Banks need to unlearn a few things

September 16, 2019

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Pakistani banks have been doing for years what they find easy to do: invest heavily in government securities and cater more to the financial needs of big businesses.

But that has to change if the banking industry really wants to thrive.

Regardless of the fluctuations in the periodic flows of bank lending to the government via debt securities, the stock of such lending peaked at Rs6.63 trillion at the end of 2016-17. Against that, the stock of bank lending to the private sector stood at Rs5.2tr.

Banks must increase their lending to agriculture, SMEs, commodity financing and consumer sectors. That’s where demand for credit exists

In plainer words, 56 per cent of banks’ money remained invested with the government and only 44pc with the private sector. Does it make sense? Should we assume that the government generates 56pc of economic activity and the private sector 44pc? If not, then what else did the figures represent?

This situation changed somewhat in favour of the private sector in 2017-18 and 2018-19. Still banks have a way to go to cater to the financial needs of the private sector, which is the engine of our economic growth.

Two months of the new fiscal year are insufficient to offer any signs of this desired behavioural change. But we already have some worrying statistics. In July-August, the federal government’s borrowing from banks stood at Rs458 billion whereas the private sector retired Rs85bn on a net basis.

The total private-sector lending by banks shows a clear and unjustifiable tilt towards the corporate sector. Currently, 60.5pc of total bank advances remain concentrated in the manufacturing sector and about 6pc in the agriculture sector. You read it right — 6pc. Forget about the yearly flows of bank money into the agriculture sector as the bulk of it is repaid within a year. Had banks been making more of long-term agricultural development loans, their stock of advances would not have been as low as it is — just Rs300bn against Rs5.07tr of advances to private-sector businesses.

Banks are yet to focus on important things like improving the advances-to-deposits ratio (ADR), catering to new small and medium-size borrowers, exploiting the vast potential of green and impact financing, making agricultural lending more development-oriented and rolling out tailor-made products to accelerate deposit mobilisation. E-banking and digitalisation of bank accounts are milestones, but the improvement in overall service delivery is wanting.

Banks’ failure to strengthen internal systems to implement the know-your-customer (KYC) regime is all but obvious — a fact that the apex court has lamented while hearing corruption cases involving layered financial transactions of tens of billions of rupees via fake bank accounts. The central bank has now started making public the names of the banks that it penalises for the violation of banking rules and regulations.

Banks often take a lenient position against politically exposed people

The State Bank of Pakistan (SBP) has done this to show to the world that it means business when it comes to enforcing anti-money laundering (AML) and combating the financing of terrorism (CFT) regime.

Pakistan’s economic growth is faltering for a host of reasons. But banks’ failure to do financial intermediation properly has also been at the heart of our economic plight.

Keeping this backdrop in mind, let’s see what challenges banks have to meet in the future and what rewards await them if they opt for course correction.

The first and foremost challenge for banks is to implement rules and regulations regarding AML and KYC regimes. Any failure will not only land them in trouble but also complicate matters for Pakistan as it struggles to make its financial system more transparent and responsible.

Related to the AML and KYC regimes is the issue of handling bank accounts and banking transactions of politically exposed people. In this area, the central bank continues to push banks to be more vigilant and responsible. Owing to our peculiar political culture, banks often take a lenient stance against irregularities that can be traced back to politically exposed people. They will have to unlearn this habit.

Enhancing ADR from 53pc is a must. A decade ago, this ratio was as high as 78pc. But then, lured by the insatiable appetite of the government of the day for bank borrowing to fix the fiscal deficit, commercial banks forgot that their basic responsibility was to cater to the financial needs of the private sector. The ADR continued sliding down.

As the government has now begun shifting its deposits from commercial banks to the central bank, the former sitting on large government funds fear the depletion of their deposit base. But since this process is expected to take years, the central bank says they should not worry. The withdrawal of government deposits from commercial banks will also give them an opportunity to lower their exposure to investments in government debt securities as part of their effort to match such exposure with the level of government deposits.

The concentration of banks’ lending in the corporate sector, constantly over 60pc for many years, is not going to serve them well. They need to expand their stock of lending to agriculture, SMEs, commodity financing and consumer sectors. These are the areas where unmet demand exists and where the potential for more profitable lending lies. But for catering to these segments, banks need to strengthen their product development, loan processing and monitoring units.

Published in Dawn, The Business and Finance Weekly, September 16th, 2019