boom of banking in pakistan

i

Boom of Banking Industry in Pakistan

Individual Research Paper (IRP)

8th Mid Career Management Course


By

Saeed Ahmed Sheikh (Information Group)

The paper submitted to the Faculty of the National Institute of Management, Karachi, is in partial fulfillment of the requirements of the 8th Mid Career Management Course. The contents of the paper are the end product of my own efforts & research and reflect my own personal view and are not necessarily endorsed by the National Institute of Management.

Signature:

Date:

Paper supervised by:

Ms. Zarrin Qureshi

ii


Lt. Col. ® Ijaz Ahmed

PREFACE

National Institute of Management, Karachi, like its other counterparts, has developed a tradition of

entrusting research assignments to the participants of different courses. The basic purpose of

conducting & supervising these research assignments is, of course, to accustom them of examining

& analyzing different problems and issues at length. Since, as part of the requirement of Mid

Career Management Course (MCMC), I was assigned to write an Individual Research Paper (IRP)

on ‘Boom of Banking Industry in Pakistan’, which initially appeared to me an uphill task. With no

background knowledge of banking and with a pinching sense of paucity of time hovering over my

mind, my position was similar to that of a young bird who had a vast horizon ahead and no

experience to fly.

But first of all I thank Almighty Allah Who gave me the courage, health, energy and will to accept

this challenge & work on it with such a zeal & dedication that Alhamdulillah I have no remorse for

not doing justice with my research assignment. What could be of more satisfaction to me than the

belief that His help stood by me till the last page of this research paper was completed.

Motivation, encouragement, guidance and overall support are the key elements required from the

supervisor (s) to write and complete a research paper of a good standard & quality, within

deadlines. It is a matter of utmost pleasure for me to extend my gratitude to my supervisors Ms.

Zarrin Qureshi and Lt. Col. ® Ijaz Ahmed whose support was with me during this hectic exercise.

Further, I am also in praise for the Director General, Mr. Tauqeer Ahmed, the Chief Instructor Ms.

Nighat Mehroz & rest of the faculty members of NIM Karachi for sparing/allocating research hours

on daily basis during the course-schedule of 8 th MCMC, making it easier for the participants to

carry out their research along with other activities.

I would also like to thank my younger brother Mr. Naveed Ahmed Sheikh whose valuable

comments, suggestions & proof-reading of the original draft of the paper made colossal

contribution in improving my dissertation.

SAEED AHMED SHEIKH

8th MCMCNIM, KarachiE-mail: [email protected]

iii


EXECUTIVE SUMMARY

A growing and dynamic banking sector is essential for the economic growth of any

country. The growth in the banking sector and the real economy mutually reinforce each

other. It is a proven fact that an inefficient banking sector drags the economy. The financial

system of Pakistan is highly bank-centered. This phenomenon in itself further intensifies

the need of a dynamic, profitable, respectable and strong banking system.

The aim of this study was to examine and evaluate the performance of the banking

industry in Pakistan with a view to gauge i) whether boom in baking industry is a reality or

a mere perception; ii) is this boom (if it is a reality) making any contribution towards the

growth of the economy, and iii) does the banking sector embodies in itself a potential to

further boost the economy.

The study, with support of analytical & quantitative research, unfolds the dynamism,

robustness, profitability and strength of Pakistan’s banking industry in its different phases

of history (including the era of liberalization/privatization), proving that boom is a reality;

it is not a mere perception or deception. The boom in Islamic Banking, since its re-launch

in Pakistan in 2002, also finds a special portion in this study. Banks’ contribution towards

the economic development of Pakistan has also been discussed with special reference to

their enhanced lending in Microfinance, SME, Housing and Infrastructure sectors.

The achievements made by the banks in Pakistan are impressive; however, many

challenges (including the need for greater financial access, availability of financial safety

nets, deepened financial intermediation etc.) still lie ahead. While discussing these

challenges in brief, the study also touches upon the need to focus more on Microfinance &

SME sectors. This paper also maps out a strategy for developing an efficient ‘consumer

protection system’ in order to bring transparency in interest rates & other issues of

common-man’s concern.

The gist of the study as to how our banking system can be made more responsive towards

our economic growth reveals itself in the portion of suggestions/recommendations.

iv


GLOSSARY

AB Allied BankADB Asian Development BankBSC Banking Services CorporationCAR Capital Adequacy RatioCBs Commercial banksCFI Commercial financial institutionCLA Corporate Law AuthorityCY Calendar YearDFI Development finance institutionEMO Expanding Microfinance Outreach strategy, State Bank of PakistanESOP Employees Stock Ownership PlanEMG Employees Management Group FMFB First Micro Finance Bank Ltd.FY Financial YearGoP Government of PakistanIB Islamic BankIBIs Islamic Banking InstitutionsIDB Islamic Banking Department, State Bank of PakistanIFI Islamic Finance InstitutionsIMFB Islamic Microfinance BankMCR Minimum Capital RequirementsMCB Muslim Commercial BankMF MicrofinanceMFB Microfinance bankMFI Microfinance institutionMFP Microfinance providerNBP National Bank of PakistanNIBAF National Institute of Banking and FinanceNCBs Nationalized Commercial Banks NPL Nonperforming loanNRSP National Rural Support Programme, PakistanNSC Non-shareholding companiesPBC Pakistan Banking CouncilPBSRPP Pakistan Banking Sector Restructuring and Privatization Project PKR Pakistani rupeePMN Pakistan Microfinance NetworkPPAF Pakistan Poverty Alleviation FundPRSP Punjab Rural Support ProgrammeROA Return on assetsROE Return on equityRSP Rural Support ProgrammeSBP State Bank of PakistanSCBPL Standard Chartered Bank Pakistan LimitedSECP Securities and Exchange Commission of PakistanSME Small and medium enterpriseSMEDA Small and Medium Enterprise Authority, PakistanZTBL Zarai Taraqiati Bank Limited

v


CONTENTS

Preface iiExecutive Summary iiiGlossary iv

CHAPTER 1 (1-3)INTRODUCTION 11.1 Introduction to the study 11.2 Statement of the Problem 11.3 Limitations of the study 21.4 Methodology 21.5 Study Layout 21.6 Review of Literature 3CHAPTER 2 (4-7)BANKING IN PAKISTAN - A BACKGROUND HISTORY 42.1 Formative Phase (1947-1948) 42.2 Phase of Emergence (1949-1958) 42.3 Phase of Growth (1959-1970) 52.4 Phase of Strains (1971) 52.5 Phase of Nationalization (1972-1977) 52.6 Phase of Healing Reforms (1978-1996) 62.7 Phase of Structural Reforms (1997-2002) 7CHAPTER 3 (8-12)BOOM OF BANKING IN RECENT YEARS 83.1 A Real Boom by All Indicators 83.2 Base of Boom 83.3 Analysis of Boom 9

3.3.1 Profitability 93.3.2 Solvency 103.3.3 Balance Sheet Analysis 11

CHAPTER 4 (13-15)ISLAMIC BANKING-A NEW STORY OF SUCCESS 134.1 Introduction 134.2 Brief History of Islamic Banking in Pakistan 134.3 Islamic Banking in Pakistan- A Performance Review 13

4.3.1 Profitability 134.3.2 Solvency 144.3.3 Balance Sheet Analysis 14

vi


CHAPTER 5 (16-21)ROLE OF BANKS IN PAKISTAN’S ECONOMIC GROWTH 165.1 Resume 165.2 Financial Stability 165.3 Domestic Macro-developments 175.4 FDI 185.5 Foreign Exchange Reserves 185.6 Development Finance 19

