“I am son of my father and my mother”, thus answered a young beau, nicknamed Apphi, when asked whose son was he. Although Mr.Apphi’s childish reply was not very informative, yet it was neither misleading nor a piece of disinformation as happens to be the case with the statements quoted below from the State Bank’s publications regarding financial savings, financial deepening and financial intermediation.

Financial savings:” Financial savings can be defined as the amount of deposits and other savings held by the financial institutions for the households, business organizations and other institutions. Four major components of financial savings are deposits of scheduled banks, deposit of NBFIs, investment in government debt instruments by non-banks, and currency in circulation—-greater availability of savings and checking deposits and other financial instruments contribute to the expansion of financial savings”. (Pakistan: Financial Sector Assessment 1990-2000 (FSA), p-104). The above definition of financial savings is not only misleading but tantamounts to disinformation. The financial claims of households, business organizations and other institutions on banking system, comprising both State Bank of Pakistan and the scheduled banks, and the NBFIs in the form of deposits or in any other form are total financial assets held by the former and total financial liabilities of the latter.

Thus deposits of scheduled banks, deposits of NBFIs, investment in government debt instruments by the non-bank and currency in circulation are four major components of total financial assets and not of financial savings. The statement, that greater availability of savings and checking deposits and other financial instruments contributes to the expansion of financial savings is nugatory.

The economic units have to take two decisions: (i) how much to save; and (ii) in what form to hold their savings. The financial savings in an economy may be defined as savings held by surplus economic units in the form of financial claims on individuals, corporate sector, financial institutions and the government. The importance of loans from friends and relatives has relatively declined considerably.

The direct placement of savings by the household in newly floated shares, bonds, debentures and Term Finance Certificates (TFCs) at the time of their issue by the non-financial corporate sector is also not very significant in Pakistan. In fact, the bulk of savings originating with the surplus economic units in the household and non-financial corporate sectors is held in the form of claims on financial institutions and government debt.

This needs further explanation. Suppose some households save part of their income and purchase existing government securities or marketable treasury bills with it; at the same time a number of other households buy existing shares, private corporate bonds, TFCs, etc. with their savings. Has financial saving taken place in these cases? Not exactly.

Financial saving takes place when, and only when, there is an increase in the aggregate level of financial assets in an economy. Even an increase in aggregate outstanding level of financial assets over a period is not a true index of financial savings taking place during that period. In fact, in the above case financial savings taking place during this period are underestimated to the extent some economic units save a part of their income and use it for repayment of their debt to the financial institutions.

Thus it is not the increase in outstanding level of liabilities of financial institutions to the non-financial sectors of the economy over a period but disbursement of credit by financial institutions during that period that is relevant for estimating financial savings in an economy. In 1981,the research department of the SBP had asked the banks to provide data regarding disbursement of credit. Despite the advice tendered to them that “under the present practice of loaning and investment it would be very difficult for the banks to provide data regarding their credit disbursements both for financing of working capital requirements and fixed investment”. As expected, the banks expressed their inability to provide data regarding disbursement of credit since the bulk of credit extended by them was in the form of “overdrafts” and “cash credit limits” and in both cases debit balance in different accounts kept on fluctuating due to periodic repayments and availing of the limits.

The SBP has been publishing data regarding “monthly average loan disbursements by banks at various rates of mark-up”, for all banks: Pakistani banks, foreign banks, Pakistani commercial banks and specialized banks separately. However, these data are meaningless from the point of view of working out financial savings mobilized by the scheduled banks.

