

130

150

170

190

210

CY08 CY09 CY10 CY11 CY12 Jun-13

(mn)Rs('000)

Average deposit per bank accountNo. of bank accounts Average deposit size (L.H.S)

30%

41%

1%

27%

0.25%

Current accounts Saving depositsCall deposits Fixed depositsOther deposit accounts

Deposit mix

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000Rs(bn)

Breakup of Industry deposits by account typeCurrent accounts Saving deposits Call depositsFixed deposits Other deposit accounts

CY08

CY10CY11CY12Jun-13

CY09

4,000

5,000

6,000

7,000

8,000

9,000

10,000

20%

30%

40%

50%

60%

70%

80%

CY08 CY09 CY10 CY11 CY12 Sep-13

Rs(bn)

Banking sector assets growing in favour of investmentsTotal assets (R.H.S) IDR ADR

Segment-wise advances & infection ratio (Sep-13)

Sta� loans Corporate sectorConsumer financeAgriculture

SMECommodity finance

0% 15% 30% 45% 60% 75% 90% 105%

Top 5 banks6-10 banks11-20 banks21-28 banksForeign BanksSpecialized Banks

Lending split of di�erent banking tiers (Sep-13)

Top-10 sectors (in terms of lending) & their infection ratio (Sep-13)


Corporate

SME

AgricultureConsumer finanace

Commodity finance Sta� loans0%

10%

20%

30%

40%

50%

0 500 1000 1500 2000 2500 3000Advances Rs(bn)

Infe

ctio

n ra

tio

AgricultureTransportation

Cement

ChemicalsFinancial

Individuals

Energy

Electronic

Sugar

Textile

0%

10%

20%

30%

40%

50%

0 100 200 300 400 500 600 700 800Advances Rs(bn)

Infe

ctio

n ra

tio

400

550

700

850

Breakup of industry deposits by depositor type (June-13)

Foreign constituents

GovernmentNon-financial PSEs

NBFCs

Prviate sector enterprises

Trust funds & non-profit organizations

Personal

Others

3,000

3,200

3,400

3,600

3,800

4,000

9%

11%

13%

15%

17%

19%


Rs(bn)

Industry infection ratioAdvances (R.H.S) Infection ratio

150

250

350

450

550

650


Rs(bn)

NPLs Loan Coverage

NPLs and coverage

05101520253035


%

Category-wise NPLs to total loansPublic sector commercial banksLocal private banks

Foreign banksSpecialized banks

Category-wise coverage ratio

45

55

65

75

85

95

105


%

Public sector commercial banksLocal private banks

Foreign banksSpecialized banks

4%

5%

6%

7%

8%

9%

10%

200

350

500

650

800

950

1100


Rs(bn)

Islamic banking growthIslamic industry assets (L.H.S) Share in banking industry

Financingmix of Islamic banking industry

Musharaka

Mudaraba

Istisna

Ijarah

Salam

Murabaha

DiminishingMusharaka

Others Islamic banking infection ratio

2%

6%

10%

14%

18%

22%


Infection ratio-Islamic bankingInfection ratio-industry

(6)

(3)

0

3

6

9

12

15

18


Category-wise ROEPublic sector commercial banksLocal private banks Foreign banks

Category-wise ROA

(0.5)

0.0

0.5

1.0

1.5

2.0


%

Public sector commercial banks Foreign banksLocal private banksSpecialized banks

1000

1150

CY08 CY09 CY10 CY11 CY12 Sep-13300

400

500

600

700

Rs(mn)

No. of branches (L.H.S)Average deposit per branch

Islamic branch network


143.53 (Rs. mn) 99.97 (Rs. mn) 97.92 (Rs. mn) 83.16 (Rs. mn) 82.13 (Rs. mn)

Top 5 Banks in terms of CEO remuneration (Data based on annual reports -2012)

15%20%25%30%35%40%45%50%

KASB BOP NIB Summit Askari

Banks with the highest infection ratio

2%

5%

8%

11%

BIPL MEBL BAFL ABL BAHL

Banks with the lowest infection ratio

Industry average of listed commercial banks (As of Sep-13)

ADR 52%

IDR 51%

Infection ratio 16%

Coverage ratio 79%

CASA 59%

Spread ratio 38%

Non-funded income to total income 15%

Saving deposit to total deposit ratio 34%

60%

65%

70%

75%

80%

85%

90%

MCB HBL BAFL BAHL AKBL

Top 5 banks in terms of CASA (As of Sep'13)

40%

50%

60%

70%

80%

NIB Silk Bank Faysal Bank Samba NBP

Top 5 banks in terms of ADR (As of Sep'13)

40%

55%

70%

85%

100%

115%

130%

Samba MCB MEBL BAHL JS

Top 5 banks in terms of IDR (As of Sep'13)

35%

40%

45%

50%

55%

60%

65%

SCB MCB UBL

Top 5 banks in terms of spread ratio

HBLMEBL80%

100%

120%

140%

160%

180%

NBP ABL BAHL MEBL SAMBA

Banks with the highest coverage ratio


Meezan Bank CEO anticipates a larger share of pie

Irfan Siddiqui is the founding President & CEO of Meezan Bank Ltd. He initiated the forma-tion of Al-Meezan Investment Bank in 1997, which was converted into a full-fledged sched-uled Islamic commercial bank in May 2002. This was the first ever license to be given for Islamic commercial banking in Pakistan. Meezan Bank is now the largest Islamic commercial bank in Pakistan with 351 branches spread across 103 cities.

Siddiqui is a Chartered Accountant from England & Wales and has extensive financial sector experience with Abu Dhabi Investment Authority, Abu Dhabi Investment Company, Kuwait Investment Authority and Pakistan Kuwait Investment Company.

Irfan SiddiquiFounding President andChief Executive O�icer, Meezan Bank Ltd.

BR Research: Take us through the journey of Meezan Bank so far.

Irfan Siddiqui: Meezan Bank was launched in 1997 as an Islamic investment bank, and the first three years of its life were as an investment bank. We got the opportunity to venture into commercial banking through acquisition of Societe Generale’s operations in Pakistan back in 2002. From that point we have grown from just one small o�ice in 2002 with a sta� of 30, to over 350 branches in more than 100 cities across the country now. The response from the market has been very positive. It is a combination of what we o�er to our customers and their receptive-ness. Ten to fifteen percent of the popula-tion will always be die hard Islamic banking customers and there would be another 10 percent who might not be. This leaves you with the remaining 80 percent. If you provide them the right service, pricing and environment, there is no reason why they should not come. We call them as ‘why-nots’, that if you o�er them a good Islamic package, they will come to Islamic banking. Just labelling your product would not help, as people are well aware in the market. O�ering a truly Shariah-compliant product is a must for the Islamic banking model to be sustainable.

BRR: Did you have to create the demand among the ‘why-nots’?

IS: You must make conscientious e�orts to market your products. The product positioning and availability are critical for achieving success and that is what Meezan Bank has done. An edge that Meezan has in

the market is that we deliver what we promise, not only in terms of product but the overall environment as well. Deep inside their hearts people have to be convinced on what they are working for.

BRR: With a lot of conventional banks growing their share in the Shariah-compliant segment, how does Meezan manage to di�erentiate from the pack?

IS: We have never conscientiously tried to di�erentiate ourselves – our aim and wish is that the market should grow. We have never seen other Islamic banks or windows as direct competition to Meezan Bank. Instead, we work with them and support them; we share good assets with our peer Islamic banks, which is how the market will gain depth and growth. The di�erentiating factor is up to the consumer; we grow as the industry grows. For some it would be pricing, for others it would be accessibility or environment – it all depends on the consumer. We would never advertise saying how we are di�erent from other Islamic banks.

BRR: Does the whole industry have a similar set of principles and guidelines?

IS: We have the same regulator and the SBP Shariah board on the macro level. Within that, every individual bank has its own Shariah board, all pre-approved by the State Bank of Pakistan. There are minor di�erences of interpretation – not a matter of right or wrong - and it does not impact the Shariah compliance of Islamic banks.

BRR: Critics say that a lot more needs to be done to make the system fully Shariah compliant. What’s your view on that?

IS: On the question of Shariah compli-ance, I can safely say that we are 100 percent Shariah-compliant. Whether we can do even better is another thing and yes there are areas in which we can get even better, but that does not take anything away from our compliance.

BRR: Is our model any di�erent from the Malaysian model in terms of compliance strictness?

IS: The Malaysian model has some di�erence, but by and large everybody in the industry is following the compliance guidelines to a good extent. The industry is moving in uniformity; the latest example is

our recent advertising campaign, that was released from one platform which included the State Bank and all Islamic banks and windows. It is in the interest of all the players in a comparatively new industry to go hand in hand as we fully realise that we cannot move on to the next level in isolation. You need to have a critical mass and Meezan Bank provides that to the industry as the industry leader.

BRR: Why is the penetration still quite low in Pakistan despite having such a massive Muslim population?

IS: The industry started very late and the performance has been satisfactory in my view. We are 10 percent of the industry right now, which is commendable, given that this is a new industry in the Pakistani financial sector. And I believe that the next 10 percent growth would be comparatively much quicker. I see the Islamic banking industry growing at double the pace of conventional banking for a good five to seven years.

Interview by Zuhair Abbasi and Sobia Saleem

I see the Islamic banking industry growing at double the pace of conventional banking

for a good five to seven years.


Money that praysBefore joining Burj Bank as its President and CEO, Ahmed Khizer Khan worked as Chief Operating O�icer of ICD (Islamic Corporation for Development of the Private Sector), Jeddah. ICD is one of the two main sponsors of Burj Bank and is a group company of Islamic Development Bank (IDB), Jeddah. Prior to joining ICD, Khizer was the Chief Executive of Barclays Global Retail and Commer-cial Banking, the UAE from 2006 to 2010. He was associated with Citigroup from 1997 to 2006 in various senior level assignments including Country Business Manager, Pakistan and Managing Director Operations and Technology, Central Europe.In this interview Khizer talks about future and potential of Islamic banking and challenges thereof. He also sheds light on how the pegging of minimum deposit rate can trigger private sector credit o�- take.

Ahmed Khizer KhanChief Executive O�icer, Burj Bank

BR Research: Despite being one of the largest Muslim majority countries, the penetration of Islamic banking in Pakistan is still low. Is the environment not condu-cive enough?

