Pakistan banks have to trim their sails or get ready for rough waters

ISLAMABAD Days when milk and honey were flowing their way may not exactly be over, but banks now have to trim their sails or get ready for rougher waters.

By M Aftab

Published: Sun 16 Mar 2003, 12:19 PM

Last updated: Wed 1 Apr 2015, 9:02 PM

However, there could also be a silver lining in the travails that the banks now face. It's time for them to wake up and shed their excess baggage, trim themselves and be aggressively competitive to face the banking and financial sector ground realities of the 21st century. The central bank, State Bank of Pakistan (SPB) has been repeatly warning about these. Why?

SBP's benchmark discount is now down from 14 per cent in July 2001 to 7.5 in November, 2002. March saw the six-month tenure Treasury Bills (TBs) tumbling down from 3.17 to the lowest-ever 2.17 per cent on March 5, from an average of 6.3 per cent in July 2002. The big, March 5 decline in TB rate followed 155, low- priced bids offered by commercial banks, out of which SBP picked up only 14.

The government's 10-year tenure Pakistan Investment Bonds (PIBs) March 8 were down to a record-low yield of 4.8 per cent. TBs and PIBs have been a longtime favourite of easy-going commecial bankers as these were safe, scure and high-yielding instruments, involving hardly any effort.

The reduced discount rate, and lower TB and PIB yeilds are SBP's signals, for nearly two years now, for the bankers to lower their lending rates in order to boost the economy. The bakers have proved to be the reluctant grooms to do so. But having none other sources to invest, rising liquidity and fear of reduced profitability have forced the banks to lower their average lending rates to 9.95 per cent in January. But at whose cost?

Again the banks are not really being generoues, nor they are being accommodative of the needs of the economy.

They have principally done the rate-cutting at the cost of the savers, in a country that has the dubious distinction of having one of the lowest savings rates even among the developing countries.

In fact the banks have already slashed down the profit rates to savers to a paltry 3.21 per cent a year in January this year, from the already meager 4.02 per cent in July 2002, according to SBP.

With deposit and profit rates that low, who is going to save? SBP Governor Dr. Ishrat Hussain keeps on urging everyone to increase savings to feed the economy and attain a modicum of self reliance. But, should he not force banks to heavily slash their cost of intermediation, drastically narrow down their spread, and stop utter extravagance to raise - and not reduce - profit on deposists?

If Ishrat cannot do so, he and other economic bosses of the country should forget about the national rate of savings, and let it plunge down to zero. Hasn't his monetary policy been totally unmindful of the savers who have been left to wolves. Remember: the inflation rate rose to 3.53 per cent at the end of the first eight months of fiscal 2003. Also, can Finance Minister Shaukat Aziz still gaurantee that his projection of inflation rate for the year will stay below 4 per cent?

Whether or not that happens, doesn't the present situation mean that the depositors are paying from their own pockets to let banking flourish at their cost because of the negative return and erosion of their inflation-hit deposits?

An 11.3 per cent monetary expansion has already taken place in the first seven a half months of the year, according to the central bank. SBP January 29 raised the the monetary expansion projection for the year from 10.8 to 16 per cent, because it expected that substantial forex in the form of home remittances and other inflows will continue in the foreseeable future.

What has, or may, hit the banks and their profitability? One of the top global bankers and currently Pakistan's Finance Minister Shaukat Aziz puts this in a nutshell: "Pakiatsn has undergone a paradigm shift in banking over the last two years. This challenge can alone be faced if the banks launch new products and instruments. Banks should find new borrowers and sectors, such as housing and mortgage, small and medium enterprises, farm sector financing, and consumer loans."

Aziz and others know that its easier said than done for Pakistani and Pakistan-based foreign bankers who have generally lived a cushy life in a country where SBP lorded over a tight monetary policy, and a perpetual credit squeeze resulting in a perennial short supply of credit, while interest rates, for decades, remained astronomically high, and it was considered an act of great favour if one succeeded in borrowing from a commercial bank.

