October 12, 2003	Sunday	Sha'aban 15, 1424

KARACHI, Oct 11: Banking reforms, initiated in 1997, are focused on privatization, liberalization and integration of domestic financial markets.

As these reforms are modelled on evolving financial markets in the West, the roadmap followed by local and foreign banks can be no different. The state of development may differ. Here, the context is banks’ role in equity markets.

A buoyant stock market has provided the local banks with a lucrative avenue for investment. The inflated share prices can be explained as much by these institutional investments as reverse flight of capital.

In the coming years, the banks are likely to play a more vital role in share market, as indicated by the decision in principle last week of the European Union’s finance ministers to allow banks to compete with stock exchanges in share trading.

Sooner or later, Pakistan may have to look at this option if credit continues to be priced cheap over the long- term (not unlikely with the world awash with money) and the local stock exchanges acquire needed depth. For the moment, the proposed creation of another stock exchange, has created a controversy.

Under the EU draft law, banks will be permitted to trade in shares in-house for both retail and institutional clients, ending what is stated as the monopoly of the stock exchanges in countries like France, Italy and Belgium.

In his off-the-cuff and spontaneous remark on the EU move, a bank president said: “The banks will wither away.” But Moin Fudda, managing director, Karachi Stock Exchange says: “we have still a long way to go.”

The banks are re-directing their businesses. Globally, as well as in Pakistan, the ratio of bank revenue from interests is declining and fee-based and other incomes including trading in shares and currency are rising fast. For many leading foreign banks, the incomes from interest have come down to 60 per cent or less. In Pakistan, the average is reckoned to be around 75 per cent. The trend towards fee-based incomes would be strengthened in the domestic market by the growing consumer banking including mortgage financing, penalty on low deposits and similar other measures.

The banks are not much concerned about mobilization of local deposits in a fiercely competitive credit market. There is a negative rate of return on deposit/savings.

In a low rate environment, excess liquidity and lack of adequate avenues for investment in the real economy, the banks have profited out of trading in T/bills, PIBs, corporate bonds, stocks and currency.

Finance capital is fragile and is facing unprecedented risks as its link with economic development is weakening. So, the reforms, backed by tax and other incentives, appear to be continuing process to keep the banks fit outfits to perform.

The mandate of nationalized banks on socio-economic objectives has been deleted to exclusively focus on profit- making. Trimming of the banks followed and the World Bank has extended loans to pay off the redundant staff.

In a bid a restore two leading banks to financial health, about Rs50 billion were also injected. UBL and MCB were privatized.

Weak banks have been encouraged to merge through tax incentives to realize the object of fewer but stronger banks which could “withstand exogenous shocks, manage risks prudently and introduce innovative products and services.” The process continues with mergers of banks and financial institutions.

Financial institutions with unacceptable track record were weeded out. Mandatory targets for bank credit that impacted on profits were withdrawn. Banks have been allowed to repossess property without recourse to legal proceedings in courts. Corporate taxes are being reduced to the level of non-banking companies. The State Bank is allowing banks/corporates to hedge against interest rate risks on a selective basis through derivatives.

The incentive-loaded reforms are an exercise to make nationalized banks viable for privatization. But it would not be enough. In the ever-changing market scenario, universal banking in the private sector must become an integral part of the capital market to keep it viable. So, the banks may need a new mandate to work as stock exchanges.