Ahmed Khizer Khan: In Pakistan, Islamic banking penetration stands at about 10 percent in terms of overall deposits of the industry. Considering that it has only been 11 years since the re-launch of Islamic banking, this percentage reflects an unparalleled growth trajectory. While the market shares of Islamic banking in other Muslim countries like Kuwait, Malaysia, Saudi Arabia and the UAE are much higher, these markets are much more mature in terms of the tenure of Islamic finance. It would be safe to conclude that the growth of Islamic banking in Pakistan has been exceptional. It is also important to note that the overall penetration of banking is low in our country whereby till date the banking sector has only been able to tap roughly 20 million customers.

BRR: What’s the market potential?

AKK: It is enormous. According to our analysis, an untapped banking market of over 40 million customers still exists within the country. Islamic banks in Pakistan are presently in their evolution phase thus providing enormous potential to grow this market.

BRR: So then what is preventing the industry from realising this potential?

AKK: Currently, the greatest challenge to growth is the awareness gap and the central bank has taken some very significant steps in this regard including a mass media

awareness campaign launched this year. However, Islamic banks must also contribute at their own level towards this awareness drive by conducting micro marketing initiatives, seminars and mass communication campaigns which promote the values and supremacy of the Islamic financial system. The second greatest challenge facing the industry is the human capital gap. The SBP is playing a pivotal role in this regard with NIBAF (National Institute of Banking & Finance) being at the forefront of these initiatives. Given the dynamics and psychographics of our consumers, Islamic banking has the potential to become the system of choice within the country. With the commitment of our regulators, I have no doubt that this will be made possible in times to come.

BRR: Islamic banks face problems in asset creation and liquidity management due to a lack of short-term Islamic instruments o�ered by the government. How is Burj Bank tackling the maturity gap? AKK: Due to lack of Islamic Instruments for liquidity management and an under-developed Islamic finance market, Islamic banks are facing some problems in managing liquidity. An under-developed money market as well as limitations in money market instruments are also major constraints towards the liquidity manage-ment process. Having said that Burj Bank is e�iciently managing liquidity with greater reliance on interbank placements through Mudaraba, Musharakah and Wakalah with Islamic banks and through commodity Murabaha with conventional banks.

BRR: Islamic banking is limited in its ability to o�er personal finance. How are the Islamic banks battling against that?

AKK: Since Shariah is the basis of Islamic banking, therefore, Islamic banks cannot lend money or price money because it is Riba and that is prohibited as per Shariah. Instead of lending money or o�ering working capital financing, Burj Bank finances the need of the customer in the form of commodities, goods or assets. For example, if the customer requires working capital for raw material purchases, Burj Bank o�ers Murabaha financing (cost plus profit sale). Similarly, if the customer is a manufacturer and it requires financing to manufacture goods, Istisna is o�ered to them. Recently Burj Bank has also launched a structured financing product for the service sector, Service Ijarah and a working capital financing product for finished goods called SAHL. BRR: Islamic banks are privileged in terms of not having a floor on saving deposits. Besides, asset-backed financing also curbs NPLs. How are the Islamic banks leveraging these factors to be better than the conventional banks? AKK: It has surely helped Islamic banks in providing actual rate of returns to the customer but at the same time it has created a new challenge of providing competitive rates to saving depositors while managing the liquidity issue. Since Islamic banks finance the need of customers instead of lending money, therefore all the transactions of Islamic banks are backed by assets. This is the primary di�erentiator which makes Islamic Banking superior, balanced and more secure in comparison to conventional banking. The recent global financial crisis has proved this point. An IMF study conducted in the aftermath of the reces-sion compared the performance of Islamic

banks and conventional banks during the financial crisis, and found that Islamic banks, showed stronger resilience during the global financial crisis. According to the report, Islamic banks worldwide performed better than conven-tional ones in terms of profitability, credit and asset growth. The profitability crunch of Islamic banks worldwide was less than 10 percent, whereas the profitability of conventional banks slumped by more than 35 percent.

BRR: Will the pegging of minimum deposit rate with discount rate trigger private sector lending? How will the banks combat spread shrinkage?

AKK: It is most likely to generate private sector lending. To counter the impact on spreads, banks will now move to more lucrative avenues, which include penetra-tion in consumer segments. Besides, product innovation keeping in view the revision of Prudential Regulations by SBP for small and medium enterprises, may also attract program lending to small enterprises, which o�er better returns. Though, there is a possibility that private sector o�-take will improve but corre-sponding increase in economic activity is also pivotal to make the risk taking worthwhile. Banks may continue to shy away from assuming risk until the private sector demand remains depressed and pressing issues like energy crises continue to dent the economic activity.

Interview by Zuhair Abbasi & Sobia Saleem


Schooldays generally start for children by the time they are 4-5 years old. But it seems that Pakistan’s 5-year old branchless banking (BB) sector is itself schooling the developing world on how it’s done. Global financial institutions consider Pakistan as a BB innovation laboratory, while private philanthro-pists are keen on the socioeconomic spillovers. Five years after the State Bank of Pakistan (SBP) issued detailed BB regulations – a first in South Asia – the non-existent market base has now grown to 7 service providers (more pilots are underway) and over 100,000 retail agents. As of September last year, the sector was handling transactions worth nearly $25 million a day or over $700 million a month! All the mobile network operators are now deeply involved, as are some of the leading commercial banks. Those currently not in the mix also seem interested – some are dipping their toes by partnering with existing players, while the rest of the fence-sitters are finding it hard to ignore this sector any longer. This special BB feature – which is an acknowledgment of the promise this sector holds to bridge the gaping financial divide, also an accolade to the SBP’s enabling and proactive role – intends to highlight the sectoral performance with a forward-looking agenda. Readers will find pictorials that describe this growth story over the years. Then there are market insights on key learning and challenges, for which BR Research interviewed three individuals who have led BB deployments in their respective organisa-tions right from the start. Due to space constraints, we could include these insights from the top 3 BB service providers (based on SBP’s market shares as of September, 2013). BR Research appreciates the divergent perspectives (especially the telco-bank divide and the financial inclusion vs. financial access debate) on how best to mainstream the financially excluded population. We are witnessing a growing private sector appetite in this sector, which is a good omen for increasing the coverage and usage of financial services in the country.

Key LearningsEven simple financial services make a huge di�erence in the lives of people. This is evident from the customers we interact with and the stories we get to hear. But people want more than just transactional services. That is why Easypaisa is the first BB service in Pakistan to venture into more than just transactional services with products like Khushaal Beema, Khushaal Munafa and ATM Cards. Another key learning is that apart from convenience and reliability, security is also very impor-tant to the customer. There is still a huge untapped need for more convenient and more accessible financial services, especially at the bottom of the pyramid or those we call ‘un-banked’ or ‘under-banked’. We estimate a total of 60 million users who have a need to use branchless banking services and Easypaisa is only serving 6 million every month.

ChallengesOne of the main challenges we face is that the regulatory requirements for BB accounts are not attractive to move

customers over from over-the-counter (OTC) services. Not all customers carry their Nadra CNICs at all the times. Moreo-ver, verifications from Nadra on important transactions are often expensive. Collect-ing an image of the customer, an image of the CNIC and a physical visit to an agent location are restrictive. SBP can revise the BB regulations to introduce a true ‘entry level’ account for customers who can sign-up easily. Account limits also need to be revised to provide an incentive to customers to migrate to BB accounts. There is a great need to digitise payments, especially the G2P and P2G payments, which are typically held in monopoly between a few banks and force customers to inconvenient, time-consuming options of payments. Anybody would know the di�iculty one faces to pay for a tra�ic challan or a Nadra CNIC card fee at a NBP branch.

Customer preference for OTC transactions…There are literally no barriers to using OTC services. Customers can simply walk up to the agent and carry out a transaction in a

few minutes. There is no sign-up required and the entire transaction is merchant-assisted. Even with low literacy levels, customers don’t have to do anything but go to their nearest agent with their CNICs. There has to be a greater focus on BB accounts by the players. At the moment, with so many new players coming into the market in the last 15 months, most of them are focused on fighting over existing agents and setting up their OTC transac-tions, with some not even promoting their BB accounts. However, BB players currently incur a heavy cost in opening each BB account. There are commissions to pay and Nadra verification charges (amongst other costs), which are almost twice as much is charged to other commercial banks. The revenue from a BB account is so low that it often takes the payback period up to a year on the initial account opening costs. So it’s imperative to reduce these costs. Customers need to be o�ered more than money transfer and bill payment services on their BB accounts. Since these services are available on OTC as well, the BB

accounts must provide more value to customers. Payments, savings, lending and other advanced financial products are much-needed.

Promoting Mobile WalletsAll BB players need to realise that operat-ing behind walled gardens will not work out in the long run. There is a need to integrate and connect with the existing infrastructure. For example, Easypaisa has taken the lead to connect with 1-Link. We now o�er ATM cards to our customers which can be used for cash withdrawal at any ATM machine in Pakistan. There is also a need to provide Retail Payments, for which Easypaisa has already rolled out a service where BB accounthold-ers can purchase items directly from their BB accounts from any Easypaisa agent location. But the current processes are seen as cumbersome and time-consuming, so there is a continuous need to keep attempt-ing better solutions for retail purchase.

On Omni’s four-year journey so far…UBL Omni’s four-year journey is just the beginning of providing a�ordable basic financial services to the masses via BB services, i.e. via retail outlets. There is a huge demand for BB services by consum-ers who need to send money, receive money, pay their bills and keep their savings secure yet readily available for use. A key learning is that the industry needs to continue to increase awareness and promote usage of these services to more fully realise the potential of these services.

Another key learning is that consumers have repeatedly exhibited their willingness to try new products and services. This trend has been observed in both rural and urban markets. UBL Omni’s experience with the G2P payments projects for the poor and underprivileged that reside mainly in remote rural areas, demonstrated that those people were equally keen as their urban counterparts in learning the usage of BB channels. Due to this, the industry has many opportunities to take new products for consumer trial.

A few myths need to be debunked, as well. Unlike general perception, there is no definite urban-sender, rural-receiver pattern out there, for rural areas are also the origins of BB transactions and lots of small cities are also generating good volumes. Another myth is that people are sending money back home for monthly expenses. That is not entirely true. Through this platform, people are sending money to their kids; companies are disbursing salaries to their employees; people on daily wages are being paid, etc. So, there are a

variety of funding needs that are being e�ectively served through this channel.