5.6.1 Microfinance & SME 195.6.2 Trade 205.6.3 Agriculture 205.6.4 Housing Finance 215.6.5 Infrastructure Sector 21

CHAPTER 6 (22-26)RECOMMENDATIONS: HOW BANKS CAN FURTHER HELP OUR ECONOMY TO GROW 226.1 Logic 226.2 Extending the Base of Banking Services 226.3 Microfinance Sector 226.4 SME 236.5 Islamic Banking 236.6 Agriculture Lending 246.7 Housing Sector 246.8 Government-owned Banks 246.9 Interest Rates 256.10 New Banking Act 25CONCLUSION 26BIBLIOGRAPHY (27-28)APPENDICES I Group-wise Composition of Banks 29II Financial Soundness Indicators 30III Financial Soundness Indicators 31IV Composition of Banks’ Total Assets & Deposits 32V Bank-wise Major Statistics 33VI Group-wise Balance Sheet & Income Statement of Banks 34VII Group-wise Balance Sheet & Income Statement of Islamic Banks 35

1


Chapter 01

INTRODUCTION

1.1 INTRODUCTION TO THE STUDY

Banking industry in Pakistan has shown an unprecedented growth in recent years. Judged

by any indicator, the dynamism and robustness of banking sector is impressive and stands

out particularly relative to its state in early 1990s when the financial system was dominated

by public sector dominated banks. The growth in banking system has been driven by rise

in deposits and advances to trillions1. This particular growth has compelled different

industrial economists & analysts to name this growth as ‘boom’. The entry of Islamic

Banks into this arena has further made the case of banking in Pakistan as more grappling as

this particular banking industry is emerging as a strong competitor to decades-old

conventional banking.

Economists, while studying banking as a component of a country’s financial system, take

its growth or otherwise as a matter of deep deliberation. In an economy like that of

Pakistan, where financial system is highly bank-centered, banking system demands special

focus & attention from both the researchers & analysts.

The study of boom in banking industry of Pakistan therefore in fact refers to a healthy

working of financial system. But, as Pareto efficiency may demand, boom in banking

industry should, as a matter of fact, contribute to a boom in overall economy as in general

practice the growth in the banking sector and the real economy mutually reinforce each other.

1.2 STATEMENT OF THE PROBLEM

The aim of present study is to examine & analyze firstly, the nature & genesis of the

present boom in banking and secondly, correlating it with overall economic development

of the country. Pakistan’s economy, after coming out of the aftermaths of global recession,

is again returning towards stability. This particular situation also necessitates a study of

banking system vis-a-vis economic development, focusing upon the point that how a boom

in banking industry can reinforce a boom in overall economic development. The

1 Deposit base of Pakistan’s banking industry rose to Rs 4.48 trillion and gross advances to Rs 3.11 trillion by September 2009. Supported by the growing financial intermediation process, banks’ aggregate profitability rose from Rs 63.3 billion in 2005 to Rs 73.3 billion by 2007 and Rs 71.1 till September 2009. (Source: Quarterly Performance Review, SBP, September 2009)

2


hypothesis for the study is that the recent boom in banking industry of Pakistan has

positively impacted the overall economic growth.

1.3 THE LIMITATION OF THIS STUDY

The study, in its quantitative analysis, is all based on State Bank of Pakistan’s evaluation

of banks’ performance that is made under traditional frame work of financial analysis. It

excludes any analysis of the banking sector under structure, conduct and performance

paradigm of industrial organization2 (especially when like other countries, we also name

our banking system as ‘banking industry’) due to the reason that no such data about

Pakistani banks is available to assess their true potential of growth on the internationally

acceptable standard (which has been referred above).

1.4 METHODOLOGY:

The method adopted in this study will be chronological in Chapter 2, while in rest of the

Chapters it would be both descriptive & analytical. The primary source of data in present

study includes different reports of SBP (Development Finance Quarterly Reviews,

Financial Stability Reviews, Quarterly Performance Reviews of Banking System and

Yearly Financial Reviews) and Economic Survey(s) of Pakistan. While the secondary data

comes largely from different policy documents of State Bank of Pakistan & Ministry of

Finance. The relevant literature including books & journals’ articles also come under

perusal for the purpose.

1.5 STUDY LAYOUT:

The study has been divided into six chapters. Chapter 1 contains an overview of the

purpose, importance, need and benefits of this particular research, followed by brief notes

on methodology, study layout & book review. Chapter 2 of the study presents a brief

historical background of the banking system of Pakistan. Chapter 3 highlights the post-

liberalization/privatization scenario of banking industry vis-à-vis its overall performance.

Chapter 4 delves briefly into the past, present & future outlooks of Islamic banking with a

view to assess its growth. Chapter 5 of the study highlights the role of banks vis-à-vis

economic development. Chapter 6 gives suggestions that how banks can further help our

2 Arby, Muhammad Farooq, in his research work under the title ‘Structure and Performance of Commercial Banks in Pakistan’ (2003) argues that the study of commercial banks in Pakistan under structure, conduct and performance paradigm of industrial organization is not only non-existent but also extremely difficult due to non-availability of information, and second even structure and performance have been so far evaluated on the basis of limited parameters, not acceptable worldwide.

3


economy to grow. The study ends up with a conclusion, followed by bibliography and few

important appendices.

1.6 REVIEW OF LITERATURE

Existing literature on both conventional & Islamic banking industry of Pakistan unleashes various

studies. ‘Performance of Islamic Banking and Conventional Banking in Pakistan: A Comparative

Study’ (2008) by Mr. Shahzad Moin highlights the financial performance of Islamic banking in

Pakistan in comparison with conventional banking. ‘Financial Sectors Reforms & Efficiency of

Banking in Pakistan’ (2007) by Mr. Qayyum Ahmed and ‘Financial Sectors Reforms & Soundness

of Banks Operating in Pakistan’ (2007) by Azam Ali and Ishaque Ahmed Ansari, largely discuss

financial sector reforms with their impact on the soundness of banks. ‘Trade, Financial & Growth

Nexus in Pakistan’ (2006) by Mr. Muhammad Irshad Khan and Mr. Abdul Qayyum empirically

investigates the impact of trade and financial liberalization on economic growth in Pakistan using

annual observations over the period 1961-2005. ‘Financial Liberalization and Macroeconomic

Performance: Empirical Evidence from Pakistan’ (2006) by Dr. Imran Sharif Chaudhry makes an

empirical study of banks’ liberalization vis-à-vis macroeconomic stability. ‘Structure &

Performance of Commercial Banks in Pakistan’ (2003) by M. Farooq Arby, attempts to analyze the

structure and performance of commercial banks in Pakistan under the framework of industrial

organization. ‘The Effect of Privatization and Liberalization on Banking Sector Performance in

Pakistan’ (2006) by Umer Khalid & ‘Post-liberalization Efficiency and Productivity of the Banking

Sector in Pakistan’ by Syed Fawad Ali Rizvi, both discuss the effects of privatization/liberalization

on banks’ performance. There are also some important books related to the topic: ‘Islamic Finance,

Opportunity and Challenges’ (2008) by Dr. Shamshad Akhter and ‘Defining a Prosperous

Financial Future’ (2005) by Dr. Ishrat Hussain, highlight the potential & strength of Pakistan’s

banking system. ‘Money and Banking in Pakistan’ (1977) by S.A. Meenai, discusses money &

banking in Pakistan from 1947-1977. Some reports from international organizations like ‘Pakistan

Economic Update, 2009’ by World Bank and ‘Asian Development Outlook Update: Broadening

Openness for a Resilient Asia’ (2009) by Asian Development Bank and important journals

published by State Bank of Pakistan like ‘Pakistan’s Islamic Banking Sector Review’ (2007) &

‘Strategic Plan for Islamic Banking Industry of Pakistan’ (2008) that highlight different

weaknesses & strengths of Pakistan’s banking system also include the review of literature for this

particular study.

