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IMF for stronger banks

THE caretaker government agreed in principle to borrow $5 billion from the International Monetary Fund in an Extended Fund Facility last month.

Haunted by a burgeoning fiscal deficit and depleting foreign exchange reserves, the interim government is looking for a bailout. But any agreement of the sort will be negotiated by the next elected government.

But it is clear that the IMF has not kicked away its habit of tying strings to every dollar that it agrees to lend. The Fund wants Pakistan to introduce major reforms, including those in the banking sector.

“The State Bank of Pakistan (SBP) has been asked to take effective steps, in consultation with the government, to introduce safeguards in case of failure of small banks by increasing the capital adequacy ratio (CAR), and possibly setting up a common fund for facing off risks of small and medium private commercial banks,” a source privy to the talks with the international lending agency disclosed. He added the IMF programme proposes that the insurance scheme for bank depositors be expanded through an effective mechanism.

Yet the focus is perhaps on the CAR. Simply defined, it is a ratio of a bank’s capital to its risk. Regulators track a bank’s CAR to ensure that it can absorb a reasonable amount of loss, and that it is complying with statutory capital requirements. CAR is calculated as a measure of the amount of a bank’s core capital, expressed as a percentage of its risk-weighted assets.

For a layman, the confusion is confounded when a banker goes deeper into explaining Tier 1 capital and Tier 2 capital, and the Basel III requirements for banks to have a minimum core Tier 1 capital ratio of seven per cent by 2018.

All of these rules impact the CAR. To simplify, a banking sector analyst at Topline Securities, Zeeshan Afzal, affirmed that CAR was the ratio of capital to risky assets. Raising the CAR means switching over from investments in which there is risk of default of the principal amount, to safer assets such as government securities and cash.

Afzal recalled that the SBP had fixed the CAR requirement at 10 per cent. But according to his calculations, CARs of some bigger banks at present are much higher: MCB’s is at 22.13 per cent, UBL’s at 14.8 per cent, HBL’s at 15.8 per cent, Meezan Bank’s at 14.08 per cent and Bank Alfalah’s 12.67 per cent. The analyst said that balance sheets of many smaller banks lacked full disclosure, which made it difficult to figure out their CARs.

But keeping the CAR aside for a moment, it needs to be noted that the central bank had also raised the minimum capital requirement (MCR) to further strengthen the solvency of individual banks. On October 28, 2005, the SBP had directed banks to raise their MCR in a phased manner to Rs19 billion by December 31, 2011, and to Rs23 billion by December 31, 2013.

However, on April 15, 2009, the SBP stepped back and slashed the MCR to Rs10 billion, to be achieved by end of 2013, to provide the banking sector breathing space following the global financial crisis of 2008.

At the time, the Pakistani banks were staring at a deterioration in their asset quality, as they were being dogged by non-performing loans (NPLs), and low deposit growth. Banks’ infected portfolio had surged to Rs325 billion by the end of 2008, and the bad loans were a threat to the capital base of the banking system.

The ‘Financial Stability Review’ of the SBP, released on November 12, 2012, showed that a dozen banks were short of the MCR of Rs8 billion stipulated for the year ended December 31, 2011. Five banks, with a market share of 3.6 per cent, stood short of the CAR requirement as well.

While the SBP noted in the Review that NPLs were on the slide, yet they were high enough to adversely affect the solvency of the banking sector.

However, in its latest conditions for the EFF, the IMF mentioned the CAR, but overlooked the MCR. Former SBP governor Syed Salim Raza told Dawn on Thursday that excluding a few banks, the rest of the banking sector ought to be comfortable with the MCR. To bring about a change in CAR is within the control of individual banks, he said, before adding that IMF’s observations with regard to the banking sector could be good housekeeping comments.

“I expect the SBP is on top of the situation,” he said. The former SBP governor recalled that during the global financial crisis of 2008, Pakistani banks were relatively safe. However, by the end of 2008, three to four banks were faced with dire liquidity problems. Mr Salim Raza emphasised that the issue was of ‘liquidity’, and not ‘solvency’. And it was all due to money supply contraction, currency depreciation, and a sharp fall in foreign exchange reserves. He affirmed that since there was no problem of solvency of these banks, the issue was resolved within three or four months.

Meanwhile, former chairman of the Pakistan Bankers’ Association and former managing director of Citibank, Mr Zubyr Soomro, said following the financial crisis of 2008, risks had increased, and globally, banks were playing safe. They were concentrating on the quality of their deposits, and investing in government papers.

He said as regulators work their way through the mess of the banking crisis, it was realised all over the world that credit quality and corporate governance were of vital importance. To improve the efficiency of banks, it was essential to raise the standard of their board of directors, said Mr Soomro. “Sure footed management, careful customer selection and heavy investment in technology are the key for banks to survive and grow.”

Another senior banker, who asked not to be named, said in order to improve their CARs, banks need to shun riskier assets that offer higher returns. He also believed that by imposing banking related conditions in the $5 billion EFF, the IMF may not necessarily be making a political point.

“It may be treading cautiously after lessons learnt from the 2008 crisis and the Cyprus banking debacle, so as to ensure that all savings are safe,” he observed.