Challenges for a solo service provider like OmniUBL Omni has a telco-agnostic business model, which means that the Omni users have the freedom and flexibility to choose the mobile service provider that best meets their needs in terms of service, price and location.

BRANCHLESS BANKING SECTION

Omar Moeen Malik,Head of Strategy, Easypaisa

Omar has been part of the core Telenor Easypaisa team since before its launch in 2009. Prior to his 3-year experience in Mobile Financial Services, he gathered over 4 years of GSM experience with Telenor where he headed the Value Added Services department. Omar holds a B.Sc. in Computer Sciences from the University of Texas at Austin and an MBA from LUMS.

Abrar has led the UBL Omni’s retail distribution network development since the start. He has also led the development and ongoing improvements in an in-house technology platform that enabled the multichannel transaction capabilities for Omni customers. Abrar holds a bachelor's degree in Electronics Engineering from UET, Lahore and an MBA from the Illinois Institute of Technology, Chicago.

Abrar A. Mir | Group Head and EVP, Branchless & e-banking, United Bank Limited

The original concerns that many people had were around UBL’s capability and capacity to build a retail agent distribution structure as compared to the perceived advantage of the telco service providers who already had a massive distribution footprint. However, selling financial services is a di�erent line of business and requires a di�erent level of retailer engagement. As a full-services bank, UBL was aware of the level of engagement required to ensure the provision of quality banking services delivery from agent locations, which only comes through retailer training and education. Today, the industry with 6-7 active service providers boasts a sum total agent network of over 100,000 retailers, but a probable estimate of unique outlets is just 30,000 to 35,000. Meanwhile, Omni is available at over 15,000 active locations and continues to grow its market share. The key challenges that we face are

sector-related, which are common to all service providers. They include expanding the agent network, creating customer awareness, and enriching the customer experience. Being part of a large commer-cial bank has provided numerous benefits. We were very particular about our internal controls, risk management, and product definition right from the very beginning. That has enabled us to run the business in a very controlled manner with an emphasis on consumer service quality.

OTC: An unforeseen trap…Currently, the market is dominated by the OTC money transfer business, which does not o�er the same features of BB account services, such as higher transaction limits, instantaneous ATM/Debit card issuance from retail outlets, usage of countrywide ATMs, mobile and SMS transaction functionality and lower charges than OTC. Thus, there is an unrealised opportunity for

consumers to benefit tremendously by using BB accounts. In the last 2 years, UBL Omni has been aggressively promoting account proposition in its advertising, customer communication and investment in account product innovations. Unfortunately, we as an industry have fallen into a short-term revenue generation trap whereby we have made our business models OTC-centric at the expense of accounts’ growth, the cost savings, customer convenience and the long-term benefits to industry. I am sure as the business models mature, as consumers become more demanding, and as new products are rolled out, the market will move away from being predominantly OTC-centric.

The way forward… The future is extremely exciting and o�ers huge opportunities to transform the retail, G2P, B2B and C2B payments in Pakistan.”

We are fortunate to have SBP as our regulator in that they are extremely forward-looking and work very closely with the industry to support the evolution of new business models around this structure. However, one of the most critical enablers for that revolution to happen will be widespread availability of retail agent locations that are providing these services to customers across Pakistan. It is about time that the industry agreed on a code of conduct whereby the service providers refrain from signing the same shared agents. The industry needs to work towards expanding the agent base, maybe with selected geographies and interoper-able networks. Multiple sharing of agents results in liquidity and management challenges at the retail location which ultimately can translate into a poor customer service.

Continued on next page25 / Banking Review 2013

-

10

20

30

40

50

60

-

50

100

150

200

250

1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14

Branchless banking transaction mixValue Rs (bn) Volume (mn)

-20,000 40,000 60,000 80,000 100,000 120,000


Number of agents

1,492,639

1,028,775

26,897

94,630

Level 0

Level 1

Level 2

Level 3

Composition of BB accounts (as of June 30, 2013)

- 0.5 1 1.5 2 2.5 3 3.5

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

Number of accounts (mn)

-500

1,000 1,500 2,000 2,500 3,000


Deposits Rs (mn)

715

3341

3138

2634

Rural Urban

Adults with an account at a formal financial institution (%)Pakistan India South Asia Lower Middle Income (countries’ average)

- 50 100 150 200 250

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

Total Loan repayment, bulk payments and othersBill Payments & Top-ups Deposits & WithdrawalsFunds Transfer

Value of transactions Rs (bn)

17

3

44

26

41

2534

23

Male Female

Adults with an account at a formal financial institution (%) Pakistan India South Asia Lower Middle Income (countries’ average)

- 5 10 15 20 25

1QFY12

2QFY12

3QFY12

4QFY12

1QFY13

2QFY13

3QFY13

4QFY13

1QFY14

Number of transactions (mn)

Bill Payments & Top-ups Deposits & WithdrawalsLoan repayment, bulk payments and others Funds Transfer

OTC volume mix (Jul-Sep 2013)

P2P Fund Transfer

G2P Pensions and salaries

Withdrawal through G2P Cards

Bills payment and Mobile top-ups

Loan repayments and others

M-wallet volume mix (Jul-Sep 2013)

Fund Transfer

G2P Pensions and salaries

Cash Deposit in MW

Cash withdrawal from MW

Bills payment and Mobile top-ups

Sources: SBP quarterly newsletters on Branchless Banking | Global Findex Database


On Omni’s four-year journey so far…UBL Omni’s four-year journey is just the beginning of providing a�ordable basic financial services to the masses via BB services, i.e. via retail outlets. There is a huge demand for BB services by consum-ers who need to send money, receive money, pay their bills and keep their savings secure yet readily available for use. A key learning is that the industry needs to continue to increase awareness and promote usage of these services to more fully realise the potential of these services.

Another key learning is that consumers have repeatedly exhibited their willingness to try new products and services. This trend has been observed in both rural and urban markets. UBL Omni’s experience with the G2P payments projects for the poor and underprivileged that reside mainly in remote rural areas, demonstrated that those people were equally keen as their urban counterparts in learning the usage of BB channels. Due to this, the industry has many opportunities to take new products for consumer trial.

A few myths need to be debunked, as well. Unlike general perception, there is no definite urban-sender, rural-receiver pattern out there, for rural areas are also the origins of BB transactions and lots of small cities are also generating good volumes. Another myth is that people are sending money back home for monthly expenses. That is not entirely true. Through this platform, people are sending money to their kids; companies are disbursing salaries to their employees; people on daily wages are being paid, etc. So, there are a

variety of funding needs that are being e�ectively served through this channel.

Challenges for a solo service provider like OmniUBL Omni has a telco-agnostic business model, which means that the Omni users have the freedom and flexibility to choose the mobile service provider that best meets their needs in terms of service, price and location.

The original concerns that many people had were around UBL’s capability and capacity to build a retail agent distribution structure as compared to the perceived advantage of the telco service providers who already had a massive distribution footprint. However, selling financial services is a di�erent line of business and requires a di�erent level of retailer engagement. As a full-services bank, UBL was aware of the level of engagement required to ensure the provision of quality banking services delivery from agent locations, which only comes through retailer training and education. Today, the industry with 6-7 active service providers boasts a sum total agent network of over 100,000 retailers, but a probable estimate of unique outlets is just 30,000 to 35,000. Meanwhile, Omni is available at over 15,000 active locations and continues to grow its market share. The key challenges that we face are

sector-related, which are common to all service providers. They include expanding the agent network, creating customer awareness, and enriching the customer experience. Being part of a large commer-cial bank has provided numerous benefits. We were very particular about our internal controls, risk management, and product definition right from the very beginning. That has enabled us to run the business in a very controlled manner with an emphasis on consumer service quality.

OTC: An unforeseen trap…Currently, the market is dominated by the OTC money transfer business, which does not o�er the same features of BB account services, such as higher transaction limits, instantaneous ATM/Debit card issuance from retail outlets, usage of countrywide ATMs, mobile and SMS transaction functionality and lower charges than OTC. Thus, there is an unrealised opportunity for

consumers to benefit tremendously by using BB accounts. In the last 2 years, UBL Omni has been aggressively promoting account proposition in its advertising, customer communication and investment in account product innovations. Unfortunately, we as an industry have fallen into a short-term revenue generation trap whereby we have made our business models OTC-centric at the expense of accounts’ growth, the cost savings, customer convenience and the long-term benefits to industry. I am sure as the business models mature, as consumers become more demanding, and as new products are rolled out, the market will move away from being predominantly OTC-centric.

The way forward… The future is extremely exciting and o�ers huge opportunities to transform the retail, G2P, B2B and C2B payments in Pakistan.”

We are fortunate to have SBP as our regulator in that they are extremely forward-looking and work very closely with the industry to support the evolution of new business models around this structure. However, one of the most critical enablers for that revolution to happen will be widespread availability of retail agent locations that are providing these services to customers across Pakistan. It is about time that the industry agreed on a code of conduct whereby the service providers refrain from signing the same shared agents. The industry needs to work towards expanding the agent base, maybe with selected geographies and interoper-able networks. Multiple sharing of agents results in liquidity and management challenges at the retail location which ultimately can translate into a poor customer service.

Waseela’s year-long experiencesA year after operations, our basic assump-tion – that there is a large market of unserved people for sending and receiving money, paying utility bills, etc. – stands validated. Currently, Mobicash is handling 1 million transactions a month (mostly urban-to-rural domestic transfers) worth a total of Rs4 billion in transaction value. The number of BB customers and volumes have been picking up rapidly. We are confident that in the long run, the growth rate will be even faster as we’ll be able to use the synergies with Mobilink and promote the usage of mobile wallets (or m-wallets). Our target market is those 100 million+ individuals who have a cell phone but no bank account. We understand that bringing them on board is the first step, which has to be followed by the broaden-ing of services menu. The channel is new and therefore cannot handle very sophisti-cated financial products at this time. It’s a big market, and more number of players will help the market in expanding its outreach. After mobile operators, commercial banks are also trying their hand in this sector. It will be interesting to see the competition in the sector. We also understand the importance of expanding our microfinance footprint as much as our branchless banking network. We have been able to position ourselves in core micro business of small deposits and

micro loans. The microfinance bank is firmly established, with about 30 fully-functional branches, 5000 individual borrowers and Rs180 million in loan portfolio.