4


Chapter 02

BANKING IN PAKISTAN - A BACKGROUND HISTORY

2.1 FORMATIVE PHASE (1947-1948)

Banking system, that Pakistan inherited, started from a virtual scratch. The announcement

of Partition Plan of 3rd June 1947 brought a hasty closure of Indian banks from the areas

which were to constitute Pakistan and by June 30, 1948 the number of scheduled bank

offices in Pakistan had declined from 487 to 195.3 Pakistan’s banking system by that time

consisted of 19 non-Indian banks (with their small branches) and two of its own banks:

Habib Bank, which had transferred its office from Bombay to Karachi in 1947 & the

Australasia Bank, which had already been functioning in Pakistan’s territories prior to

1947. During the period, a number of subversive activities by the Imperial Bank of India4

forced Pakistan to set up its own Central Bank as early as possible. So under SBP Order of

May 12, 1948, State Bank was declared open on 1st July 1948 by the Father of the Nation. 5

It was also in this period that MCB shifted its head-office in 1948 from Calcutta to Dhaka.

2.2 PHASE OF EMERGANCE (1949-1958)

During 1949-1958 banking system emerged to its best. NBP was set up under an

Ordinance in November 1949 with a view to work an agent of SBP6. Habib Bank also

continued expanding its organization. During the period, where the number of banks rose

from 195 to 307 (by the end of June 1958), the role of banks in mobilizing domestic

savings and meeting credit requirements also grew manifold. “From Rs. 88.05 crores in

July 1948 deposits had risen to Rs. 238.94 crores. Total bank credit rose from Rs. 19.78

crores to Rs. 122.55 crores over the period”.7

3 Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.24 Imperial Bank of India which was working as the agent of Reserve Bank of India, did all to disturb Pakistan’s banking system. a) It closed down most of its offices. b) It declined to purchase token amounts of Government of Pakistan securities on the plea that they were not marketable. c) It refused to assist Government of Pakistan with an advance against ad-hoc securities to enable the State to make its essential disbursements such as salaries, etc. d) Above-all, it withheld Pakistan’s share of Rs. 75 crores in cash balance held by the undivided Indian Government at the time of partition. 5 Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.46 Ibid, p.57 Ibid, p.11

5


2.3 PHASE OF GROWTH (1959-1970)

The period 1959-1970, that also included General Ayub Khan’s ‘Decade of Progress’,

brought a remarkable growth in banking. In 1959, United Bank was established.8 During

1960-65, SBP opened six new offices9. Several new banks were added to the list of

scheduled banks; two principal additions were the Commerce Bank and the Standard Bank.

The total number of scheduled bank offices rose from 430 at the end of June 1960 to 3133

at the close of 1970. During the period banks’ credit rose from Rs. 145.83 crores to Rs.

949.20 crores at the end of June 1970. Banks’ deposits also grew from Rs. 294.31 crores to

Rs.1314.69 crores.10

2.4 PHASE OF STRAINS (1971)

In the wake of political disturbances during 1971-72, Pakistan’s banking system witnessed

serious shocks & strains. There was heavy withdrawal of deposits from banks.

Government started a demonetization operation in June 1971 that also brought certain

stresses for the monetary system of the country.

2.5 PHASE OF NATIONALIZATION (1972-1977)

After the separation of East Pakistan, the new government introduced far-reaching banking

reforms in May 1972 by which SBP was vested with wider powers.11 The banking reforms

of 1972 were still immature that Nationalization of Banks Act, 1974 came into force. The

SBP and all the CBs were brought under the ownership of Government with effect from 1st

January 1974. “The shareholders were compensated in the form of Federal Government

bonds redeemable at par at any time within a period of 15 years”12. After nationalization,

Pakistan’s banking system registered further growth. The number of bank offices rose to

5187 in 1977; the expansion was particularly rapid in rural areas of the country.

Government’s aim to “nationalize banks in 1974 was to make credit availability to highly

8 United Bank started with an initial authorized capital of Rs. 2.0 crores and a paid up capital of Rs. 1.0 crore, as quoted by Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.119 These officers were opened in Chittagong, Peshawar, Quetta, Khulna, Lyallpur and Rawalpindi.10 Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.1211 SBP could “remove directors or managerial personnel, if necessary, and supercede the board of directors of a banking company and appoint administrators during the period of such repression. It was also empowered to nominate directors on the board of every bank”. Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.1812 Meenai, S.A., ‘Money and Banking in Pakistan’, Karachi 1977, p.20

6


priority sectors of the economy”13. This step of nationalization completely wiped out the

private sector from the banking business.

2.6 PHASE OF HEALING REFORMS (1978-1996)

Nationalization affected the performance and efficiency of the banks in the long run.

During 1982-1987 (pre-reform period) ‘the earning assets to total assets ratio declined

from 76.3 % in 1982 to 73.7 % in 1987. Throughout the period, return on assets remained

around 1 %, which reflected the inefficiency of the banking industry. Return on equity

remained below 25 % while earning to assets ratio found below 12 % during the period.” 14

Again the analysis of the period (1988-1990) made Government to revise nationalization

policy. Consequently the Banks (Nationalization) Act, 1974 was amended in 1991. As first

step twenty three banks were allowed to work (10 banks belonged to domestic sector and

rests were international/foreign banks). Please see Table underneath

TABLE: 1 PRIVATE AND FOREIGN SCHEDULED BANKSESTABLISHED IN 1991

1 Metropolitan Bank Limited, 13 Bank AI-Habib Limited2 Faysal Bank Limited 14 Bank of Punjab3 Mehran Bank Limited 15 Union Bank Limited4 Askari Commercial Bank Limited 16 Prime Commercial Bank Limited5 Republic Bank Limited. 17 Capital Bank Limited

6 Schon Bank Limited 18 Habib Credit & Exchange Bank Limited

7 Prudential CommercialBank Limited

19 Platinum Commercial BankLimited

8 Bank of Khyber 20 Trust Bank Limited9 Soneri Bank Limited 21 Bank AI-Falah Limited10 Indus Bank Limited 22 Oman International Bank11 Bolan Bank Limited 23 Gulf Commercial Bank Limited12 Bank of Ceylon 24

Source: FSA 1990-2000

The process of denationalization/privatization of Nationalized Commercial Banks (NCBs)

was also started with the privatization of MCB and ABL15. The SBP in its enhanced role as

13 Chaudhry, Imran Sharif: ‘Financial Liberalization and Macroeconomic Performance: Empirical Evidence from Pakistan’, London (2006).14 Azam Ali & Ansari: ‘Financial Sectors Reforms & Soundness of Banks Operating in Pakistan’, (2007).15 In 1991, 26% shares of MCB and ABL were offered to the private sector, followed by floating of 49% more shares of MCB during 1993. Consequently the management and control of MCB was transferred to the buyer. Under the Employees Stock Ownership Plan (ESOP) 25 % shares of Allied Bank Limited (ABL) were sold to private sector in August 1993. As a result the management and control of the bank was handed over to Employee Management Group (EMG).

7


regulator in 1993, advised banks to set quarterly recovery targets, submit their progress

reports and formulate strategies to improve future recovery.

