THE process of reforms in the banking sector commenced in 1997 with the appointment of professional management in the nationalized commercial banks. The present economic managers took the process forward since late 1999 which still continues. In recent pronouncements, our economic managers have reiterated that banks in the past had been catering basically to the needs of the government organizations, subsidizing the fiscal deficit, serving a few large corporations and engaging in trade financing. There was no lending to small and medium enterprises/ housing sector or to the agricultural sector which create most of the growth and employment. The banking system suffered from political interference in lending decisions. The middle class which is the backbone of any economy was not given any attention.

Bank employees had developed a bureaucratic mindset. There had been overstaffing, administrative costs were high which resulted in reducing the depositors’ profit. The banking sector bore the high punitive rate of taxation at 58 per cent which along with the burden of stuck-up loans was passed on to customers in the form of high lending and low deposit rates.

To address these issues, reforms were undertaken by the present economic managers. A brief overview of the outcome of the reforms follows:.

That banks had been subsidizing the fiscal deficit is only partially true and is a very old story. Government’s borrowings at the rate of 05-1.00 per cent per annum were restricted to SBP only. Borrowings from commercial banks were at the rate of six per cent per annum regardless of banks’ lending rates. But this system ceased on the February 26, 1991 when, in pursuance of World Bank’s reform package, Government commenced borrowings at the market rate through the auction of the Treasury Bills. Thus the system inherited by the present economic managers was that of government borrowing at the market (and not the subsidized) rate.

That the banking sector bore the punitive rate of taxation at the rate of 58 per cent which along with the burden of stuck up loans was passed on to customers in the form of high lending and low deposit rate needs examination. Tax is levied on the profit accruing to a banking institution after accounting for all its expenses out of the income. Tax therefore, essentially is an item of appropriation of profit and not the item of expense chargeable to the Profit and Loss account.

The items chargeable to the profit and loss account obviously get passed on to the customers in the shape of high lending and low deposit rates but it will be erroneous to hold the same view about the taxes even though there is a good rationale in keeping the uniform tax rates for the banking and other corporate sector.

As for the lending rates, SBP had itself fixed the bracket of 10-22 per cent per annum during 1990s perhaps to contain (or lower) the inflation which target could hardly be achieved. But the positive impact of high lending rates was that the depositors were also getting interest at slightly over the on-going inflation rate.

On assumption of office in 1999, the economic managers endeavoured to bring the lending rates in the single digit but could not succeed. It was only after 9/11 that the large scale inflow of funds from abroad commenced and the banks finding no investment outlets lowered the lending rates and SBP also permitted consumer and house financing to provide the banks with new lending outlets.

The consumer financing is growing fast. Reform measures, therefore, helped handling the fait-accompli situation viz-a-viz the excess liquidity with banks but to assume that the down-slide in the interest rates is the outcome of these measures will be tantamount to self-deception.

About the consumer financing, there are divergent views. Some people think that achievement of the industrial sector growth by increasing demand through bank lending does not present a sustainable solution and that the creation of demand through increasing employment is the feasible solution. But the economic managers are content with the creation of demand through bank lending.

The lowering of the interest rates has been basically at the cost of the depositors who are getting interest at a very nominal rate; for instance, the weighted average deposit rate came down from 2.12 per cent per annum. (end FY -03) to 1.29 per cent p.a. (end FY-04)- a reduction of 39.15 per cent. The lending rates have fairly increased since July 2004 but the deposit rates remained almost static even though inflation has moved up to about nine per cent since then. The corporate and non-corporate sector is not prepared to pass on the benefit of interest rate reduction to the general public and the economic managers have no remedy. The lower interest rates scenario has thus resulted in the passage of the resources from the poor section of the society to the rich.

The housing finance seems to be basically directed towards the high income groups as is evident from the raise of the loan limit from Rs5—10 million. Although the middle class has benefited from the consumer financing scheme, authorities shall not be able to convince many that the society has benefited from housing finance in large numbers.