Challenges facing MobicashOne of the main challenges is to manage the large number of agents. Mobicash has about 27,000 retail agents located all over the country, a footprint we are targeting to expand to 40,000 locations by the end of this year. Now these outlets are the simplest possible versions of bank branches, but they are absolutely new to the world of financial business. It’s a challenge for all the market players to adequately train their agents to comply with the BB regulations for functions like money management and KYC, as well as for consumer aspects like speed, quality and delivery of the service. Currently, we are catching up in terms of building capacity and experience relative to our competitors. Ultimately, it’s the people that make the di�erence and drive business. We are trying to keep the best possible people in this venture. In terms of business, in five years’ time, our ambition is to be the market leader, which requires us to find a way to surpass the challenges.

The OTC dilemma is a hard one…Agents are well-educated in the process of registering m-wallets. But the dilemma is

that if an agent puts e�orts into registering m-wallet users (for which he is being incentivised), he starts losing his OTC-related commission and fees as the sending customer is enabled to perform transactions on his own instead of going to the agent. We need to find a way to surpass this challenge. Another issue is that customers are not aware of the benefits of usage of m-wallets. Similarly the fact that the OTC channel is neutral to both users and non-users of a particular service provider is also fueling its usage. In addition, receivers, which are found more on the rural side, have natural preference for OTC. The reality is that OTC is serving well in developing the market; it’s growing agent business; and it’s convenient for low-income end users. The SBP data shows that OTC uptake is increasing every quarter, which means that there is a need for it.

Migration to m-walletsThe m-wallet uptake is increasing, and the number of their subscribers now exceeds 2.8 million. But this number is small compared to the potential size of the market. A lot more consultation has to take place to promote m-wallet usage. The regulator and the industry are trying to encourage m-wallet usage. But there are several impediments, including agent incentivisation and customer awareness. On our part, our ads are particularly

designed to make people aware of the benefits of m-wallets. We are also coming up with an ATM card for our m-wallet users to give them an added incentive like a bank account does.But this is a challenge for the entire industry and the regulator, because there are other issues involved here. There are many retailers who do not want to document their transactions, meaning they cannot partner with the BB service providers for payment settlement. It will take at least 5 years for a major shift towards m-wallet adoption. Market players would need to seriously invest more money in technology and awareness campaigns. Over in Bangladesh, there is a good usage of m-wallet, thanks to the 50 million+ customer base of microfinance banks. Therefore, growth of domestic microfinance sector will also help.

BB services and the Payment Ecosystem It’s a question of connecting small and big retailers to this payment platform. The sooner outlets like small grocery stores and vegetable shops are able to settle their payments through this system; the better it will be for m-wallet usage. It’s also a question of education and time. People will get sensitised over time. We can take the cue from the adoption of debit cards in Pakistan. I foresee a time where any institution which will remain out of this payment platform will lose out.

Continued from previous page

Ghazanfar helped launch Waseela and Mobilink’s joint BB deployment, Mobicash in November 2012. He has previously served as the President and CEO of Kashf Microfinance Bank. He is an MBA from the University of Punjab, Lahore, and has attended executive education and leadership programmes at LUMS, Penn State University, and the Harvard Business School.

Ghazanfar AzzamPresident and CEO, Waseela Microfinance Bank

Interviews by Hammad Haider



Qasif Shahid and Shamsulhaq Niaz

Improving mobile banking growth prospects

Mobile

Bank

Mobile banking takes banking relationship to a whole new level. Customers get the conveni-ence of banking from their homes, while branches enjoy decongestion as they no longer need to process low-value transactions and can focus on better service to high-value customers. As many as eleven commercial banks are currently offering this service in Pakistan. The commercial banks that are not offering mobile phone banking are either in the process of developing the channel or they are public sector banks. Other banks sitting outside the mobile phone banking market are doing so because they are niche market players where the size and nature of the customer base does not justify a decent return on investment or they are simple not profitable enough. Though still in its infancy, mobile phone banking continues to see a healthy quarterly growth. While the number of transactions from 1QFY11 to 1QFY14 has grown at a CAGR of 26 percent, the volume of transactions has grown at a CAGR of 99 percent. Part of this can be explained by inflation (particularly in utility bills), but it is also likely that consumers have gained enough trust in the system to carry out higher value transactions through this channel. According to the central bank’s Payment Systems Review of 1QFY14 transactions under this segment primarily fall into payment of utility bills and account-to- account funds transfer. Aside from these two factors there are three macro trends that are driving mobile banking in Pakistan. First, is the growing use of smartphones and internet in the country. Smartphone penetration is around 10 percent with feature phones comprising 75 percent of all phones in the country. Nowadays virtually every new phone being sold is a smartphone; Chinese smartphones are available in the market offering an impressive array of features for very low prices. Because of smartphones, internet connectivity is also fast becoming a way of life for the ordinary person. Most upscale or medium scale supermarket/restaurant/public area offer Wi-Fi hotspots. Besides, 3G network technology is also expected to be rolled out this year. Soon, even the most out of touch will be brought – voluntarily or otherwise – into the connectivity fold. The second factor is the growing importance of Alternate Distribution Channels (ADCs) for

commercial banks. There is no debate on the value of ADCs in the banking industry. Banks want to stay in touch with their customers as much as possible in a day, which is why over the years we’ve seen branch timings increased to 5pm (end even beyond) from 1pm. Similarly, the ATM network is spread across the country. More so, branded debit cards have now become virtually a mandatory requirement for account holders. The third driver has been the introduction of Mobile Financial Services (branchless banking) by mobile network operators (MNOs). There is already a very high penetration of mobile phones in the population and the MNOs are seeking revenue growth from this ‘Value-Added Service’. They have made phenomenal strides to global acclaim and have blurred industry lines. Now any mobile phone user can easily open a branchless account with his/her service provider without having to fill out lengthy forms and wait a few days. The attention they have received is disquieting banks because they need to offer something above and beyond the branchless banking menu to conventional banking customers.

A payment ecosystemCurrently, mobile banking primarily provides relatively basic transactions and facilities to the customers, such as balance inquiry, online funds transfer, mobile top-ups and bill payments. Bill payments are limited to utilities and cellular post-paid bills, and are pretty much similar for most of the banks. In the near future, the direction we are likely to see is all the players attempting to create payment ecosystems to try and ring-fence their customers by keeping their money within a closed loop. An example could be of: “A bank offers salary accounts to the employees of a corporate client A. These employees receive their salaries and spend them in various ways such as using their debit cards to pay for groceries at a hypermarket which is also a corporate customer. In turn, the hypermarket would pay its supplier online which happens to be corporate client A, thus completing the loop.” To do that, a two-pronged approach will be required. Firstly, alliances and loyalty programs should be offered to the consumer. Secondly, institutional solutions – including salary processing, cash management/collections, etc. – must be provided.

At the moment, the number of online billers is very limited because it is cumbersome for banks to bring each biller on board. Bringing them onboard requires negotiations and drafting legal agreements, which takes time in bureaucratic environments. The way forward is through billing aggregators – third parties which sign up bulk billers and merchants and provide a single interface to the bank while handling the backend processing. This is already happening, which is why we’ll be seeing non-utility billing options on the menu such as train tickets, school fee payment and later on, maybe even government payments such as traffic violation fines, etc.

Digital WalletsWhen MCB launched its mobile banking service in 2009, we were one of the first banks in the industry. Till date, we have had over 10 million transactions worth more than Rs40 billion performed on our mobile banking platform. We have used insights gained from our experiences to develop a digital wallet – the recently launched MCB Lite – in our bid to stay ahead of the competition in the mobile payments space.We believe digital wallets are the next big thing in mobile payments and will drive the payments landscape into a whole new stratum. Traditional mobile banking is encumbered by the underlying core banking systems. A digital wallet, on the other hand, offers endless possibilities for innovation in payments solutions because it leverages mobile technology, social connectivity and the power of cloud computing.

Awareness and financial literacyLack of awareness is really what is keeping customers from using mobile banking despite the fact that a lot of time and money can be saved through mobile banking. With today’s petrol prices, even a small trip to the bank can cost more than a hundred rupees, so anyone with the awareness would do the math and choose to transact online given the opportunity. However, we don’t feel this is going to remain a major issue as people are catching on fast and whichever banks can go out and educate consumers and offer the simplest or most convenient solutions will be well positioned to lead the market. With smartphone usage on the rise, we expect a lot of players developing mobile apps for mobile banking. Such apps may offer improved

interfaces for carrying out transactions and offering various utilities such as GPS-based loyalty programs, complaint logging/tracking, directions to the nearest branch/ATM through GPS, etc.

Technological limitationsPerhaps one of the greatest limitations for lack of innovative products in mobile banking is technological in nature, especially for banks. Their legacy core banking platforms are rickety and do not provide flexibility or scalability. It is very difficult and expensive to upgrade them or to add innovative features to them. There is also considerable cost involved with scaling up in terms of manpower and infrastructure. Banks can learn from the telecom industry in Pakistan which has discovered that it makes more economic sense to share infrastructure with competitors. The policymakers might be able to enable such thinking if they relax frameworks to allow collaboration such as infrastructure sharing. That will relieve the banks of the burden of continuously upgrading and maintaining their infrastructure and they will actually pay more attention to innovation and design. Despite these limitations, mobile banking has outpaced internet banking. Internet banking has been around since 2003, but mobile banking, which was introduced around 2009, already has more registered users (1.4 million vs. 1.3 million). Though internet banking provides a richer experience with more features, the trend is explained by the fact that it requires users to have email addresses while mobile banking users are registered through their phones. In the longer run, however, we feel that if banks can drive uptake of mobile banking successfully, this will create a second wave of internet banking. It is important that banks don’t try to price transactions on both channels, as this will do more harm than good – discouraging large scale uptake and not generating much income.


The writers are members of the Digital Banking team at MCB Bank Ltd.

Mobile phone bank-ing continues to see healthy quarterly growth. While the number of transac-tions from 1QFY11 to 1QFY14 has grown at a CAGR of 26%, the volume of transac-tions has grown at a CAGR of 99%.

Barclays: Strategy by design

Shazad Dada joined Barclays Bank Pakistan as the Chief Executive O�icer in October 2010, with overall responsibility of managing all business operations in the region including corporate and retail banking. He started his banking career in the USA, joining Bankers Trust in 1990, which was acquired in 1999 by Deutsche Bank AG, before becoming Chief Country O�icer and Head of Global Banking Deutsche Bank. Prior to taking up his role with Barclays, Shazad was a Managing Director in the Mergers, Acquisitions and Corporate Advisory Group at Deutsche Bank Securities.

