Back to main page

Banking sector’s problems and development

The banking sector needs to step out of its short-term objectives and expand itself to satisfy depositors who look forward to getting good returns on their deposits

By M. Sharif

Banking sector, after the successful privatisation supported by the WB during late 90s that attracted substantial inflows of foreign capital, was envied as a fast growing sector with substantial profits until the beginning of global financial crisis. Since then, it has been slipping into troubles on account of increased NPLs (non-performing loans) that presently stand at Rs 398 billion, 11.5 per cent of total loans by the end-June 2009. This is mostly because of consumer financing that peaked in 2006-07 and created an environment for imprudent lending to earn unusually high profits. Liquidity crunch arising because of low growth of deposits and crowding out of private sector from borrowing, owing to high interest rates on one hand and high commercial borrowing by the government on the other, to meet its fiscal and energy sector needs.

According to State Bank of Pakistan’s latest quarterly review; “there is visible shift of credit from private sector to public sector” - but that hardly augers well for the economy because contribution made by the former towards economic growth and development is larger than the latter. During the last fiscal year, commercial banks made net fresh loans of Rs 18.0 billion only to the private sector and remained reluctant to lend to private sector during the first quarter of current fiscal year. There are indications of increase in net credit off-take during first quarter of current fiscal year.

Difficulties of the sector

The banking sector after privatisation in the 90s was modelled on the American banking pattern. It had to assimilate the spirit of American capitalism based on being efficient and competitive, providing prompt services to clients and playing an active role in the country’s economic growth and development through private sector, development and project financing. Contrary to committing to these objectives, experience shows that the banking sector’s main focus has remained on making high profits. This very purpose has constrained it to boldly step into risk-prone sectors of the economy and to make long-term investments such as development of the country’s physical infrastructure.

They focused on making the sector efficient and created environments for mergers of smaller banks into larger ones to generate competition within the sector, strengthen it, and make it safer to withstand domestic shocks, along with safeguarding the interests of customers. For these very reasons, minimum capital requirement (MCR) was raised from Rs 500 million in early 1990s to Rs 6.0 billion by end of 2009. It is to be further raised to Rs 23.0 billion by end of 2013. The measure is now stuck-up because of the constraints faced by the sector. The condition of MCR of Rs 6.0 billion has been relaxed to let the smaller banks operate that would have otherwise either opted for a merger or for closure.

Increase in financial liquidity from 2004 onwards and low interest rates enabled the sector to fully go along with the then government’s strategy of boosting economic growth through consumer financing --- car leasing, mortgage, personal loans, credit cards etc, notwithstanding the fact that it entailed greater risks. The sector covered its risk through a higher interest rate of around 20.0 per cent. Some of the analysts had then predicted that it could be the beginning of troubles of the sector. They had, perhaps, foreseen that sustaining high economic growth with flawed fiscal and money policies and too much dependence on external funds was extremely difficult. Even a short-lived domestic shock to the economy could shoot difficulties for the sector. Time has proved that their assessment was not totally off the road.

The challenges

The sector presently faces two serious challenges of attracting more deposits by rationalising deposit rates and removing structural deficiencies, that have inhibited to reach out to many potential depositors and to increase its share in development finance that is on the decrease.

The liquidity crunch faced by the commercial banks to a larger extent is attributable to low deposits; lower than the required level, a fact also accepted by the senior bankers. According to available statistics, deposits of commercial banks increased to Rs 4.162 trillion by end-September, 2009 showing a Y-o-Y growth of 10.0 per cent, better than the growth of 9.15 per cent a year before. But, the growth is comparatively much less than the average growth of 18.5 per cent between 2002 and 2007. Primary reason for reduction in deposits is low interest rates on deposits offered by the banks.

According to an analysis, average deposit rate of 6.3 per cent in September 2009 has decreased by 150 bps, from 7.8 per cent during the corresponding month of last year. Slow down in economic growth, double digit inflation during last 15 months, and prevailing uncertainty in law and order situation and war on terrorism are additional factors contributing towards slow growth of deposits. It is pertinent to observe that the banks have remained oblivious to increasing deposit rates, despite repeated assertion made by the previous governors of the SBP.

The commercial banks increased deposit rates because lending rates by banks had swelled to 18.0 to 20.0 per cent due to increase in interest rates from 1,300 bps to 1,500 bps by the SBP. It is interesting to note that whereas average deposit rate during one year period between September, 2008 and 2009 decreased by 150 bps, the lending rate decreased by 0.1 per cent during the same period from 13.8 to 13.7 per cent. Bankers have argued that fall in deposit rates is justified because of cut in interest rates by the SBP by 200 bps during the past nine months. Consequently, the banking spread has increased to 7.4 per cent, near to its previous level of more than 7.0 per cent. It is perhaps one of the highest in the world to the great disadvantage of customers. It clearly reflects that the banking sector has acted to make up for its falling incomes.

Banks’ inability to mobilise high deposits has kept savings-to-GDP ratio low around 14.0 per cent, much lower than the regional average of around 20.0 per cent, with the result that the government is to resort to external borrowing to meet its fiscal needs. It is already stuck up because of low tax-to-GDP around 9.5 per cent that has over the past few years decreased from around 11.0 per cent. External borrowing is not without strings that impinge on national sovereignty as has been recently debated in national media about the Kerry-Lugar law. It is therefore, imperative that the banking sector should play its role in national development more objectively by improving deposit rates to attract higher deposits.

Sub-sectors of the economy such as SMEs, agriculture, infrastructure and housing, export refinancing and micro-finance did not get ready access to finance from formal financial institutions. Some of the measures taken by the SBP in the recent past have, however, improved the level of formal financing in these sectors. But, banking sector’s own troubles have inhibited its full participation in development finance. According to development finance quarterly review released by the SBP, “share of the banking sector during past one year has decreased because of rise in inflation, power outages, NPLs and credit crunch.”

The SMEs sector is the second largest recipient of development after corporate sector. At the end of first quarter of current fiscal year, SMEs sector’s outstanding credit stood at Rs 349 billion, 11.5 per cent of the total credit of the banking sector. A negative quarterly growth of 6.9 per cent has been recorded in the advances made to SMEs sector for the reasons stated above. On the contrary, infrastructure project financing portfolio, with 30.7 per cent share in DF during first quarter of current fiscal year has registered an increase of 40.0 per cent on year-to-year basis from March 2008 to March 2009, because of significant increase in the share of power sector. Agriculture, the vital sector of economy with a share of 17.8 per cent in DF is the most sidelined sector. Its share in the total outstanding credit by the banking sector is around 5.0 per cent. It certainly asks for increasing it by reaching out to the farming community by capacity building of the banking sector.