2.7 PHASE OF STRUCTURAL REFORMS (1997 - 2002)

In 1997, SBP revised disclosure standards and banks were directed to submit their annual

accounts on new formats of CAMELS & CAELS16 as per with international accounting

practices. Government also amended two important banking laws17 & repealed two

others18. Moreover, the Pakistan Banking Council was abolished and the SBP was given

sole responsibility to regulate banking sector. In its help to Government, WB approved a

credit for the Pakistan Banking Sector Restructuring and Privatization Project (PBSRPP)19

that included privatization of NCBs, corporate governance, capital strengthening,

improving asset quality, etc. SBP was also divided into three organizations20 Securities

and Exchange Commission of Pakistan (SECP) was also created in 2001 that replaced

Corporate Law Authority (CLA), creating two regulators of financial sector such as the

SBP and the SECP itself.21

Chapter 0316 CAMELS stands for Capital adequacy, Asset quality, Management quality, Earnings, Liquidity and Sensitivity to market risk systems and controls and CAELS for Capital adequacy, Asset quality, Earnings, Liquidity and Sensitivity.17 i.e., Banking Companies Ordinance (1962) and the State Bank of Pakistan Act (1956)18 The Banking Tribunal Ordinance (1984) and Banking Companies (Recovery of Loans) Ordinance (1997) were repealed through promulgation of Banking Companies (Recovery of Loans and Advances, Credit and Finance) Ordinance (1997).19 “The main focus of PBSRPP was to improve the efficiency of state owned banks by reducing the cost structure, complete privatization of banks, liberalizing bank branching policy, reduction in taxes, integration of national savings scheme to the financial markets, discontinuance of the mandatory placement of foreign currency deposits by the commercial banks, and strengthening the central bank to play effective role as a regulator of banking sector”. (Qayyum, Ahmed, ‘Financial Sectors Reforms & Efficiency of Banking in Pakistan, 2006)20 This division was: 1) the SBP as a Central Bank, 2) SBP-Banking Services Corporation (SBP-BSC), and 3) National Institute of Banking and Finance (NIBAF).21 Qayyum, Ahmed, ‘Financial Sectors Reforms & Efficiency of Banking in Pakistan, (2006)

8


BOOM OF BANKING INDUSTRY IN RECENT YEARS

3.1 A REAL BOOM BY ALL INDICATORS

Judged by any indicator, the growth of Pakistan’s banking sector in recent period is

impressive. With a rise in deposits to Rs. 4.48 trillion, advances to Rs. 3.11 trillion &

accumulated assets over to Rs. 3.11 trillion by the end of September 2009 (please see

Annex-IV) banks are on their route to success. Recapitalization and prudent lending,

supported by strong regulatory and supervisory framework, lowered net Non-Performing

Loans (NPLs)22 to historical lows in CY 2008. In line with international trends, SBP

introduced Basel II23 under which banks have attained higher capital adequacy levels --well

above the minimum level for the sector as a whole. Despite economic shock and stress in

stock market in CY 08, the banking system has been showing an increase in profitability

since FY 09.

3.2 BASE OF BOOM

This boom in banking system is not accidental as it has a strong base. Firstly, it emerges

from well coordinated restructuring process by GoP with recapitalization through (i) equity

injection of Rs. 46 billion in some of the public sector banks and write offs equivalent to

Rs. 51 billion, (ii) lay off of close to 35,000 employees in two phases from public sector

banks and (iii) closing of over 2000 un-banked branches. To reduce the level of NPLs, the

Government and SBP coordinated to establish the Committee for Revival of Sick Industrial

Units (CRSIU) and the Corporate and Industrial Restructuring Corporation (CIRC) which

2222 Non-Performing Loans (NPLs) are loans and advances whose mark-up/interest or principal is overdue by 90 days or more from the due date. Net Non-Performing Loans (NPLs) is the value of non-performing loans minus provision for loan losses. (Source: Glossary, Quarterly Performance Review of Banking System)23 The final version of New Capital Adequacy Framework (Basel II) was released in June 2004 by Basel Committee on banking supervision (BCBS). The Basel II Capital Accord is not a treaty. It is based on consensus building approach to enhance the interaction between supervisors and the end users. It aims to: a) align bank’s capital with their basic risk profiles, and b) to give impetus to development of a sound risk management system and in this way, it leads to more efficient, equitable and prudent allocation of financial resources. The new capital framework under Basel II is built on three naturally reinforcing pillars; the first pillar Regulations – aligns the minimum capital requirements more closely with bank’s actual underlying risk .The second pillar – Supervision – addresses the need of “effective supervisory review” by allowing the supervisors to evaluate a bank’s assessment of its own risk and determine whether that assessment seems reasonable. And the Pillar III – Market Discipline – ensure that effective market discipline provides an extra set of eyes besides the supervisor

23

9


together enabled debt recovery of Rs. 15.1 billion, while settling write offs to acquire the

NPLs of public sector banks. Secondly, post-liberalization period enunciated a healthy

competition that persuaded banks to reduce cost of intermediation, diversify products

through innovation, provide better services to clients, broaden the client-base, retain

clients’ confidence etc. Thirdly, the reduced costs of financial intermediation accompanied

by better customer service & diversified products is helping in mobilizing more saving that

is then being used to finance prudent investments. Fourthly, SBP’s regulatory and

supervisory framework, administered by highly qualified cadre of staff in line with the

international best practices and norms, is also the base of this boom. Fifthly, the prudent

use of IT (starting from ATMs to E-banking) is providing banking system an increased

customer base, cost saving, mass customization, development of non-core business,

offering of services regardless of geographic area and above-all introducing branchless

banks- with no associated cost such as rent & staff.24

3.3 ANALYSIS OF BOOM

There are number of ways to gauge the efficiency & growth of a banking sector. However,

keeping in view the limitation of our study we will use selected few main indicators based

on accounting data.

3.3.1 Profitability

Between CYs 2005 and 2008, when the economy witnessed an average growth of

more than 7.5 per cent, average pre-tax profitability in banking sector stood at Rs.

108.1 billion and at Rs.73.5 billion after paying the taxes. By the 3 rd quarter of

CY09, it stood at Rs. 70.1 billion (pre- tax) and Rs. 42.2 (after-tax). It is likely to

improve further in coming quarters because of improvement in macroeconomic

indicators and increase in credit to private sector that remained negative during

most parts of 2008 and 2009. (Please see Table underneath)

24 N. Muhammad Resheed, ‘Analysis of Internet Banking Issues in Pakistan: (A Case Study Internet Banking Issues in Pakistani Community)’, 2007

10


(Source: Quarterly Performance Review of Banking System CY 05-09, SBP 2009)

3.3.2 Solvency25

The banking system of Pakistan has been posting consistent improvement in risk-

based Capital Adequacy Ratio (CAR26) since the introduction of Basel-II

framework. The global financial crisis was a test for Pakistani banks; however,

banks largely maintained their resilience & registered improvement in key solvency

indicators. No doubt, NPLs have been & still are creating stress but a system whose

asset-base is growing by 6% has the tendency to show resilience against risks.

Accordingly, due to growth in asset base, the capital to total assets ratio of

Pakistani banks has also improved over the period from 2005 to onwards. (Please

see Table underneath).