In this interview with BR Research Shazad, who is also the Chairman of Pakistan Banking Association, talks about the bank’s strategy to increase advances, the pegging of deposit rates to discount rate and his views on the draft Corporate Rehabilitation Act.

Shazad DadaChief Executive O�icer, Barclays Bank

BR Research: What has been the overarch-ing theme behind Barclays Pakistan?

Shazad Dada: Our clients and customers are at the center of what we do. Across our business, we are innovating and redesign-ing our services around them, while also reaping the benefits of greater e�iciency and control. While this will be an ongoing process, some of the results are already apparent. If you look at the numbers, we had realignment in 2012, intending to refurbish and reshape our business, which certainly has yielded good dividends. We want to play our local and global strengths and become the ‘Go-To’ bank for multinational and large local corporations, financial institutions, high net-worth individuals and development organizations/foreign missions. The year 2013 was a testament to our value-driven strategy’s popularity where we continued to take market share and with the support of our clients, we have seen both our deposits and assets grow steadily. BRR: We have seen the administrative expenses coming down by Rs750 million; however, the topline seems to be su�ering. Why is that so?

SD: It’s by design. We have leveraged our products, capital, networks and expertise to drive sustainable progress; however, there were some clients who we cannot service e�ectively. We have to pick our ground in which to be competitive. We decided to let go of some clientele because of their domestic focus. Gener-ally, they do not have FX or cash manage-ment needs, so we took a revenue shortfall

with the resulting greater cost reduction. By concentrating on targeted segments we are better able to provide a higher level of service, understand clients’ needs in greater depth and tailor products and solutions accordingly. Working with one large enterprise client on their financing solutions can lead us to provide similar but tailored solutions to other clients in the same sector.

BRR: Do you plan on expanding your branch network?

SD: Currently, we have no plans to expand our branch network. Our existing branches are state of the art in the design and geographically well placed to our targeted client needs with a capacity to scale up if required. Furthermore, making use of the technology we are working towards branchless banking covering geographies, which are required to service our target clients.

BRR: Why have your advances stagnated?

SD: Our overall advances are stagnated, compared to last year. However, if we go into details, the advances to our existing clients have actually increased. As I mentioned earlier, it is by design that we have exited some non-core relationship which caused a decline, but that was o�set by an increase in advances to our target clients.

BRR: Do you see your ADR getting higher than IDR anytime soon?

SD: Mostly likely yes. Our clients are again in an expansionary mode and trade

volumes are likely to be higher. Both of these key indicators suggest that our advances should increase in 2014.

BRR: What are your views on opportunity for Pakistani businesses in Africa?

SD: For many exporters Africa is the final frontier. The vast and diverse nature of the continent and its people makes trading with Africa seem simply too much of a challenge. However, the infrastructure across many of Africa’s largest economies is improving rapidly and I encourage all Pakistani businesses to view Africa as a fast growing new market to be explored. With more than 50,000 employees on the ground in Africa, we know very well the challenges that businesses face, but also the success stories of so many of our clients who have started business relations with African companies. This is the ‘ground floor’ for many African economies, in which Pakistani exporters have the opportunity to build their brand in Africa at a time when a growing middle class is beginning to make long term brand decisions. Pakistan should not be missing out.

BRR: Being the Chairman of PBA, what are your views on the State Bank’s decision to peg deposit rate with discount rate?

SD: By pegging the deposit rate to discount rate, the spreads have been fixed, with the result that banking sector cost of deposit has increased, however, varying between banks. The hardest hit category is basic saving accounts which are generally in Pakistan used as normal transaction accounts with

all the features of checking accounts. Therefore by capping the saving account spreads and considering the cost associ-ated in servicing these accounts the deposits become very expensive. Personally, I believe banks should have the freedom to determine their own rates based on their cost structure and funding requirements. In a free market depositors should be the ultimate winners.

BRR: Has there been any progress with the Corporate Rehabilitation Act after the recent meeting with the SECP?

SD: The banking community is clearly in favour of enhancing the current law or enact a new law that provides interim relief to debtors in case of genuine challenges they may face in meeting their financial commitments. Having said that, we are also concerned if the act is not drafted properly, it will be misused by willful defaulters and cause an increase in NPLs. As for the draft of Corporate Rehabilitation Act, which was initiated in 2008, banks reviewed the draft individually, and through the platform of PBA proposed certain changes in the draft act. These suggestions are yet to be incorporated in the draft, and based on the recent feedback from all the stakeholders, it has been indicated that the SECP is reviewing the draft act afresh.

Interview by Ali Khizar and Zuhair Abbasi


Citibank N.A. cautiously optimistic about Pakistan

Meet Nadeem Lodhi, who rejoined Citibank N.A Pakistan as its Country Manager and Managing Director in 2012. Prior to that, Nadeem was associated with Abraaj Capital where he was heading the business for sub-Saharan Africa. During his earlier tenure at Citi, Nadeem held various roles in Pakistan and Africa including the CEO for Uganda. Below is the edited transcript of a recent sit- down with BR Research.

Nadeem LodhiCountry Manager and Managing Director, Citibank N.A.

Nadeem kicks o� the discussion by explaining the business strategy of the bank. “Globally, Citibank N.A. classifies its banking business into two major domains: consumer banking and institu-tional banking. The institutional business of the bank primarily comprises treasury & trade services, advisory & investment banking and corporate banking, which forms the core essence of Citi’s opera-tions worldwide.” He explains that the bank remains at the forefront of taking clients in Pakistan to international capital markets and introduc-ing new products from other geographies by adapting them to local needs. Recalling Citi’s feats, Nadeem says that “fundamentally, Citi Pakistan is now a wholesale bank serving its corporate and institutional clients – all their other o�erings are designed to facilitate the delivery of services to such clients. Some of our most significant transactions include Government of Pakistan’s first foreign currency Sukuk, first local currency Sukuk, first oil hedge in Pakistan and so on. We have also been involved with the govern-ment as Joint Arranger on three Eurobond issues in 2005, 2006 and 2007 and the OGDCL GDR issue in 2005.” He emphasizes on how Citi’s business model is di�erent from other banks operating in Pakistan and also explains the rationale behind the bank’s limited market presence - having just three corporate branches in the country. “Citi’s primary focus is to serve top tier Pakistani corporates and public sector entities as well as MNC clients present in various locations across the globe with heavy presence in the country. In Pakistan we are uniquely positioned with a well-entrenched franchise and continue to

successfully deliver value-added solutions to this niche client base from areas of structured financing, M&A advisory, electronic payment solutions, export credit agency supported financing, working capital management and risk management. Just to give you an example, we handle over 50 percent of the total MNC trade volume in the country,” he said. Some of the most recent and significant achievements of Citi include, jointly arranging $130 million syndicated foreign currency Islamic facility for Pakistan International Airline (PIA) in October 2013 which was the second biggest transaction in the last 2 years. The bank also arranged $70 million FMO & OPIC supported financing for Pakistan Mobile Communica-tion Limited (Mobilink) in 2012. On the investment banking front, the bank holds a leading position in the market. “We’ve recently advised Unilever on share buy-back of Unilever Pakistan and delisting from the Pakistani exchanges which contributed to be the single largest FDI in the recent history of Pakistan. The bank also advised on AkzoNobel's sale of its controlling stake in ICI Pakistan, and acquisition of 35 percent stake of Pakistan International Container Terminal by ICTSI.” Among all the categories of institutional banking, Lodhi terms trade and cash business to be the anchor of the bank’s business and the single most important area that pours in flow into the bank, while on the treasury front, Citi also provides hedging and derivative to its clients besides FX sales. As part of its commitment to the country, Citibank N.A. has been conduct-ing road shows since last year to show-case the potential of the Pakistani market. In collaboration with the US State Depart-

ment, the bank also hosted an investment conference in Dubai in June last year, providing an opportunity to Pakistani companies to highlight the multiple opportunities available in the country to US investors. The bank is already Basel-III compliant while other banks are likely to achieve the same level in 2018, as per the plan chalked out by the regulator. Further-more, Citi is pioneering e�orts to imple-ment state-of-the-art technological systems in line with a regulatory push to automate banks’ operations. Commenting on the ‘banking float’, which is the duplicate money present in the banking system between the time when a deposit is made and when the funds become available in an account, Nadeem says that the State Bank of Pakistan wants to reduce the banking float, which “could be achieved through a technology engine called Real-Time Gross Settlement (RTGS). Citibank N.A. is expected to be the first bank automated on RTGS with the SBP in the first quarter of CY14.” When asked about the economic backdrop, Lodhi said the bank remains bullish about the Pakistani market in the CY14. “Our niche clientele, mainly MNCs, consider Pakistan to be in their top ten growth markets. If they do well, it reflects positively on our performance,” comments Lodhi. He believes that the energy sector is the key area that will turn around economic growth in the coming years and bring a revival in the fiscal system. “The decision to tackle the three Es [energy, economy and extremism] is the correct formula employed by the government and will bear fruits soon.”

Interview by Zuhair Abbasi & Sobia Saleem

“We’ve recently advised Unilever on share buy-back of Unilever Pakistan and delisting from the Pakistani exchanges which contributed to be the single largest FDI in the recent history of Pakistan.”



Agri lending

There is perhaps no need to argue that agriculture is one of the most important sectors of the economy and, therefore, requires frequent pats on the backs and incentives such as priority on the lending roster. However, like most developing economies, Pakistan's rural credit market has the usual suspects in store: co-existence of formal, semi-formal and informal lenders and a weak regulatory framework that bogs down more than it enables. However from the face of it, things have been rapidly improving. The State Bank of Pakistan had set the agriculture loan disbursement target at Rs360 billion for fiscal year 2014, following which the banks disbursed Rs159.3 billion – or 44 percent of the annual target - in the six months ending December 2013. The outstanding portfolio of agri loans also surged by 17.3 percent to Rs 276.7 billion at end of December 2013. A lot of that can be credited to the inclusion of the private sector into the lending mix. With the induction of 14 domestic private banks into the agricultural credit scheme in 2002 and the removal of mandatory credit targets for big five banks from 2005, the share of commercial banks has shown significant rise in the overall agri credit disbursement. Conversely, the share of specialized banks, namely ZTBL & PPCBL, in agricultural credit has declined from 73 percent in FY01 to 26 percent in FY13. The trend also shows that while commercial banks are continuously surpassing their indicative credit targets, the like of ZTBL, which only managed to extend Rs23.7 billion at the close of the first half against its annual target of Rs70 billion, have started to lag behind conspicuously.

