November 4, 2002	Monday	Sha’aban 28,1423

The overall financial efficiency of the scheduled banks has not improved due to faulty design and improper sequencing of reforms. In fact, the financial efficiency, gauged by the interest rate spread, shows a deterioration, despite a more competitive market structure brought about by banking reforms initiated in 1997.

To quote the State Bank figures, interest rate spread increased to 4.9 per cent in 2001 from 4.7 per cent in 2000 and 4 per cent in 1991.

A financial sector assessment report prepared by State Bank admits that” the reforms could not succeed in increasing the efficiency of the banking sector, when measured in terms of interest rate spread.” The report covers the decade of 1990-2000 but the trend has not yet been reversed.

The report, compiled by a competent team of local professionals after inter-action with all stakeholders is rated of a standard and quality that matches those of international financial institutions.

That the reforms have failed to achieve positive results in financial efficiency is explained by the improper sequencing of reforms together with the weaknesses in design of debt management reforms. The report points that these two factors were responsible for mounting debt burden as well as dis-intermediation of the financial system.

The State Bank figures show that the spread between weighted average lending and deposit rates widened further, to 8.3 per cent in June 2001 from 8.1 per cent in 2000 and 2.4 per cent in 1990. However, central bankers say that compared to interest rate spread, the spread between deposit and lending rates “is an inferior indicator of efficiency.”

Dwelling on the nature and sequence of the reforms, the SBP financial assessment report points out” that premature liberalization of government debt market in developing countries seldom lead to financial restraint, rather it became easier for these countries to get into trouble through rapidly rising interest expense on domestic debt. The fiscal reforms should have preceded the financial reforms.”

“ However, the opposite sequencing was followed, because probably the fiscal reforms were the hardest to implement. “Even within the financial reforms, debt management reforms were implemented first in early 1990s, instead of the banking institutional reforms, that should have been implemented first but had to wait till 1997, “ the report adds.

Apart from these indicators, there is yet another dimension of negative financial performance of the public sector banks.

The negative return on assets for public sector scheduled banks recorded for calender year 2001 jumped up to - 1.4 per cent from -0.4 per cent in 2000.

The non-performing loans (NPLs) in December 2001, as compared to 2000 reveal” an apparent deterioration of asset portfolio, “ says the latest annual SBP report.

In the report, the SBP has this explanation to offer.”Though most of the public sector banks (six out of nine) substantially increased their profits in 2001, exceptionally large losses suffered by two banks in the group dragged the profitability of the whole sector into losses.... Losses were mainly because of higher provisioning by these banks.”

Specifically, the non-performing loans of the overall banking system surged by 5.2 per cent over the last year.

As the state of affairs in the banking sector would indicate, it is too preoccupied with its own restructuring and reforms for the past five years, to play a pro-active catalyst to support other industries and sectors of the economy. The only exception has been cut in lending rates made possible by lowering of deposit rates on the back of falling inflation rate.

Without specifying the time span, Finance Minister Shaukat Aziz said at the launching ceremony of AKD and incidentally Pakistan’s first on line stock trading service in Karachi on Friday that the average weighted lending rates have fallen by three per cent and the interest rates now range between 7-14 per cent. The future trend in interest rates would be set by the extent of the success or otherwise that is achieved in containing fiscal deficit and inflation. He says the inflation rate is currently under four per cent.

What is no less laudable is that Habib Bank is now extending term loans, ranging from three to five years that carry interest rates under ten per cent. These are not short-term but long term facilities that are expensive, says Habib Bank President Zakir Mahmood and adds:” These are floating rates and they are tied to the discount rate but the overall cost is less than 10 per cent.”

Of course, as pointed out by the State Bank, more public sector commercial banks have become competitive and have also improved their financial performance. A restructured UBL stands privatized and HBL is now ready for privatization. In the past three years, HBL president Zakir Mahmood says that the average interest rate for his bank has dropped by more than 2.5 per cent. In some cases, the range of the drop in lending rates has been as much as five per cent.” The best risk gets the best pricing” he added. The intermediation cost at 4.1 per cent in 2001 is expected to come down to 3.6 per cent. HBL’s return on asset is at 1.48.