To illustrate the point, I still remember that commercial banks' lending rates were as high as 22 to 25 per cent a year even until 1999. The businsses suffered. The credit ordeal was one of the key factors of shuttering down nearly five thousand industrial units, and many more businsses vanished, as mostly fake, and some genuine borrowers, ate up nearly Rs. 300 billion (b) in defaulted loans. Several of these huge credits were granted as political favours, while in other deals bankers themselves had enjoyed huge sums behind the cover of invisible borrowers.

Things reached a head when the recession-hit economy, wornsed by political uncertanity and a frequent change of governments - and policies - and large inflows of home remittances sent by overeseas Pakistani working in the Gulf, Saudi Arabia, Middle East and North America sharply rose. It meant a large and progressive build up of liquidity with the banks. There simply were no takers as the lending rates stayed high. The credit targets, SBP set for lending to the private sector, remained largely unutilised. The credit offtake, though, has just improved.

In fact, the banks' travils had started in May, 1998 when after eight years of dollarisation of the economy during which most people converted their value-loosing Rupees into dollars and deposited a total of $ 11 billion (b) with banks in what was called Foreign Currency Accounts (FCAs). The FCAs were frozen, as successive governments had used up the greenbacks leaving hardly $ 400 million as SPB's forex reserves. The banks until then had relied on lucrative dollar business, and cared little to mobilise, or invest, domestic rupee resources, in parallel with lack of high-interest credit takeoff.

Aziz and SBP Governor Dr. Ishrat Hussain, are persistently urging both domestic and foreign-based banks in Pakistan to go for innovative ways in order to lend to the private sector.

There are two main reasons for that: the government, fujturely, does not require much borrowing - including through the instruments of TBs and PIBs - from the banks and interest rates are declining. In fact, the government will retire Rs. 29 billion (b) of its debt to banks during this fiscal, and borrow nothing. SBP has scaled down the expected private sector borrowing at Rs.50 billion (b) down from the earlier projection of Rs.94 billion (b) for 2003. Private businesses borrowed Rs.77 billion (b) during the first eight months of this year, but it has also started repaying a substantial part of these credits. Private sector credit takeoff in 2002 was only Rs.30 billion (b). No government borrowing and smaller private sector credit take off means a further increase in the banks' accummulating liquidity.

The banking sector, at the moment, is in an ideal situation to help the economy boost after it has been through years of stagnation.

But, that will be the situation if the financial sector, in particular, and the economy in general, were operating under a perfect market. Pakistan is not only an imperfect market in every sence - and in every sector or activity, its elite operators wish the government, and particularly its people and clients - to spoon-feed them.

That may not be pissible even for an SBP that itself is loosing an estimated Rs.20 billion (b) this year on account of its support operations of keeping the rupee-dollar parity in a state of stability. The government, too, can hardly be help as it itself is slowly coming out of decades of huge budgetary and fiscal deficits. IMF and Islamabad's other financial godfathers will not let it slip back into rivers of red, once it has attained a modicum of coming into black, even though it is partly thanks to 9/11, but mainly through the courtesy of the ever-neglected overseas Pakistanis whose remittances have played a great role in keeping the economy afloat.

Operational results for the calender year ended December 31, 2002, just out, show good profits for almost all types of banks, ranging from Abu-Dhabi owned United Bank Ltd. to Faysal Bank and Union Bank that have large Gulf-Middle East shareholdings to locally owned First Women's Bank, PICIC Bank, and the National Bank.

But, during calendar 2003 that started January 1, amidst interest rate cuts, profitability may never be the same again for this, as yet, robust sector.

What is the way out? Only one: the bank executives and their elite class has to come out into the open market, compete, and compete aggressivly, produce new and innovative products, go into new fields that they have always shunned for their alleged high-risk and low creditworthiness. Because, isn't banking, itself, the calling and profession of risk-taking?