It is claimed that legal reforms have removed difficulties and time delays in the recovery of the defaulted loans. But how much success has been achieved is an enigma. Despite claims of recovery, there is no sizeable reduction in the non-performing loans (NPLs). When the present economic managers took over, the outstanding stock of the NPLs as on the June 30,1999 was Rs212.1 billion.

As per the information from SBP website, the stock of outstanding NPLs as on the December 31, 2004 stands at June,1999 level i.e. Rs211.166 billion. The figures of NPLs posted on SBP website do not include interest (unrealized) charged on the NPLs and transferred to “memorandum” account with effect from 1st October,2003. SBP does not provide the figures of such interest but it would not be less than Rs15 billion

Apart from that NPLs amounting to over Rs25 billion were written off during the tenure of the present economic managers [from 1999 to 2003]. The figures of write-offs during 2004 will become available by the middle of the current calendar year when the annual reports of the banks are issued but the amount will hardly be less than Rs6-7 billion. Sans the write-offs and camouflage of the interest element since October, 2003, the real outstanding NPLs as at the end of 2004 would have been Rs243 billion, much higher than the stock inherited by the present economic managers.

The injection of government funds to the extent of Rs30.7 billion, which is the tax-payers’ money, in the nationalized commercial banks for recapitalization and for covering the losses has been termed as “Reforms”. The figure of public money pumped in these banks on account of recapitalization during 1997-2002 really is Rs46.6 billion.

Further, additional public money was also poured in these banks for meeting the staff exodus cost/ writing off of some loans in the Middle East. Thus total government money pumped aggregates Rs 5.637 billion.

The detailed picture will emerge from Table I appended. Now let us also examine the impact of reduction of the staff and closing of branches at a mass scale. Table II appended provides the necessary details.

It will be seen that during 1997-2003, NBP curtailed the staff strength by 44.07 per cent and closed 22.89 per cent of branches but despite all this, administrative expenses rose by 20.96 per cent. In the case of HBL, staff strength was reduced by 39.54 per cent and 26.20 per cent of the branches were closed but all this did not help in reducing the administrative expenses which at the end of 2003 remained at 1997 level. UBL’s administrative expenses increased by 33.90 per cent despite retrenchment of staff to the extent of 59.34 per cent and closure of 36.38 per cent of the branches. Similarly Muslim Commercial Bank’s administrative expenditure increased by 9.16 per cent despite 30.99 per cent and 25.97 per cent reduction in the staff and branches respectively.

It has been claimed that “sifarish” and nepotism has been eliminated from the process of recruitment in the banking sector, now merit is the only criterion and recruitment is through test and interview. This is rather a rhetoric. The smaller banks are conducting the tests and interviews. The big banks are still using the discretion. NBP had dislodged 2968 employees in 2002 and employed 1077 in 2003. Were these recruitments on merit through written tests followed by interviews?

During the last 57 years, we have effectively created “classes” in education; better education is for rich people and sub-standard education for the poor people through government schools and colleges as this section does not afford the expenses of the “standard” institutions.

With the completion of exodus of poor people from the standard education, authorities have now embarked on exodus of the lower middle/ middle and down-trodden classes from the employment. The beginning has already been made via the banking sector with the massive retrenchment of the old employees during the last seven years and replacing them with the new ones from upper strata of the society as the qualification criterion fixed by big banks also followed by some small banks is MBA degree from a 4-5 designated institutions where the poor/lower middle and middle class children can hardly afford to enter. The process of getting rid of the low income groups of the society is likely to be completed by the banking sector in the next decade and a half or so.

The merger of the smaller banks has also been termed as “reform”. But SBP has not been successful in getting private small banks to merge. The merger so far has been through take over of the branches of foreign banks operating in Pakistan by the domestic financial institutions. To compel the banks to merge, SBP has enhanced the limits of the paid up capital and the banks are complying instead of merging. In principle, mergers depict a move towards monopoly. Why mergers and bias against small institutions if they are functioning well.

Small banks emerging in 1990s have fared well with the exception of Mehran, Indus, Prudential and Schon Bank. If these banks failed, the responsibility squarely lies on the then economic managers as they knew well who the sponsors were. The positive point is that it was the right decision to close down the Indus Bank and change management/ownership of Prudential and Schon.