Commercial banking, one of the main mechanisms of financial intermediation in bringing the investor and the saver together and providing credit to the investor as well as the consumer, has an important role to play in the economy.

A reduction in lending can lead to an effective decline in investment as well as aggregate demand. However, rightly or wrongly, common perceptions about banking in this country are ‘not very positive.’ These include:

* banking is unfriendly to small enterprise; banking has catered to the whims of the influential and the rich; banks follow self-defeating policies that make obtaining credit difficult and the cost of obtaining one high. In other words, they run counter to the very purpose of banking.

The problem is compounded by the absence of other developed institutions in the field. What we have are usually on small scale in the informal sector or are community-based. To the housing (and construction) industry, banking has been more or less closed. For this purpose, the government set up the House Building Finance Corporation at an early stage. Some foreign banks and housing finance companies, who sensed a vacuum in this area, are making credit available for individual home owners as well, but at rather severe terms for people of ordinary means.

In theory, commercial banks are supposed to disburse three types of loans: industrial and commercial loans, real estate loans and consumer loans. Considering the high percentage of default in the bigger loans, the risk factor is likely to go down with greater loan disbursement for small and medium businesses and enterprises.

Now that the government have woken up to the possibilities of ‘micro finance for poverty alleviation’ of the very poor, separate ‘microfinance institutions’ are coming up with much fanfare, that perhaps spend more funds on publicity than on real disbursement. As in other fields, so in banking there is little manifestation of creativity and innovation. An idea is taken our only after someone else has shown the way; in this case the Grameen Bank of the Bangladesh. The idea is worth taking up, nevertheless, by all commercial banks, which can prescribe a part of their funds for microfinance operations, and also make it easier for small entrepreneurs to obtain loans. They usually play safe by catering to the more well-off segments of society and subsidizing industries that fall under the definition of consumption rather than production, such as car and other consumer loans for government and corporate employees is one example of this trend.

This is not to say that such practices are exclusive to our banks. But one must heed warnings such as by the American author, Christopher L. Culp, in his “How to Solve the Debt Crisis”. He reminds the banks of the well-known proverb: “If bank loans out a thousand dollars and the debtor defaults, the debtor is in trouble, but if a bank lends a hundred million dollars and the debtor defaults, the bank is in trouble.” This applies forcefully in our situation, when was consider how our banks have allowed themselves to be exploited exclusively by big and influential borrowers. When they default, not only banks get into trouble, but often the bank officials as well, who obliged the influentials in the first place. But the practice continues, the remedy sometimes applied being worse than the malady: manipulative accounting, or more lending to pay off past debts and interest, which further compounds the interest and the vicious circle continues.

There are complaints of high gaps between lending and borrowing interest rates. The depositors suffer in this process, and the practice contributes to a decrease in the saving habit. According to the Economic Survey, even with the lending rate constantly coming down since 1997, the difference between the deposit and the lending rate is much in favour of the banks, and yet the banks are charging highly for their services! Dr Ishrat Hussain, the SBP governor, wanted the banks to reduce this large gap, but the “bankers argue they are plagued by the non-performing loans at almost Rs300 billion and the loan default of Rs 170 billion.” (Dawn, EBR January 7-13, 2002, p. VI). This only goes to prove our assertion about the big loans. The government has further rewarded the banks and punished the savers by the recent further two per cent cut in NSS interest rates.

Neither the banking courts set up under the Banking Companies Recovery of Loans Advances, Credits and Finances Act, 1997, nor the military government (after October 1999) has had more than a limited success in recovery of large loans, although the latter had made it their foremost aim to ‘recover’ loans from big defaulters. The biggest hurdle in this exercise seems to be the influence and higher ‘bribing power’ of the big loan defaulters.

The small entrepreneur, simply because he is less influential - and hence meek and humble, unlike the influential and arrogant big borrower, is more inclined to pay off his debt in time. Unless in real dire straits, he just cannot afford not to return his loan. For every case of a small loan default, there will be thousands of those who would timely pay their debts.

Poverty cannot be fought, nor economic growth sustained, without making available substantial credit facilities to small entrepreneurs. Small entrepreneurs encouraged could become the real big entrepreneurs of tomorrow. Traditionally, there has existed a larger proportion of non-genuine entrepreneurs among big borrowers, for obvious reasons.

SMEDA, established in 1998 as a federal autonomous corporate body with prime minister as its head, and governing board members from both public and private sectors, was in principle a step in the right direction, but the government needs to re-institute the practice of partly underwriting and fixing targets for small loans disbursed by the banking sector as was done prior to 1995.