25 In finance or business, solvency is the ability of an entity or individual to pay debts. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth. The better a company's solvency, the better it is financially. When a company is insolvent, it means that it can no longer operate and is undergoing bankruptcy. Solvency is a different concept from profitability, which refers to the ability to earn a profit. Businesses can be profitable without being solvent (e.g. when they are expanding rapidly). Businesses can be solvent even while losing money (e.g. when they cannibilize future cash flows, like sellingaccounts recievable). A business is bankrupt when it is unprofitable and insolvent. (Source: Wikipedia)

26 Capital adequacy ratio (CAR), also called Capital to Risk (Weighted) Assets Ratio (CRAR), is a ratio of bank’s capitals to its risk. National regulators track a bank's CAR to ensure that it can absorb a reasonable amount of loss and are complying with their statutory Capital requirements.

11


(Source: Quarterly Performance Review of Banking System, SBP 2009)

The concentration analysis for solvency indicators in terms of asset size of the banks also

depicts improvement across all banks, with top five banks significantly contributing to

strong solvency position of the system (see Table underneath)


3.3.3 Balance Sheet Analysis

The asset base of the banking system not only remained stable during CY 05-09 but

also showed a remarkable growth over the years. (Please see Table underneath).

During five years from 2003-07, banks’ deposits grew successively at an average of

18.1 %, though during CY08 they fell to 9.4 % due to economic recession.

Financial experts take a growth in banks’ deposits as detrimental to overall strength

of economy as banks in such a case offer low interest rates on deposits and charge

high interest rates on loans to boost interest incomes. The banks avoid sharing their

earnings with the depositors, to the extent they should, on the pretext that increase

in inflation and administrative & operational expenses have left them with no other

viable option. A win-win situation (for both the banks & general public) has

however been created by SBP as it has instructed the banking sector to pay a

12


minimum of 5% on all categories of savings/PLS deposits from June 2008”.27.

Accordingly, the composition of the asset base has been shifting away from

advances to investments - and internal composition of advances from private sector

to public sector and from SME and Consumer to Corporate segment. (Please also

see Annex III & V for details)


Chapter 04

ISLAMIC BANKING–A NEW STORY OF SUCCESS27 BPRD Circular No. 7 dated May 30, 2008.

13


4.1 INTRODUCTION

Since its emergence in 1970s Islamic finance has grown significantly. There are now more

than 300 IFIs operating in around 75 countries. According to an estimate, total shariah

compliant assets worldwide have grown to about US$ 700 billion – with annual growth

exceeding 10.0 % during the past decade28 and are projected to grow to US$ 1.6 trillion by

2012.29 Islamic banking and Sukuk represent the most well established forms of Islamic

finance, whereas Takaful and shariah-compliant mutual funds are also evolving rapidly. In

terms of contribution to the global shariah-compliant asset base, Islamic commercial banks

take the lead with a 74% of assets30.

4.2 BRIEF HISTORY OF ISLAMIC BANKING IN PAKISTAN

In Pakistan, since its re-launch in 2002, Islamic banking31 has grown progressively

showing 59 % per annum increase in asset base since 2005. As a proportion of the overall

banking industry, the combined share of Islamic banking is 5.3 % in deposits and 5.5 % in

assets. Total assets of Islamic banking industry have grown to Rs. 323 billion while their

deposits have reached to Rs. 245 billion till September 200932. The branch network of six

full-fledged Islamic banks and 13 conventional banks, covering 80 cities33, has increased

up to 560.

4.3 ISLAMIC BANKING– PERFORMANCE REVIEW

4.3.1 Profitability

IBIs are in the process of growing, yet their profitability is remarkable. Since

CY2007, their profit after tax has been crossing Rs. 1 billon. During 2nd quarter of

CY 09, the profitability of IBs has picked up with an increase of more than 150 %.

It would further grow as the economy is showing improvement & also when IBs

penetrate into so far unexplored areas of agricultural & SMEs financing34.

28 Islamic Finance Outlook 2009, Standard & Poor’s, February 2009.29 “The Next Chapter in Islamic Finance - Higher Rewards but Higher Risks”, Oliver Wyman, April 2009.30 Islamic Finance 2009, International Financial Services London (IFSL) Research, February 2009.31 Islamic banking refers to Islamic banks, Islamic branches of conventional banks and Islamic windows.32 SBP’s Governor Syed Salim Raza’s address in Karachi on November 25, 2009 posted at SBP web-site. 33 Ibid34 Till June 2009, the industry had very negligible exposure to agricultural financing and the share of SMEs in overall financing was a mere 8.6 per cent. (Source: Article by Mohiuddin Aazim, posted at http://www.accountancy.com.pk, accessed on February 26, 2010).

http://www.accountancy.com.pk/

14



4.3.2 Solvency

The CAR of the six dedicated Islamic banks as specified in the Basel II framework

clearly shows that with a target of achieving 9.0 percent CAR for CY0835, the

actual CAR achieved by IBs is significantly higher. CARs for the 4 new banks in

the industry indicate that both organic growth and implementation of Minimum

Capital Requirements (MCR) have helped in augmenting their capital base36.

4.3.3 Balance Sheet Analysis

Keeping in view the difficult competitive environment for the banking industry,

IBIs’ performance can be safely called as remarkable. Every newly established bank

takes three to four years to become profitable; with economic slowdown it might take

35 BSD Circular No.30 dated November 25, 2008.36 In terms of compliance with MCR, 4 out of the 6 dedicated Islamic Banks (IBs) have been able to meet the MCR of Rs. 5.0 billion at end CY08. Two IBs were granted extension to meet the CY08 MCR requirements in CY09, and one of them is now in compliance, while the other has planned a rights issue for Q3-CY09. Albaraka Islamic Bank, on the other hand, is allowed to maintain an MCR of Rs. 2.0 billion in its capacity as a branch of a foreign Islamic bank.

15


relatively longer period of time. But Pakistani IBs, though they are in an expansion phase

and resultantly their administrative costs are relatively higher, (please see Table

underneath) are still showing 60.0 % per annum growth in both the assets and

deposit base. The overall deposits of IBIs at the end of CY08 stood at Rs.201.7

billion and reflected a share of 5.9 % in banks deposits as compared to 1.4 % only

in 2003-04. Total assets of Islamic banks reached to Rs.276.3 billions from Rs.

44.1 billion in 2003-04 and contributed 5.8 % in banking assets till the end of

CY08. “Keeping in view the small size of the industry and its evolutionary nature,

the growth achieved so far has been impressive and has persistently outpaced its

conventional counterparts. The highest share in financing products of Islamic banks

is contributed by Murabaha, Ijara and diminishing Musharakah in 2008-09 (Dec).

Murabah is still the mainstay of Islamic banking though its share has reduced

substantially over the years. Ijarah and in particular musharakah now have sizeable

shares. With a share of 29 percent Musharakah is currently the second most

utilized mode of finance.”37


Chapter 05

ROLE OF BANKS IN PAKISTAN’S ECONOMIC DEVELOPMEMT

5.1 RESUME

37 Economic Survey of Pakistan 2008-2009.

16


Banks collect savings from the people and mobilize them for investment (preferably in

new sectors), thus working not only as storehouse of country’s wealth but also as tool for

development. Banks also promote the growth rate through restructuring their loan policies

and facilitating trade activities. The foreign capital also flows through banks to developing

countries for investment in projects. Banks also help a country to achieve balanced

development by transferring surplus from developed regions to less developed or under-

developed regions and also by offering investment in those sectors which are vital for the

growth of a country ( as they may not be as much vital for banks’ own benefits).

5.2 FINANCIAL STABILITY

The stability of the Pakistan’s financial system finds its roots in the predominant position

of the banking sector, as in comparison to other components of the financial system, the

banking sector has grown more in relative terms (Please see Table underneath).