Segmentation and collateral: still some way to go!Money lent for agriculture is still widely being used for purchase of urban properties and expensive cars, a fact alluded to by almost every banker this scribe talked to during initial research on the subject.

Additionally gross irregularities are also visible in other avenues. Recall that the State Bank of Pakistan introduced rules for mandatory insurance of total credit extended to farmers and also promised to reimburse premium pertaining to ‘subsistence level farmers’ visible across the board. However, a majority of the amounts extended remain uninsured and even if the losses are indemnified by insurers, corporations like National Insurance Corporation, consistently fail to make timely payments. Furthermore, an enquiry into a break-down of credit extension to farm household also reveals anomalies. According to calculations computed from the latest Agriculture Census of 2010, households with large operational holding (more than 25 acres), who make less than one percent of the total borrowers, obtained 73 percent of total credit exclusively from formal sources. In contrast, households with operational holdings under 5 acres, which constitute 65 percent of the total farming households in the country, received only 31 percent of loan extended by formal sources. Additionally,

subsistence farmers, comprising 35 percent of borrowing households as per the census, got only 18 percent of their total loans from formal sources during the same time. Of those that relied exclusively on informal sources 31 percent were subsistence farmers and 25 percent were landless households, which means that the highest proportions of those who can be categorized as the poorest households still depend exclusively on informal sources. One of the reasons often cited to explain away this skewed disbursement of credit is the inability of small and tenant farmers to provide acceptable collateral.However, some headway has been recently made to remedy the situation. The assessment of the value of the land for collateral, are now computed on the basis of the 3-year averages of the value of land mutations in the area, according to the government land record. This has helped slightly ease a major impediment to the proper assess-ment of the value of the collateral. Nonetheless, the State Bank still needs to look into this area and rationalise the loan and

collateral ratio so that more financing institu-tions can take up the cause. But to give credit where it is due, the SBP has recently been on a bit of an agri bender, having made amendments to the prudential regula-tions, indicative credit limits and the list of items eligible for agri credit earlier this year. Some of the important revisions to the regulations are highlighted in the enclosed box. However, clearly enough, the increased level of agricultural lending alone cannot raise the farm productivity and contribute to the national economy if bottlenecks like water efficiency, land record management, proper marketing and storage, adoption of modern techniques, mechanization and other agri innovations and efficient use of extension services are not addressed.

Javeria Ansar

Source: Agriculture Census 2010

Agriculutre credit by source and farm size

Supply of agri credit by institution

Z.T.B.P1176911,7694364470362690147332163447340881294520431699

C.B's508851,7826798937379898529819245942413588624

MFI's291572,024705980503709470422609513163449

NGO's157031,0713721318231622142168861886435

Commission agents2305027,8985100751161399363525026972130103896654700

Friends & Relatives49338253,594145900107712698897227327013775362136

Source of credit

1018190775,084237762225783174993164723119656580501953631853154

Total households under agricultural debt

Farm household totalUnder 1 acre1.0 to under 2.52.5 to under 5.05.0 to under 7.57.5 to under 12.512.5 to under 25.025.0 to under 50.050.0 to under 100.0100.0 to under 150.0150.0 and above

Size of farm (Acres)

• State Bank of Pakistan has very recently enhanced per acre limits for major and minor crops, orchards and forestry. According to revised report on Indicative Credit Limits & List of Eligible Items for Agri Financing released in early 2014, financing limits per acre for rice, wheat, cotton and sugarcane have been increased to Rs 34,000, Rs 29,000, Rs 39,000 and Rs 53,000, respectively from existing limits of Rs 19,000, Rs 16,000, Rs 21,000 and Rs 30,000 fixed in 2008.

• The bank has also re-developed working tables for assessment of per acre credit for each crop, which may be used by field officers in case of variation in limits rather than indicative lending limits.

• Per acre use of fertilizers for major crops and orchards has been updated. Size/Classification wise number of farms as percentage of total number of farms in province has also been re-defined.

• List of eligible items for agri. financing has been updated.

• Total cash and credit requirements for seeds, fertilizers, and pesticides for medium and large farms are revised to 80 percent and 60 percent, respectively, compared to 70 and 50 percent in the previous report.

Amendments in indicative credit limit and eligible items for Agri-financing


-20

0

20

40

60

80

100

120

140

160

180

FY08 FY09 FY10 FY11 FY12 FY13

Rs Bn

5 big CBs ZTBL DPBs PPCBL MFBs

Source: SBP

Attock

Bahawalpur

Baha

wal

naga

r

Bhakkar

Chakwal

Chiniot

Dera Ghazi Khan

Faisa

labad

Gujranwala

Gujrat

Hafizabad

Jhang

Jhelum

Kasur

Khanewal

Khushab

Lahore

Layyah

Lodhran

Mandi Bahauddin

Mianwali

MultanMuza�argarh

Narowal

NankanaSahib

Okara

Pakpattan

Rahim Yar Khan

Rajan

pur

Rawalpindi

Sahiwal

Sargodha

Sheikhupura

Sialkot

TobaTek Singh

Vehari

PUNJAB

Abbottabad

Battagram

Buner

Charsadda

Chitral

Hangu

Haripur

Karak

Kohat

Kohistan

LakkiMarwat

Malakand MansehraMardan

NowsheraPeshawar

Shangla

Swabi

SwatUpper

Dir

LowerDir

Bannu

Tank

DeraIsmailKhan

KHYBERPAKHTUNKHWA

Thatta

Karachi

Badin

TandoMuhammadKhan

Mirpurkhas

Tharparkar

Umerkot

Jamshoro

Hyderabad

Tando Allahyar

SangharMatiari

Shaheed

Benazirabad

Khairpur

Sukkur

Ghotki

KashmoreJacobabad

Shikarpur

KambarShahdadkot

NaushahroFiroze

Dadu

Larkana

Awaran

Barkhan

Kachi Chagai Dera Bugti

Gwadar

Jafarabad

Jhal Magsi

Kalat

Kech

Kharan

Kohlu

Khuzdar

Killa Abdullah Killa Saifullah

Lasbela

Loralai

Mastung

Musakhel

Nasirabad

Nushki

Sibi

Panjgur

Pishin

Quetta

Sherani*

Washuk

Zhob

Ziarat

SINDH

BALOCHISTAN

These maps show district wise bank branch density in the country. The density is presented as number of people serviced per branch in each district (See legend). The maps highlight a clear demarcation of districts that remain under-banked relative to others. The disparity is visible both inter-provincially as well as within each province. Although maximum accuracy was sought during this exercise, readers are advised to note the qualifications stated below. In our opinion, however, these qualifications do not distort the overall picture. Di�erence in dates: Data pertaining to the location of bank branches have been

obtained from State Bank of Pakistan’s annual publication called Banking Statistics of Pakistan for the fiscal year ended June, 2012. We thank Free and Fair Elections Network (FAFEN) for providing us the latest district-wise population estimates (as of June 2013), which in turn was obtained from Election Commission of Pakistan. Bank selection: The branches of all scheduled commercial banks with retail operations were included. Accordingly, for the sake of consistency, foreign banks, DFIs and micro-finance banks have been excluded. Unidentified branches: 223 or 2.3 percent (of 9,792) branch locations

remain unidentified in terms of district due to lack of clarity over tehsil/council/ village name. Branch locations for AJK, FATA and Gilgit-Baltistan have been identified, but are excluded from mapping for the sake of consistency in comparison with other provinces. District classification: Boundaries of several districts have been redrawn since the year 2000, with new districts created at di�erent stages. Outside FATA and Gilgit-Baltistan, the total number of districts in the country is 118, including the four provinces and the Islamabad Capital Territory.

Mapping the disparity in bank branch networkacrossPakistan

Islamabad

*No bank branches were identified in SBP statistics for Sherani district, Balochistan.

Latest district wise demarcation has been sought while locating bank branches, but lack of availability of accurate data on newly created districts led to their inclusion within the former boundaries. These exceptions include:Harnai, Balochistan: carved out of Sibi district in August, 2007Torghar, KPK: carved out of Mansehra district in January, 2011Lehri, Balochistan: carved out of Nasirabad district in May, 2013Sohbatpur, Balochistan: carved out of Jafarabad district in May, 2013Sujawal, Sindh: carved out of Thatta district in October, 2013

1 - 9,99910,000 - 19,99920,000 - 29,99930,000 - 30,99940,000 - 49,99950,000 - 4,99975,000 - 9,999100,000 and above

The legend depicts the number of people served per branch where population estimates have been taken as a proxy.

LEGENDThe


Bank of Punjab: eyeing the unbanked

The conversation took o� from the problems inherited by the new manage-ment. From poor asset quality to deposit withdrawal and high cost of funds, the bank had su�ered from a complete range of problems that came in a variety of shapes and sizes. But the bank’s new management has managed to turn the situation around. Khan tells us that non-performing loans has come down to Rs65 billion from Rs80 billion in FY10. He adds that Rs3.6 billion has been recovered from Harris Group, whereas 1,912 recovery suites against defaulters have been filed by the new management. The massive deposit withdrawal of Rs50 billion to due to negative market percep-tion has also reversed to a point that the deposits rose to about Rs295 billion from Rs164 billion in 2008. Even the cost of funds has dropped to 7.15 percent from nearly 11 percent booked earlier. The bank has also improved on its investments side. Khan says that at the close of FY13 the bank’s investments stood at Rs136 billion, up from Rs25.7 billion in 2008 with an improved mix. In 2008, 53 percent of investments were in illiquid mutual funds, now 94 percent of investments are in government securities. As a result of these e�orts, the bank’s bottomline went from pre-tax loss of Rs16.8 billion in 2008 to a modest pre-tax profit of Rs523 million in 2011 and Rs1.54 billion for the six months ending June 2013. Total assets grew from Rs143.5 billion in 2008 to Rs329.4 billion at the end of FY13.