Zakir Mahmood says that the average lending rates in the banking system have come down appreciably. HBL has a significant market share of 18 per cent and our rates are in line with the market. We have to be competitive. This is an important consideration because there is considerable liquidity, the market has a wider range of financial services and the customers have a lot of choice.

Since Pakistan embarked on the road to reforms five years ago and many Asian countries had not started the restructuring, HBL president says the NPL portfolio, net of provisions was a mere two per cent of the GDP as compared to 15 per cent for Thailand and 15-20 per cent for China.

According to a senior banker, apparently, China is focusing on economic growth and banking reforms have been accorded a much lower priority.

In the past three years, the HBL says it had a singular success in recovery of non-performing loans. The bank recovered Rs10.5 bn, restructured Rs15 bn of which Rs 10 bn is operating in a stronger manner, which means these have now been taken out of NPL. Thus, overall the bank has Rs 21 billion reduction in NPL in last three years.

The bank has been strengthening its balance-sheet on the progressive basis since early 2000 by provisioning against NPL. During this period an additional provisioning of Rs 6.5 bn has come from bank earnings. The bank is adequately provisioned. At this point of time, the provisioning level is 61.5 per cent of the NPL. The balance is covered by fore-sale value of collateral as per SBP regulations.

Currently, most of problem loans relate to a period prior to 1997 banking reforms. In the last five years, the loss on new loans was Rs.250 million. The loss ratio was 0.5 per cent which was substantially larger on old problem loans. The systems and efficiency have improved.

The public sector banks, with large retail deposit base and improved skills, products and services are expanding their business in areas that were previously dominated by foreign and private banks.

According to the SBP, the deposit base and corresponding lending volumes of foreign banks has shrunk. Yet the return in 2001 on equity for foreign banks was 0.8 per cent, twice that of the private domestic bank and -1.4 for public sector banks. Foreign banks’ appetite for funds, on the back of depleting deposit base, increased. A good part of increase in foreign bank assets came from borrowings that went up by Rs.17 billion or 30 per cent over the year.

To quote Zakir Mahmood a large part of the foreign banks’ deposits comprised dollar deposits under the old scheme. The scenario has changed. A large part of these deposits have been liquidated. They have moved also into domestic private banks and also big NCBs. The lending of the foreign banks have also correspondingly shrunk. Also because Pakistani banks have become more aggressive. They are involved in many of the large transactions. So we are finding a more rightful share of the market that we did not have previously.

Small private banks have also been improving their market share. They are involved in community and niche banking. They are very successful and they have also been taking market share of large commercial banks. However, the small banks would soon discover that size will become increasingly important. They would have to perforce amalgamate and reach a critical mass and size to compete more effectively.

Mr. Zakir Mahmood sees major changes in the financial system including the banking sector. The undergoing reforms have improved the efficiency of nationalized commercial banks (NCBs). Previously, the foreign and domestic private banks were dominating certain areas of business. Having acquired efficiency, the NCBs are dominating some business areas particularly in commercial lending. This is only natural. Nothing unusual is happening. This is typical of emerging markets. About thirty years ago,foreign banks used to dominate certain sectors of the market in the Far East. Now, the foreign banks have been supplanted and most of the commercial and business activities are funded by the local banks. Exactly, the same is happening in Pakistan. This is going to intensify.

The Pakistani banks have huge advantage in terms of large retail deposit banks which gives them an overwhelming advantage. We did not have the products and services. We did not have the skills to really exploit our advantage. Now that has happened. For example, HBL is one of the major commercial investment bank . In commercial banking and consumer banking, the large local banks will become dominant.

Foreign banks will move into more-value added and sophisticated services. There is always a place for them but NCBs have improved in commercial banking, in which their foreign peers would have a limited role.