(Source: Asian Development Outlook 2009)

The banking sector in Pakistan fulfills almost all the basic requirements of the function of

financial intermediation. The deposits of Pakistani banks have been growing successively

at an average rate of 18.1 % for the last 5 years.38 Deposit base rose to Rs 4.1 trillion and

gross advances to Rs 3.3 trillion by September 2008. Supported by the growing financial

intermediation process, banks’ aggregate profitability rose from Rs 63.3 billion in 2005 to

Rs 73.3 billion by 2007 and Rs 46.0 billion for half year 2008. The overall assets of the

banking sector have also increased from Rs. 3.6 trillion in December 2005 to Rs. 5.5

38 The growth in deposits did slowdown to 9.4 percent in CY08 due to global economic recession.

17


trillion by June 2008. Recapitalization and prudent lending has lowered banks’ net non-

performing loans (NPLs) to around 2.0 %.

5.3 DOMESTIC MACROECONOMIC DEVELOPMENTS

The economic growth in Pakistan has been largely consumption driven, with a low and

declining level of financial savings. Different domestic pressures (rise in inflation, imports,

fiscal deficit, etc.) & trend in the international commodity prices have been causing an

adverse impact on the country’s growth prospects such that GDP growth ultimately

declined to 2.0 % in FY09. Government’s macroeconomic stabilization program,

implemented39 by SBP with the support of the IMF SBA40, has full backing of banking

system. There is always a possibility that GDP growth is likely to improve in 2010 and

afterwards. (Please see Table underneath)

5.4 FDI

Profitability in Pakistan’s banking sector, emerging out of the growing size of the

economy, has brought a significant FDI in this sector. PICIC was acquired by Tamaesk

Holdings41 for $339 million, Union Bank by Standard Chartered Bank for $ 487 million &

39 It has been implemented from November FY09 onwards.40 SBA stands for Stand-by Arrangement. In an economic crisis, countries often need financing to help them overcome their balance of payments problems. Since its creation in June 1952, the IMF’s Stand-By Arrangement (SBA) has been used time and again by member countries; it is the IMF’s workhorse lending instrument for emerging market countries. Rates are non-concessional, although they are almost always lower than what countries would pay to raise financing from private markets. The SBA was upgraded in 2009 to be more flexible and responsive to member-countries’ needs. Borrowing limits were doubled with more funds available up front, and conditions were streamlined and simplified. The new framework also enables broader high-access borrowing on a precautionary basis. (Source: http://www.imf.org accessed on February 12, 2010)

41 Temasek Holdings is an investment company owned by the government of Singapore. With an international staff of 350 people, it manages a portfolio of about US$127 billion, focused primarily in Asia. It is an active shareholder and investor in such sectors as banking & financial services, real estate, transportation & logistics, infrastructure, etc (Source: Wikipedia).

39 http://www.wikipedia.org.com accessed on February 26, 2010.

http://www.wikipedia.org.com/

http://www.imf.org/

18


Prime Commercial Bank by ABN Amro for $228 million42. The May Bank made the

biggest investment of US$ 907 million in banking sector (as it buys up to 20% of

Pakistan's MCB Bank43). Other countries flocking Pakistan for FDI in banking sector are

Switzerland with an investment of US$ 200 million, United Kingdom US$ 125 and Saudi

Arabia US$ 200 million. On the whole, the sector has induced FDI of US$ 4.2 billion over

the last 7 years.

5.5 FOREIGN EXCHANGE RESERVES

Pakistan's total liquid foreign exchange reserves stood at $14,123.5 million: according to

break-up, forex reserves held by SBP & banks were $10,494.0 million & $3,629.5

million44 respectively. Increased outreach of banks under Pakistan Remittance Initiative45

(PRI), a round-the-clock & securest initiative of sending remittances, has brought an

unprecedented increase in the inflow of remittances. These increased gradually from

almost $1.0 billion to $7.81 billion by the end of last fiscal year. During H1 FY-10 their

amount was $4.531 billion, displaying an increase of $891.07 million or 24.48 % over the

same period of last fiscal year.46

5.6 DEVELOPMENT FINANCE

Banks have been gradually increasing their role in enhancing Development Finance in

different sectors. Supportive regulatory framework of SBP & banks’ developed capacity in

these niche areas to fully tap their potential business opportunities is remarkable after

2002.

4240 The deal, which will be completed by the end of June, is expected to provide an opening for Maybank to expand into Islamic banking, retail services, credit cards & SME.

41 Statement by SBP Governor appearing in daily the News on November 14, 2009.

42 The government of Pakistan conscious of the positive effects of remittances on an economy and poverty alleviation, in the 3rd quarter of CY 09 launched PRI (Pakistan Remittances Initiative) to streamline flow of remittances through commercial banks and official channels, against illegal transactions through hawala system, with a focus on doubling the remittances within five years.

43

44

45

46 Qazi, S.M., ‘Remittance and Economic Development’ posted at http://economyofpakistan.blogspot.com, accessed on February 26, 2010)

http://economyofpakistan.blogspot.com/

19


5.6.1 Micro-finance & SME

The overall outreach by microfinance sector (MFIs + MFBs) has remained positive

in terms of different outreach parameters. The number of borrowers has increased

up to 1.83 million. Similarly, number of depositors and policy holders also showed

a healthy growth with satisfactory increase in value of deposits and sum insured.

The overall MF deposits show positive growth of 20% at the end of June

2009.There has been a remarkable growth of 36.1% during the period June 05 to

June 09 in the SME number of borrowers. At the end of June 2009, SME borrowers

stood at 219,062 constituting about 4.7 % of the total borrowers in the banking

industry47.

5.6.2 Trade

Banks’ role in boosting trade after the introduction of Part I & II of Export Finance

Scheme (EFS48) & also Islamic Export Refinance Scheme (IEFS) in 2004 has been

tremendous. In November 2008 SBP also reverted to 100% refinancing instead of

previous practice of 70%. In short, refinance limits at Rs 221 billion assigned to the

various banks for current FY 2009-10 are 58% higher than limits on June 30, 2008.

47 While a duration wise analysis of the borrowers reveal that the share of borrowers availing long-term loans ( exceeding 3 years) was 42.6, short term loans ( up to 1 year) was 51.6 %and the medium term loans ( 1-3 years) constituted about 5.8% of the total SME borrowers

48 The Export Finance Scheme (EFS) was originally introduced in 1972 by SBP.

20


5.6.3 Agriculture

Agriculture is an important sector of our economy, a dominant driving force for

growth and the main source of livelihood for 66% of the country’s population. Its

share is about 17.9% in the total Development Finance portfolio. Banks disbursed

Rs. 233 billion during FY 008‐09 in agri-credit & the number of agri-loan

borrowers was 1.91 million at end June, 2009.

5.6.4 Housing Finance

The housing and construction sector of Pakistan with its higher multiplier effect of

having linkages with 37 allied industries49 is a key driver of the economy. After the

emergence of CBs in mortgage business, the housing finance portfolio has grown

considerably from Rs. 37 billion in 2004 to Rs 84 billion at the end of 200850.

5.6.5 Infrastructure Sector

49 Dr. Ishrat Hussain’s lecture in National Institute of Management, Karachi on February 24, 2010.50 Governor SBP, Syed Salim Raza’s address to Association of Builders and Developers of Pakistan (ABAD) posted at daily e-newspaper ‘Pakistan Times’ at http:// pakistantimes.net.com accessed on February 27, 2010.