Bad debt managementGoing to back to discussion on bad debts Khan said that “our infection ratio has already gone down; the SBP had given us a target of reducing these by 4-5 percent each

quarter and we are easily exceeding that. Going forward we are planning on increas-ing our lending in a massive way, which will make the mammoth task a little easier.” He added that the bank has “already recovered around Rs35 billion whereas we are also expected to see massive rever-sals.” “Additionally, we have foreclosed assets of around Rs12 billion from default-ers’ properties - landholdings, machinery, and other assets. Every 15 days we have an auction and sell them o�. So we’ve already recovered more than a billion rupees from these auctions in lieu of cash.” Sharing the details of the Haris Steel transaction, Khan said that they are making good progress on that front as well. Aside from the recovery of around Rs3.6 billion, “there is an ongoing litigation in UAE as well and AED52 million is at stake there. In Malaysia we have virtually auctioned o� all of Harris Steel’s assets - all their country homes and cars – and we expect around a billion rupees from that coming in by the end of this year.” While these positive developments, the di�icult cases are still with the banking courts and NAB. “NAB has been extremely ine�ective over the last year but we have higher hopes with the new head. We have filed nearly 2,500 cases in courts and we have not spared anyone - not even the highest and the mightiest. But the ball now is in the judiciary’s court. Depends on how quickly they make decisions,” he said. He stressed that all institutions can turn around in Pakistan if you put in the right people in the right place. “The biggest things keeping us behind are our own laws. And with all due respect, our judiciary needs to improve and the banking courts need to step up their game.” “In another 5 years we aim to resolve 80 percent of our bad debts, but this time would have been cut in half had the courts

been more active. Additionally sometime we also feel handcu�ed by the govern-ment and can’t make some aggressive moves because you’re afraid that it will be perceived as crony-ism or corruption.”

Growth avenuesPointing to the success of bank’s consumer side, Khan highlighted that Bank of Punjab is the biggest lender in Pakistan in car financing. Contrary to popular perception, “we’ve had a very, very successful yellow taxi scheme, with a 98 percent recovery rate. The scheme might have been politically motivated but we fought a lot to make it bankable. They came to us with a wish list but we handed them our own bucket list of requirements right back. We made sure that every car had a tracker, and that is what has helped with the recovery rate. As soon as 180 days pass, we recover the vehicle and auction it o�.” Khan adds that the bank has all major corporate on its lending books, which wasn’t the case before. “We are a growth oriented bank; we want to grow on both the asset and liability side. We want to bring our cost of funds down and are now well in control of the situation. The bank also plans to expand its Islamic footprint as a part of its growth strategy. “We’ve already launched our Islamic banking segment with four branches, and have crossed a billion rupee deposit. We also have Islamic financing proposals for around Rs1.5 billion lying with us, but deposits are low so our commercial banking side will subsidize what the shortfall rest for the time being,” he said. He added that the bank has asked for another 14 branches to be opened next year. “We expect a bright future, especially in great stretches of unbanked

areas in the KPK where there is a lot of demand for deposit and even the smallest of branches o�ering Islamic banking have low cost deposits of Rs2-2.5 billion lying with them.” When asked about any plans to acquire a bank in the medium term to help with expansion, Khan said that he had proposed to the board that Bank of Punjab should buy HSBC. But the government said “no, forget it”. While he says that he would be open to a good proposal, he doesn’t feel that there are enough good buys in the market at the moment. “If we open 40-50 branches per year, we don’t need really any mergers. The one edge that we have is the government of Punjab’s very strong backing, so I think we should be good for the time being.”

Khan says there are still so many unbanked places that we need to tap. “As the Bank of Punjab, we intend to expand aggressively across the smaller market towns and cities across the province - places where all that low cost money is lying around and there are very few banks. Places like Deepaal pur, Ghaziabad, and Siadpur - just to name a few, where potato and fruit and what-not farmers are sitting doing big money transactions with no banks for miles. So that’s where we are going now. We’ll be trying to take up concentration in smaller towns and open smart e�icient branches in extremely targeted locations next year.”

Interview by Ali Khizar & Javeria Ansar

Naeemuddin Khan has been serving the Bank of Punjab as its President & CEO since Sept 2008. He started his banking career in ANZ Grindlays Bank in 1978 and over the last 35 years has amassed a wealth of diversified banking experience. He has also previously served as a member banking on the Corporate & Industrial Restructuring Corporation (CIRC), where he was responsible for the recoveries of the NPLs of over Rs142 Billion.

BR Research recently sat down with the gentleman to talk about BOP’s journey through the troubled waters it had landed in and his vision and firm hand that has guided the bank back onto the right course.

Following is a brief transcript of the conversation that took place during the meeting.

NaeemuddinKhanPresident andChief Executive O�icer, Bank of Punjab


Sindh Bank no longer provincial in character

Bilal Sheikh assumed the charge of President & CEO of Sindh Bank in November 2010. Sheikh is a seasoned banker with over 45 years of diversified experience in banking. His last assignment before joining Sindh Bank Limited was that of President & Chief Executive O�icer, Mybank Limited. Prior to that, he served as President & CEO, PICIC Commercial Bank Ltd, Chairman National Development Finance Corporation (NDFC) and Deputy Managing Director PICIC Limited.

Below are the edited transcripts.

Bilal SheikhPresident and Chief Executive O�icer, Sindh Bank

Sindh Bank has grown fast. Like really fast. Following the permission to commence full-fledged business in April 2011 when it had only one branch, as of December 2013 the bank had expanded its network to 200 branches spread over 104 cities, towns and villages across all the four provinces and Azad Jammu & Kashmir. Commenting on this performance, Sheikh says that this is an all-time record as no other scheduled commercial bank has grown with such a speed. However, he adds, now the bank plans to consolidate and during the current year, only 25 Branches including 5 dedicated Islamic banking branches will be added to the network. But the bank has not grown in terms of branch coverage alone. Sheikh highlights how Sindh Bank has demonstrated amazing results in all key performance areas. By December 2013, its deposits stood at Rs46 billon with Government of Sindh’s deposits of Rs8 billion and the remaining 83 percent of the deposits being placed by corporate sector and general public. “This speaks of volumes of trust and confidence reposed by the general public in Sindh Bank,” he says. Sheikh expresses the hope that in the times to come, the share of government deposits will reduce as branches will be able to generate more deposits locally. “Islamic banking branches would also become functional during second half of the current year and the growth would gain further momentum achieving a deposit base of Rs65 billion by December, 2014,” he says. Commenting on advances, Sheikh says that lessons from the experience of banks and DFIs he had served and the industry at large, Sindh Bank has adopted a cautious approach towards lending. Its board has

taken a policy decision not to extend long-term loans on stand-alone basis. The bank, however, has been participating in syndicated loans according to its size and risk appetite, thus sharing risks and rewards with the syndicate. He adds that working capital financing is being allowed on secured basis, mostly against pledge of commodities with guaranteed annual clean up. “Other than pledge, such working capital loans were secured by mortgage of properties located in up-scale areas of DHA, Clifton, and KDA & CDA with minimum risk of fake titles and price fluctuation,” he said. This policy, according to Sheikh, had proved very successful and during the first three years, there were no bad loans requiring classification or provisioning. Thus Sindh Bank could claim to be the only commercial bank of the country with zero NPLs. By December 2013, Sheikh said the bank’s advances stood at Rs27 billion including Rs5 billion given to the Govern-ment of Sindh for procurement of wheat under commodity operations programme guaranteed by the federal government. Like deposits, the ratio of advances to private-public sector was also calculated as 83:17. Sheikh hopes that the bank’s advances will grow to Rs40 billion by the end of current calendar year. Coming to the bottomline, Sheikh highlight that from the very inception, Sindh Bank has been showing profit and during the first three years of operations ending December 2013, the cumulative profit was over Rs3 billion. This too, claims Sheikh is a record as no other bank, be in public or private sector, has earned this much profit during its infancy. Sheikh is confident to earn much higher profits in days to come as branches opened

during 2013 will be able to generate enough deposits to o�set the expenses incurred on their establishment and also the recurring ones. The economy is also moving in right direction and the private sector’s demand for credit is on the rise. Moreover, the bank is diversifying its credit portfolio by enlisting more remunerative new relationships engaged in power, fuel, construction and beverage businesses. Although increase in the discount rate had o�-set the mandatory higher rate of return on saving deposits, to augment its income stream, the bank is focusing on fee based exchange business, says Sheikh. Sheikh says that being a wholly owned government bank, Sindh Bank is quite zealously allowing agricultural loans in all forms like production loans, tractor loans, growers loans and non-farm loans for dairy, livestock and poultry, etc. Another item in Sindh Bank’s list of firsts is the fact that it is the only bank which had surpassed its annual disbursement target within the first six months of the financial year 2013-14. In addition to its core business, Sindh Bank is also an active participant of Benazir Income Support Program. It is o�ering free of cost services to Hajj pilgrims. Lately, Sindh Government has appointed the bank as the executing agency for granting loans for revival of sick industrial units of rural Sindh. Moreover, prompted by the success story of Sindh Bank, the Government of Sindh decided to launch three more companies in the financial sector, i.e. Sindh Leasing Company Ltd., Sindh Modaraba Management Ltd. and Sindh Insurance Ltd.

Interview by Ali Khizar & Sobia Saleem

“Islamic banking branches would also become functional during second half of the current year and the growth would gain further momentum achieving a deposit base of Rs65 billion by December, 2014”



Impediments to building a stronger bond marketIt is a sad reality that bond market in Pakistan has not been able to evolve as a vibrant, sizeable and liquid market that can serve as an engine of economic growth for the country. The size of Pakistan’s bond market - measured as percent-age of GDP - dwarfs in comparison to its money market. This article surveys a host of reasons behind the inadequacy of bond markets. One of the main impediments to growth and development of bond market is high volatility in inflation and interest rates, which discourages borrowers and lenders from taking a long-term view on the economy and making long-term decisions/commitments. Investors in fixed rate bonds feel betrayed if inflation and interest rates increase signifi-cantly over short periods of time. Even in the case of floating rates on private sector bonds, investors may be seriously discouraged if sharp increases in inflation and interest rates result in defaults by businesses. Memories from the large scale defaults in 2008 and 2009 are still afresh in the mind of investors. Bond investors also typically feel more vulnerable as the collaterals underlying the private sector bonds are usually weak and the number of investors in long-term bonds is usually quite large. In case of default by the issuer, coordination and agreement between the lenders is difficult to achieve. In order to mitigate some of these predica-ments, Pakistan needs to start targeting inflation. Inflation targeting has become a widely accepted policy throughout the world as it provides an anchor to all market participants including savers, intermediaries and spenders and allows them to make long-term saving and investment decisions with greater confidence. On that note, the government should also grant autonomy to the central bank in order for it to stick to the target.