Rapidly increasing transaction costs are one major problem for the small businessperson. When banks resort to charging exorbitantly in the name of rising prices and ‘profitability’, they are inadvertently killing the goose that lays the golden eggs, without realizing it, by inadvertently reducing the volume of their deposits and business. They must realize that transaction costs act as a damper to using banking channels as far as the small saver and the small investor is concerned. The success and continued popularity of the hundi system owes itself largely to the rising bank service charges, and the greater amount of time required by banking channels. A large number of Pakistanis abroad prefer these informal services over normal banking channels. As one fallout of the ‘war against terrorism,’ there has been a crackdown on ‘hundi’ and ‘hawala’ and other non-banking systems, but they will not be easy to eradicate unless the banking channels are made less costly and time consuming.

Finance minister, Mr Shaukat Aziz, and a former Citibank executive, admitted the greater popularity of the unofficial channels when he complained that only $1.2 billion out of $6 billion sent annually to Pakistan from abroad came through the banking system. The scrutinizing of money movements around the world has resulted in more funds entering Pakistan ‘officially’ according to him. But this may be temporary, as it is impossible to ban something that goes on without much documentation, based on trust, and provides services at a low cost that the banking system is unable to provide. They even convey money to the recipient’s doorstep in remote villages. In contrast, according to The Economist (November 24th 2001, p. 77), “Western Union, a money transfer service, charges $22 to transfer $150 from New York to Pakistan - a 15 per cent commission!”

Historically, one reason for the establishment of banks and their success was the reduced cost of transaction in loan agreements, specially for small loans, on account of economies of scale. Unfortunately, there is a trend towards rising cost, that is doing more harm than good to banking. Too many hurdles force the people to turn to informed lenders, who lend at high interest rates to small business without asking too many questions, and who usually rely on personal influence, and relationships, - or sometimes on strong-arm methods - for the return of loans. In Karachi, the transport industry is one example where such a system of lending is in place, but its destructive influence on the transport system is also well known. A multi-tiered interest rate structure of bank loans can alleviate the problem.

Different rates of interest, depending on the purposes of the loan, - industrial, commercial, or consumption - can apply to loans, since interest rates have an important bearing on investment.

Too many formalities for sanction of a loan do not prevent default by the big sharks, but do effectively exclude small entrepreneurs from the credit facilities.

The small consumption loans being given by a number of smaller of smaller banks, the foreign banks in Pakistan, targeted at upper income bracket employees of the corporate sector and the government organizations, may serve to stimulate demand in certain sectors, but their beneficiaries are confined to a narrow band. They are also promoting the credit card mania, that serves a limited segment,’ at high cost.

Banks, therefore, have come to operate within a narrow, comparatively safer segment, catering to the whims of the influential, and fixed their sights on them short term goal of profit making, and are but of little benefit to the entrepreneurial class.

Banks should be made to serve productive ends, economically speaking, and their loans diversified through judicious lending activity and proper monitoring. The banks somehow seem more inclined to rely on government’s coercive power than initiating research-based, enterprise-friendly policies. They believe that the people should be forced to use banking services through getting the government to enact laws and lay down rules. The motto should be to bring about an improvement in banking services while generating much needed economic activity.

In practice, one often finds that even ordinary Pay Orders are getting so costly that people try to avoid them in business transactions and real estate deals involving high amounts. The government’s mandatory use of Pay Order, even for minor payments to government institutions, goes to generate much public resentment.

Banks have to contribute their part by reducing the transaction cost wherever possible, and making capital available to genuine entrepreneurs on the basis of the soundness of their enterprise rather than on their political connections.

Banks can also help through simple and convenient procedures for obtaining capital on the strength of assets, a pre-requisite for the success and flourishing of entrepreneurship. In short, small loan seekers should be granted credit on the basis of their assets and the genuineness of their entrepreneurial schemes.

Small loans given against reasonable guarantees of either property or liquid assets such as government bonds, or guarantees of well placed individuals for the return of the loan, can greatly contribute to bringing many small businesses into the tax net through documentation, a necessary part of the lending process. Since showing successful performance would be in their own interest, tax evasion would become more difficult.

Responsible lending is lending that serves productive economic ends and stimulates growth, not what keeps looking for apparently ‘safer’ niches, that ironically turn out in the end not even to be safe!

Banks should also make it easier for people to maintain savings accounts, by removing impediments like the recent bureaucratic ‘directives’ that sought to impose high ‘minimum balance’ requirements for savings accounts! Here one cannot help noting that the pioneers of Pakistani banking industry after partition, the Habib Bank and the United Bank for example, stressed more branches with smaller account opening amounts. The result: banking flourished. Today, with banking more and more at the mercy of the bureaucrats and technocrats, specially the imported ones, banking is often faced with crisis. The contrast speaks for itself.