21


The share of the Infrastructure Sector occupies second place after SME Finance

with 30.7% share in total DF portfolio, which on YoY basis, has registered a rise of

25.7%. It was mainly due to a significant rise in financing to power sector from Rs.

52.4 billion in June 2008 to Rs. 115.4 billion at the end of June 2009.

Chapter 06

RECOMMENDATIONS

6.1 HOW BANKS CAN HELP OUR ECONOMY TO GROW MORE?

The study has concluded that Pakistan’s banking industry has enormous potential to grow

as well as to support faster economic growth and development when compared with other

22


emerging market countries51 (EMCs). No doubt, banks are doing ‘good’ still they have a

full potential to do ‘the best’. How? Let us see.

6.2 EXTENDING BASE OF BANKING SERVICES

Pakistan has the highest number of people per bank branch in the region, second only to

Bangladesh. Currently 37 % of adults have bank accounts. Number of borrowers (5.5

million) constitutes only 3.5 % of population. There are only 171 deposit & 30 loan

accounts per 1,000 people. Over half of the population saves, but only 8 % entrust their

money to formal financial institutions. One-third of the population borrows, but only 3 %

use formal financial institutions to do so. Most services are concentrated in Karachi and

other urban centers while 2/3 of the population resides in rural areas. Thus out of total bank

depositors & borrowers 25% & 17% respectively belong to rural areas. Surprisingly, an

average of 42,000 rural-inhabitants has one bank branch.52

With 24 % of the population (nearly 40 million people) living below the poverty line, this

exclusiveness is critical, which banks can mitigate by extending their branches in rural

areas, introducing innovative delivery channels ( such as branchless banking) & enhancing

borrower-ship by crossing illiteracy and cultural and language barriers.

6.3 MICROFINANCE SECTOR

Reach of Microfinance in South Asia tells a different story; in Bangladesh & Sri Lanka it

is high (60% of the total poor), in India & Nepal it is medium (48% & 20% respectively))

and in Pakistan & Afghanistan it is low (5 % & 2% respectively). In spite of SBP

encouragement53, commercial banks have shown little appetite to serve microfinance

clients. The size of Pakistan’s microfinance market is in the range of 10-20 million active

borrowers.54 Women are a poorly explored clientele with tremendous potential. Currently

MFIs are supporting around 2 million active borrowers.

Recognizing microfinance as an important poverty alleviation tool, Pakistan needs a

special country-wide microfinance bank with a concept of ‘banking with the poor’. CBs

51 The term was first used in Basel II. EMCs in Asia include Bangladesh, Sri Lanka, Malaysia, Thailand, Philippines, Indonesia, Vietnam, China, and India.52 Pakistan Microfinance Network (PMN), 2008.53 SBP claims to promote microfinance through different regulations, but surprisingly, at its website, it has posted an argument that “the commercial banks and other traditional financial institutions are neither mandated nor have the capacities to serve the microfinance market. They perceive the poor as high risk, high cost and difficult to serve market and keep themselves away from them”.54 Some estimates also place the number as high as 35 million.

23


should also deliberate that is their banking only for 6 million rich? Why not at least 20

millions be included to reap the benefits of over-all growth?

6.4 SME SECTOR

The SME55 sector is the backbone of Pakistan’s economy. There are approximately 3.2

million business enterprises in Pakistan & those employing up to 99 persons constitute

over 90 % of all and they also employ 78 % of the nonagricultural labor force. There are

around 214,948 SME borrowers (CY 08) as banks provide only 7–8 % of the total funding

requirements of SMEs in the country56.

There is a pool of nearly 3 million potential company customers to be tapped by the

banking sector. Banks can focus on smaller companies, farmers and the household sector.

SME Bank alone cannot perform miracle: however, if all the CBs go after a program-based

SME lending in harmony with human resource capacity helped by IT infrastructure, this

potential market can be fully captured.

6.5 ISLAMIC BANKING

IBs have been showing enormous growth potential since 2005. So far, IBs have no

branches in rural areas, where they clearly have a substantial customer base to explore.

SBP, under its new branch licensing policy, can persuade IBs to increase rural branches @

20% of all new branches opened; this figure can be risen upto 40%.

6.6 AGRICULTURE LENDING

Agriculture is a dominant driving force for growth. For Pakistan, a volume of Rs. 200+

billion agri-loan is not enough; it should be at least triple of that to meet 75-80% of the

agriculture credit requirements within 3 to 5 years. Moreover, there is a demand for

lending to the livestock, fisheries, horticulture & dairy sub-sectors according to the needs

of different areas.

To cope this, banking in rural areas demands new innovative approach of branching.

Existing SBP rules call for banks to establish at least 20% of their new branches in rural

areas, but as a matter a fact the number should be increased to 60%.

6.7 HOUSING SECTOR:

55 No single definition of SMEs at the country level exists in Pakistan. The Government of Pakistan defines SMEs as enterprises that employ up to 250 people, have paid-up capital of up to 25 million Pakistani rupees, and annual sales of up to 250 million Pakistani rupees. The State Bank of Pakistan, the Federal Bureau of Statistics, the SME Bank, the Punjab Small Industries Corporation, and the Small and Medium Enterprise Development Authority all have different definitions of the term.56 IFC’s Report: ‘Pakistan: Microfinance and Financial Sector Diagnostic Study 2008

24


In Pakistan, until recently the state owned HBFC57 was the only player in the mortgage

market. The entry of CBs into housing finance business is a recent phenomenon. Pakistan

has an estimated shortage of about 7 million housing units, of which nearly two-thirds is in

low and middle income segments. The CBs' mortgage loan portfolio is concentrated in the

major 6-8 metropolitan cities of the country and also their average loan size is nearly 1/10 th

of that of HBFC. For CBs, 70-80 % of the housing finance is for sale/purchase as they take

financing for new construction as more risky.

There is a dire need of an efficient Housing Policy in consultation with all the stakeholders

to meet not only the shortage of housing units but also to give a boost to micro-economic

developments.

6.8 GOVERNMENT-OWNED BANKS:

The House Building Finance Corporation Ltd. (HBFCL), Industrial Development Bank of

Pakistan (IDBP) and SME Bank have out-served their purposes58 as they have made only

limited contributions to the economic sub-sectors that they target. The fourth specialized

government-owned bank, Zarai Taraqiati Bank Ltd. (ZTBL), needs financial and

operational restructuring. This bank is highly strategic, as it provides about one third

(31.7%) of all credit to the agriculture sector.

In past different public sector approaches have failed to transform ZTBL due to is its

excessive debt liabilities & shareholding pattern. The Government should pave the way for

its eventual privatization, considered to be critical for augmenting its scale and efficiency.

6.9 INTEREST RATES

A distortion in interest rates deters effective mobilization of funds, and distorts possible

economic developments. A minimum deposit rate of 5 % p.a. for all PLS savings product 59

is not the remedy. The PLS system in its present form is unique to Pakistan and

57 House Building Finance Corporation58 According to SBP’s ‘Pakistan 10 Years Strategy Paper for Banking Sector Reforms’ the weak financial performances of these banks have forced them to borrow from the SBP. Thus the SME Bank is being privatized, the HBFC restructured prior to privatization and the IDBP is being incorporated as a public company and will be available for sale.59 BSD Circular No.30 dated November 25, 2008.59 Although PLS deposits originally were supposed to conform to Sharia principles, they were ruled non-compliant by the Supreme Court in 1999. Since then, new conforming Islamic instruments have been offered by IBIs. Given that the present PLS system awkwardly falls in between the two systems, there is a need of streamlining the process so that depositors should know that they are offered conventional interest-based deposits or conforming Islamic profit sharing deposits.