Institutional voidThe second stumbling block in the develop-ment of the bond market is the shortage of institutions that have a genuine need for investment in bonds.Given longer maturity and higher risk of bonds, only investors with long-term horizons and/or higher risk tolerances can potentially invest in bonds. Such investors mainly include DFIs, pension funds, insurance companies and a few categories of mutual funds. The trouble is that due to various reasons, the growth of these institutions and their demand for bonds has remained limited. For instance, DFIs have been unable to raise long-term funds at competitive rates. Similarly, public sector pension funds are unfunded in most cases and therefore, unable to invest in bonds. Those in the private sector have been mostly converted into Defined Contribution Plans which do not use an asset-liability management framework to manage their assets. These plans are being managed on the basis of an asset-only philosophy which, based

on their low risk tolerance, leads to a low allocation to bonds. In this vein, it is pertinent to highlight that the biggest pension liabilities are owed by the government itself but there is no explicit policy to fund the pension plans of federal, provincial and district governments most of which are managed on a pay-go basis i.e. the pension liabilities are paid out of taxes. This has not only resulted in poor financial management but has also deprived the capital markets of precious money that could be invested in long-term bonds. Federal, provincial and district governments must adopt explicit funding targets for their pension plans. Even in case of public or private sector entities with partially or fully funded defined benefit pension plans, professional manage-ment, that can understand and apply the concept of asset-liability management to the investment portfolios, is mostly absent. As a result, their pension plans investment portfolios have much smaller exposures to long-term bonds. A related part of the problem lies in inadequate insurance sector. Pakistan has one of the lowest insurance penetration in the world. Low per capita income and lack of an insurance culture, partly due to strong religious beliefs, have been major impediments to the development of insurance sector. With the advent of Takaful, however, it can be expected that the industry may grow at a higher rate in future. Still, the government needs to adopt explicit policies to promote a culture of insurance in the country. This may include compulsory motor vehicle insurance and life insurance by all individuals earning income above a certain threshold. Income tax rebates recently granted to individuals on payment of life insurance premiums are a welcome development. Tax rebates may also be offered to insurance/Takaful companies for creating awareness regarding the benefits of insurance through print and electronic media.

Mortgage bond market Despite the fact that housing and commercial construction sector has immense potential to jump start Pakistan’s GDP growth at a high rate for a long period of time, a robust financial system to support this sector is missing from action. Such a financial system would consist of banks and housing finance companies on the one hand, which issue mortgage loans and, on the other hand, of mortgage companies which raise money from the market through mortgage bonds and invest the money raised through such bonds in mortgage loans. This will enable the banks and housing finance companies to convert their long-term illiquid assets (mortgage loans) into cash by selling those loans and relend that money for new construction projects. The mortgage companies will buy those mortgage loans with the money borrowed from individuals and corporate

entities. This system will also help to channel the savings of individuals and corporates into housing and construction sector. To achieve this end, there is a need to develop mortgage market. Federal and provincial governments should develop the legal framework to encourage/establish business entities that issue mortgage backed securities and invest the money raised through such securities in mortgage loans. This model has been successfully used by the US for many decades – though of course lessons should be learnt from the 2008 crisis to ensure that we only adopt the good aspects of the model.

Munis, MunisPakistan does not have a market for infrastructure bonds using which federal, provincial or local governments can borrow for specific purpose of investment in infrastructure projects. Such projects are designed in a way that they can earn enough money over their lifetime to earn an attractive return on investment required to establish and run those projects. Federal government should adopt an explicit policy that borrowings through long-term bonds will only be utilised to finance infrastruc-ture projects. This will ensure that the money raised through long-term bonds will not be spent on short-term expenses and will contribute to higher future GDP growth and employment generation. The future of national development depends on higher devolution and enabling city/district governments to raise money from capital markets and invest it in infrastructure projects. This requires making requisite amendments in federal and provincial laws relating to the financial powers of local governments. It may take a few years to build the capacity of local government and to create the institutions for effective oversight of the financial activities of local governments but it will eventually create huge opportunities to mobilize resources through capital market securities (mainly long-term bonds). Bear in mind that federal and provincial governments have already passed laws relating to public private partnership laying the foundations of attracting private capital and management to the infrastructure sector. The next step is to strengthen the provincial planning and development departments so that they can provide the necessary technical and financial support to the government departments/agencies for developing and structuring infrastructure projects that are attractive enough so that private investors can raise part of the finances by issuing capital market securities.

Abdul Rehman Warraich

The writer works as Chief Investment Officer at UBL Fund Manager. His views do not necessarily represent those of his organization.

The future of national development depends on higher devolution and enabling city/district governments to raise money from capital markets and invest it in infrastructure projects.


First Women Bank Ltd. is proud to be the first bank for women in the region. FWBL both a commercial bank and DFI designed, managed and run by women, for women, was set up in 1989 by the Islamic world’s first woman Prime Minister Benazir Bhutto (Shaheed) who envisioned a bank that would meet the special needs of women entrepreneurs. Recently, the Finance Division, Government of Pakistan has given the additional charge of President of the Bank to Ms. Charmaine Hidayatullah, the senior most EVP of the Bank. The FWBL model caters to women at all levels of economic activity – micro, small, medium and corporate. Most importantly, the Bank provides women with the support services required to navigate the obstacles to the development of business. By doing so, FWBL is helping them emerge as key players in the national and global economy.The Bank has always looked at its micro-finance borrowers as potential SME and Corporate clients. The Bank’s unique credit policies promote asset ownership for women, by providing financing to business entities:

• Where women have 50% shareholding• Where a woman is the Managing Director• Where women employees are 50% or more

However, the Bank seeks deposits from and provides services to both genders. In 1992, an ILO Geneva Study recognized First Women Bank Ltd. as a major innovation in Pakistan, along with Edhi Trust and Lahore University of Management Sciences (LUMS). In 1994, Euromoney awarded FWBL the Best Bank in Pakistan for its low administrative cost.FWBL was the first Commercial Bank to launch Micro-Credit in Pakistan. In 2001, Women’s World Banking in its Global Directory profiled FWBL for Banking Innovation in Micro-Finance, and acknowledged that FWBL features among the world’s micro-finance leaders. To combat child labor in the carpet weaving industry, FWBL collaborated with ILO and directly financed women micro-borrowers in rural areas. The Bank disbursed micro-credit to 2921 women living below the poverty line in 162 villages, with 100% recovery rate. Under this project, 5842 children were weaned out from child labor and educated through non-formal educational centers. The Asian Banking Award 2005 awarded First Women Bank Limited, FWBL / ILO – IPEC Micro-Credit Program as Runners-Up in its Micro-Finance Program category. Under this

project, one of the borrowers received the Global Micro-Entrepreneurship Award (Runners-up) organized by the UN Capital Development Fund in collaboration with CITI Group Foundation, Harvard Business School and Pakistan Poverty Alleviation Fund.FWBL initiatives for the empowerment of women were recognized at all levels and the Bank received the “Brands of the Year Award (2010 & 2011) for the second consecutive year. Recently the Bank was conferred with the 8th Consumers Choice Award. This was in acknowl-edgement of FWBL’s contribution towards the promotion of women banking in the country. In Pakistan, when compared with other countries of the world, female entrepreneur-ship is amongst the lowest in the world. With very low female participation in the economy of the country, the percentage of female employers is even less than one percent. FWBL is committed to the goal of realizing the potential of women who require assistance in enhancing their access to entrepreneurial activities and forward employment. Realizing the importance of women’s entrepreneurial activity and its linkage to loan facilities, Women’s Entrepreneurship Development Division has been created with the objective of Capacity Building and Skill Development of existing and potential women entrepreneurs and their facilitation to Business Development and Financial Services provision. Three Business Development & Training Centres are functioning in Karachi, Lahore & Islamabad under this Division. To enhance women’s entrepreneurial capability, FWBL has partnered with SMEDA, Department of Youth Affairs, Government of Sindh, UNIDO, Allama Iqbal Open University Islamabad, Women Chamber of Commerce and Industry and AF USAID. Under the FWBL-Gender Equity Program (GEP), supported by AF USAID, 640 women have successfully participated in the trainings offered at BD & TC Karachi and Lahore Centres. Recently the Government of Pakistan launched a credit scheme for youth aged between 21 to 45 years at a concessionary mark-up of 8%, with 50% special quota for women. Under the scheme all FWBL branches are providing loans to women. The Account facilitates families to do business from a single point. It offers many benefits for free, including a special one where the higher the balance in the account, the higher the number of free transactions.

First Women Bank Limited (FWBL) and State Life Insurance Corporation (SLIC) have entered into a strategic partnership to sell insurance products under Bancassurance. The three product plans Endowment Plan, Three Payment Plan and Sada Bahar Plan are being offered under the partnership. In order to provide multiple benefits to customers, the Bank has collaborated with top brands such as Oxford University Press, Stile, and Singer. Now FWBL ATM card holders can get discounts on their purchases. FWBL was formed with shareholdings from all the large public sector banks. Over time, these banks were privatized; however, their shares in FWBL were not transferred to the public sector. In 2009, the Government of Pakistan decided to keep First Women Bank Ltd. (FWBL) in the public sector by purchasing the shares of private shareholder banks i.e. MCB, HBL, ABL and UBL through State Bank of Pakistan. Now the majority of shares are owned by the Ministry of Finance, Government of Pakistan. The Government of Pakistan vides its letter No. F. 4(1) –DS (BR-II)/ 2000-556 dated November 4, 2011, has exempted FWBL from the application of the Office Memorandum No. F.4. (1)/2000-BR-II, dated 12 November, 2002. Under the said Office Memo, the Government laid down certain requirements to be complied with by public sector enterprises and local/autonomous bodies while depositing their working balances for their operations with any public or private bank. FWBL has always looked out for the best interest of the women of Pakistan. From economic empowerment to financial assistance, FWBL has always put women at the forefront of their efforts. Taking another step towards the wellbeing of the women of Pakistan, FWBL has joined hands with Pink Ribbon Pakistan to promote the noble objective of Pink Ribbon Pakistan in providing cancer awareness among women. The Bank is also live on SWIFT to transfer funds internationally. At present, the Bank has a network of 41 branches in 24 cities of Pakistan. Today, FWBL’s mission for empowering women remains unmatched.

“To transform the status of women from passive beneficiaries of social services to dynamic agents of change.”

First Women Bank Ltd.Giving Women The Power To Succeed

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