Financial Intermediation:The following quotations from the SBP publications are indicative of how wrong Bank’s conception of financial intermediation could be:

i) the extent of financial intermediation can be assessed by the currency to deposit ratio. Currency and bank deposits are two competing financial assets. (Pakistan: Financial Sector Assessment 1990-2000 (FSA), p-103).

ii) “currency to GDP ratio is indicative of the size of the informal economy” (FSA, p-123).

iii) high currency/M2 and M1/M2 ratios and declining M2/M3 ratio indicated increasing cash flows out of the banking system. Moreover, high currency to total deposit ratio implies the growing size of parallel economy. (FSA, p-22).

iv) “The other problem with higher interest rates on national savings schemes is that the banks start losing their deposits as there is a powerful incentive to divert these deposits into NSS instruments and earn higher returns. Banks therefore lose their source of financing for business, investment, consumers and agriculture. This is exactly what was happening in the mid-1990s when the rates on NSS were so attractive that rupee deposit mobilization by the banks was negative”. (Dr. Ishrat Husain, Leading Issues Facing Pakistan Economy, SBP Publication, p-242).

The currency to deposit ratio cannot, by any stretch of imagination, be termed as a measure of the extent of financial intermediation. The currency in circulation and bank deposits are components of overall monetary liabilities of the banking system, comprising the central bank and the scheduled banks, and to the economic units holding monetary claims on the banking system these are financial assets. The outstanding level of monetary assets at a particular point of time represents cumulative aggregate of total assets of the economic units which they decided to hold in the form of different components of monetary assets.

The banking system acts as an intermediary between the savers and the borrowers from the banking system. However, the level of financial savings in the form of increase in monetary assets during a period is determined by the banking system and not by the decisions of surplus economic units.

The desire of surplus economic units to save in the form of monetary assets can materialize only, and to the extent, the banking system is willing to supply with additional monetary assets. In Pakistan, at the beginning of each financial/fiscal year a credit plan is prepared to work out safe limits of monetary expansion as also of domestic credit expansion in the light of unfolding economic situation. These estimates are revised in the middle of each financial year, keeping in view latest developments in the economy.

If the banking system injects more money then surplus economic units are willing to hold, that leads to pressure on the price level and, if excessive injection of money is continued for some time, inflationary expectations get built into the economy, which hurt overall saving and investment activity in the economy.

The savers do not want to put all eggs in one basket. Moreover, it is well known that there is rise in the level of financial savings, both in absolute terms and as a proportion of income, if opportunities to save are enhanced by offering savers a varied menu of financial assets to hold that suits their tastes and requirements.

On this principle, a variety of NBFIs have grown up; though, of these, stock exchanges and insurance companies are as old as joint stock banking. In Pakistan, next to the banking system,the central directorate of national savings(CDNS) is the largest mobiliser of private savings for the government. As for the financial savings mobilized by NBFIs,the SBP is for the first time getting the data compiled.

However, it is pertinent to point out that while the banking system supplies the economy with additional monetary assets either by extending net domestic credit (NDA) or by increasing net foreign exchange reserves in its portfolio, the NBFIs have first to mobilize cash resources by marketing their financial liabilities before they can increase their claims on different sectors of the economy.

The statement quoted at (ii) and (iii) above are too naive to deserve any comment. The statement at (iv) above is neither supported by facts nor is logically sound. The data do not support the claim that mobilization of rupee deposits by the banks (i.e. total deposits minus RFCD) became negative in the mid-1990s owing to diversion of bank deposits to NSS instruments.

As Percentage of GDP (MP) End-June (a) Rupee Deposits (b) M2 (c) NSS (d) Financial Deepening (Partial estimate) (c + d) 1991 24.6 39.3 16.3 55.6 1995 26.7 44.2 14.1 58.3 1999 29.5 43.6* 21.7 65.3 2003 34.4 50.3 24.0 74.3 * Owing to decline of Rs.158 billion in RFCD, from Rs.279 billion in June, 1998 to Rs.121 billion in June, 1999.

Reserve money is the base of entire financial structure. The ability of banks to provide additional credit to different sectors of the economy depends on three things:

i) supply of additional reserve money by the Central Bank;

ii) the proportion in which public chooses to hold claims on Central Bank and the scheduled banks; and

(iii) the decision of scheduled banks regarding level of cash assets to be kept against bank deposits.