Lecture # 17Role of Commercial Banks

Public Perceptions of Banks

• In United States history, the National Bank was a major political issue during the presidency of Andrew Jackson. Jackson fought against the bank as a symbol of greed and profit-mongering, antithetical to the democratic ideals of the United States.

• Currently, many people consider that various banking policies take advantage of customers. In Canada, for example, the New Democratic Party has called for the abolition of user fees for automated teller transactions.

• Other specific concerns are policies that permit banks to hold deposited funds for several days, to apply withdrawals before deposits or from greatest to least, which is most likely to cause the greatest overdraft,

• Some have expressed concern about a systemic lack of bank accountability to the public in Canada.

• In response to the perceived greed and socially-irresponsible all-for-the-profit attitude of banks, in the last few decades a new type of bank called ethical banks have emerged,

• which only make socially-responsible investments (for instance, no investment in the arms industry) and are transparent in all its operations.

• In the US, credit unions have also gained popularity as an alternative financial resource for many consumers. Also, in various European countries, cooperative banks are regularly gaining market share in retail banking.

Bank Profitability

• Large banks in the United States are some of the most profitable corporations, especially relative to the small market shares they have. This amount is even higher if one counts the credit divisions of companies like Ford, which are responsible for a large proportion of those companies' profits.

• In the past 10 years in the United States, banks have taken many measures to ensure that they remain profitable while responding to ever-changing market conditions.

• The banking industry's main obstacles to increasing profits are existing regulatory burdens, new government regulation, and increasing competition from non-traditional financial institutions.

Society for Worldwide

Interbank Financial Transactions

• ("SWIFT") operates a worldwide financial messaging network. Messages are securely and reliably exchanged between banks and other financial institutions. SWIFT also markets software and services to financial institutions, much of it for use on the SWIFT Network, and ISO 9362 bank identifier codes are popularly known as "SWIFT codes".

• The majority of international interbank messages use the SWIFT network. As of April 2006 SWIFT linked almost 8,000 financial institutions in 205 countries. SWIFT does not facilitate funds transfer. Financial institutions would need a corresponding banking relationship for financial transactions.

• SWIFT is a cooperative society under Belgian law and it is owned by its member financial institutions. SWIFT has offices around the world. SWIFT headquarters are located in La Hulpe, Belgium, near Brussels.

• It was founded in Brussels in 1973, supported by 239 banks in 15 countries. It started to establish common standards for financial transactions and a shared data processing system and worldwide communications network. Fundamental operating procedures, rules for liability etc., were established in 1975 and the first message was sent in 1977.

• There are four key areas that SWIFT services fall under within the Financial marketplace, Securities, Treasury & Derivatives, Trade Services and Payments & Cash Management.

SWIFT Services

COMMERCIAL BANKING IN PAKISTAN

• The banking sector in Pakistan has been going through a comprehensive but complex and painful process of restructuring since 1997. It is aimed at making these institutions financially sound and forging their links firmly with the real sector for promotion of savings, investment and growth.

• Although a complete turnaround in banking sector performance is not expected till the completion of reforms, signs of improvement are visible. The almost simultaneous nature of various factors makes it difficult to disentangle signs of improvement & deterioration.

Commercial banks operating in Pakistan can be divided into four

categories:

1) Nationalized Commercial Banks

2) Private Commercial Banks,

3) Foreign Banks

4) Non-Banking Financial Companies

• The central bank has been following a supervisory framework, CAMEL, which involves the analysis of six indicators which reflect the financial health of financial institutions. These are:

Capital Adequacy

• To protect the interest of depositors as well as shareholders, SBP introduced the risk based system for capital adequacy in late 1998. Banks are required to maintain 8 per cent capital to Risk Weighted Assets (CRWA) ratio.

Asset Quality

• Asset quality is generally measured in relation to the level and severity of non-performing assets, recoveries, adequacy of provisions and distribution of assets. Although, the banking system is infected with large volume of Non Performing Loans , its severity has stabilized to some extent.

• The rise over the years was due to increase in volume of NPLs following enforcement of more vigorous standards for classifying loans, improved reporting and disclosure requirements adopted by the SBP.

Management Soundness

• Given the qualitative nature of management, it is difficult to judge its soundness just by looking at financial accounts of the banks. Nevertheless, total expenditure to total income and operating expenses to total expenses help in gauging the management quality of any commercial bank.

Earnings and Profitability

• Strong earnings and profitability profile of banks reflects the ability to support present and future operations. More specifically, this determines the capacity to absorb losses, finance its expansion programme, pay dividend to its shareholders and build up adequate level of capital.

• Being front line of defense against erosion of capital base from losses, the need for high earnings and profitability can hardly be overemphasized. Although different indicators are used to serve the purpose, the best and most widely used indicator is return on assets (ROA).

Liquidity

• Movement in liquidity indicators since 1997 indicates the painful process of adjustments. Ratio of liquid assets to total assets has been on a constant decline.

• This was consciously brought about by the monetary policy changes by the SBP to manage the crisis-like situation created after 1998. Both the cash reserve requirement (CRR) and the statutory liquidity requirement (SLR) were reduced in 1999.

• These steps were reinforced by declines in SBP's discount rate and T-Bill yields to help banks manage rupee withdrawals and still meet the credit requirement of the private sector.

Sensitivity to Market Risk

• Rate sensitive assets have diverged from rate sensitive liabilities in absolute terms since few years. The negative gap has widened. Negative value indicates comparatively higher risk sensitivity towards liability side, while decline in interest rates may prove beneficial.

Deposit Mobilization

• Deposit mobilization has dwindled considerably after 1997. Deposits as a proportion of GDP have been going down. Growth rate of overall deposits of banks has gone down. However, the slow down seems to have been arrested and reversed in year 2000.

Credit Extension

• Bulk of the advances extended by banks is for working capital which is self-liquidating in nature. However, due to an easing in SBP's policy, credit extension has exceeded deposit mobilization. This is reflected in advances growing in last few years.

• Private banks were the only group that not only maintained their growth in double-digit but also, With this high growth, they have surpassed foreign banks, in terms of their share in total advances in last few years.

Banking Spreads

• Over the years there has been a declining trend both in lending and deposit rates. Downward trend in lending rates was due to SBP policy.