25


excessively beneficial to the banks60. Moreover, the interest-rates’ problem in case of CBs

lies with their loans; pleading them @ 14% & charging @ 30-40%.

The role of SBP and Banking Mohtasib, in such cases, needs a thorough revamping.

World-wide there are efficient mechanisms for consumer-protection while in Pakistan it is

weaker, not the weakest. A financial literacy program to cover both rural and urban areas

can be started, but more focus should be on the institutional remedy of this problem.

6.10 NEW BANKING ACT

There is a growing need of new SBP Act, that can establish the SBP as the primary

regulator and supervisor of all banks that can make, inter alia, perform its responsibility

for financial stability. New Act should clarify the SBP’s role as lender of last resort and

establish the conditions under which it may provide unsecured loans to institutions of

uncertain viability in situations when systemic stability is at stake. Infact SBP needs

unambiguous powers to intervene in unviable banks & non-professional banking by

reiterating its role as lead supervisor of financial groups, conglomerates and holding

companies.

CONCLUSION

The findings of the study reveal that banking system of Pakistan, since its different phases

of history, has not only been improving itself but has also shown a strong tendency to

compete with the forthcoming challenges. This base, as time has shown, proved enough in

60

26


giving the sector a boom that was impending in sector’s liberalization/privatization. After

its successful transformation into a liberalized as well as competitive sector, banking in

Pakistan is on the path of robust progress. To much of the good-fortune of banking

industry, Pakistan’s macroeconomic indicators are also showing robustness & strength.

With fiscal and external imbalances narrowing, the exchange rate stabilizing, foreign

reserves rising and headline inflation dropping sharply in country’s economy, the banking

system is converging with a conducive environment to play its maximum role in the

further improvement of this economy. Maximum in the sense that banking system can still

do a lot to help different sectors (like microfinance, SME, housing, etc) grow & stand on

their own feet which ultimately, in turn, would stabilize the general economy. Banking

sector has a full potential to do so. This particular study, with the help of different

quantitative & empirical analyses, has attempted to highlight certain areas which both the

banks & GoP can prioritize for further economic growth of the country. Overall, the

findings of this study also pinpoint the areas (i.e., case of banking sector’s outreach, role of

ZTBL vis-à-vis growth in agriculture through loans, case of CBs’ interest rates, plight of

microfinance & SME sectors, etc.) which need further elaborative studies in future. It has

always been desirable that the study of symptoms should conclude into the complete

treatment of the disease.

SELECTED BIBLIOGRAPHY

BOOKS & RESEARCH PAPERS:

Arby, Muhammad Farooq, (2003) ‘Structure and Performance of Commercial Banks in Pakistan’, State Bank of Pakistan, Karachi.

27


Chaudhry, Imran Sharif, (2006) ‘Financial Liberalization and Macroeconomic Performance: Empirical Evidence from Pakistan’, London School of Economics & political Science, London, UK.

Moin, Shahzad, (2008) ‘Performance of Islamic Banking and Conventional Banking in Pakistan: A Comparative Study’ University of Skovde, Sweden.

Azam Ali & Ansari, (2007) ‘Financial Sectors Reforms & Soundness of Banks Operating in Pakistan’, State Bank of Pakistan, Karachi.

Seema Siddiqua Hai, Safia Qamar Minhaj, and Roohi Ahmed, (2006) ‘Implementation of Basel II: Issues, Challenges and Implications for Developing Countries’, University of Karachi, Karachi.

M. Sharif, (2010) ‘The Financial Sector in the Midst of An Economic Slowdown’, Business & Finance Review, January 11, 2010 issue, Karachi.

Meenai, S.A., (1977) ‘Money and Banking in Pakistan’, Royal Book Company, Karachi.

Abid A. Burki & Shabbir Ahmad, (2008) ‘Corporate Governance Changes in Pakistan’s Banking Sector: Is There a Performance Effect?’ University of Management Sciences, Lahore.

Montiel, P. J. (2003) ‘Macroeconomics in Emerging Markets’, Cambridge University Press, London UK.

Levine, R. (1997) ‘Financial Development and Economic Growth: Views and Agenda’. Journal of Economic Literature, St. Martin Press, New York, USA.

Oliver Wyman, (2009) ‘The Next Chapter in Islamic Finance - Higher Rewards but Higher Risks’, Oliver Wyman Group, USA.

Qayyum, Ahmed, (2006) ‘Financial Sectors Reforms & Efficiency of Banking in Pakistan’, Pakistan Institute of Development Economics (PIDE), Islamabad.

Rizvi, Zaigham Mahmood, (2008) ‘Housing and Housing Finance: A Social Challenge and Economic Opportunity’, Housing Finance International, San Francisco, USA.

Adnan, Q. (2005) ‘A Study of Informal Finance Markets in Pakistan’, Microfinance Network, Mexico.

Badun, Marijana, (2008) ‘Financial Intermediation by Banks & Economic Growth: A review of Empirical Evidence’, Institute of Public Finance, Zagreb.

Rizvi, Syed Fawad Ali, (2001) ‘Post-liberalization Efficiency & Productivity of the Banking Sector in Pakistan’, Pakistan Development Review 40: 4 Part II (Winter 2001).

Harun, Sudin, (2004) ‘Determinants of Islamic Banks’ Profitability’, Global Journal of Finance and Economics, USA, Vol. 1 No.1 (March 2004)

Shahnaz A. Rauf & Tahir Mehmood, (2009) ‘Growth & Performance of Microfinance in Pakistan’, Pakistan Economic and Social review, Volume 47, No.1 (Summer 2009)

Hassn-Bano Burki & Shama Mohammed, (2008) ‘Mobilizing Saving from the Urban Poor in Pakistan’, Shore Bank International Ltd. Karachi.

Khalid, Umer, (2006) ‘The Effect of Privatization and Liberalization on Banking Sector Performance in Pakistan’, State Bank of Pakistan, Karachi.

28


REPORTS: ‘Towards Achieving Social and Financial Sustainability, SBP (2008). Financial Stability Review 2008-2009, SBP (2009). Monetary Policy Statement 2010, SBP (2010). ‘The State of Pakistan’s Competitiveness Report 2009, CSF (2009) ‘Islamic Finance 2009, IFSL, (2009). Pakistan Microfinance Network (PMN), 2008. ‘Pakistan: Microfinance and Financial Sector Diagnostic Study 2008, IFC (2008) ‘Microfinance in South Asia: Towards Financial Inclusion for the Poor’, WB

(2009). ‘Pakistan Economic Update 2009’, WB (2009). Islamic Finance Outlook 2009, Standard & Poor’s, (2009). ‘Asian Development Outlook Update: Broadening Openness for a Resilient Asia’,

Asian Development Bank (2009).

WEBSITES:

http://www.sbp.org.pk http://www.finance.gov.pk http;//www.mixmarket.org.com http://www.wikipedia.org.com http://www.imf.org http://www.accountancy.com.pk http:// pakistantimes.net.com

Annex-I

Group-wise Composition of Banks.

http://www.accountancy.com.pk/

http://www.imf.org/

http://www.wikipedia.org.com/

http://www.finance.gov.pk/

http://www.sbp.org.pk/

29


30


31


32


Annex-III

Compositions of Banks’ Total Assets & Deposits

33


34


Annex-V

35


boom of banking in pakistan

Documents

islamic banking

dynamic banking sector

inefficient banking

strong banking system

individual research

financial system of

efforts research

baking industry