Days when milk and honey were flowing their way may not exactly be over, but banks now have to trim their sails or get ready for rougher waters.

However, there could also be a silver lining in the travails that the banks now face.Its time for them to wake up and shed their excess baggage, trim themselves and be aggressively competitive to face the banking and financial sector ground realities of the 21st century.

The central bank— the State Bank of Pakistan (SBP)— has been repeatedly warning about these. Why? The SBP’s benchmark discount is now down from 14 per cent in July 2001 to 7.5 in November, 2002. March saw the six-month tenure Treasury Bills (TBs) tumbling down from 3.17 to the lowest-ever 2.17 per cent on March 5, from an average of 6.3 percent in July 2002. The big, March 5 decline in TB rate followed 155, low-priced bids offered by commercial banks, out of which the SBP picked up only 14.

The government’s 10-year tenure Pakistan Investment Bonds (PIBs) March 8 were down to a record-low yield of 4.8 per cent. TBs and PIBs have been a longtime favourite of easy-going commercial bankers as these were safe, secure and high-yielding instruments, involving hardly any effort.

The reduced discount rate, and lower TB and PIB yields are SBP’s signals, for nearly two years now, for bankers to lower their lending rates in order to boost the economy. Bankers have proved to be the reluctant grooms to do so. But having none other sources to invest, rising liquidity and fear of reduced profitability have forced banks to lower their average-lending rates to 9.95 per cent in January. But at whose cost?

Again the banks are not really being generous, nor they are being accommodative of the needs of the economy. They have principally done the rate-cutting at the cost of savers, in a country that has the dubious distinction of having one of the lowest savings rates even among the developing countries.

In fact the banks have already slashed down the profit rates to savers to a paltry 3.21 per cent a year in January this year, from the already meagre 4.02 percent in July 2002, according to the SBP. With deposit and profit rates that low, who is going to save? The SBP Governor, Dr. Ishrat Hussain, keeps on urging everyone to increase savings to feed the economy and attain a modicum of self-reliance. But, should he not force banks to heavily slash their cost of intermediation, drastically narrow down their spread, and stop uttering extravagance to raise—and not reduce— profit on deposits?

If Dr Ishrat cannot do so, he and other economic bosses should forget about the national rate of savings, and let it plunge down to zero. Hasn’t his monetary policy been totally unmindful of the savers who have been left to wolves.

Remember: the inflation rate rose to 3.53 percent at the end of the first eight months of fiscal 2003. Also, can the Finance Minister Shaukat Aziz still guarantee that his projection of inflation rate for the year will stay below 4 percent? Whether or not that happens, doesn’t the present situation mean that the depositors are paying from their own pockets to let banking flourish at their cost because of the negative return and erosion of their inflation-hit deposits?

An 11.3 per cent monetary expansion has already taken place in the first seven and half months of the year, according to the central bank. The SBP on January 29 raised the monetary expansion projection for the year from 10.8 to 16 per cent, because it expected that substantial forex in the form of home remittances and other inflows will continue in the foreseeable future.

What has, or may, hit the banks and their profitability? Finance Minister Shaukat Aziz puts this in a nutshell: “Pakistan has undergone a paradigm shift in banking over the last two years.This challenge can alone be faced if the banks launch new products and instruments. Banks should find new borrowers and sectors, such as housing and mortgage, small and medium enterprises, farm sector financing, and consumer loans.”

Shaukat and others know that its easier said than done for Pakistanis and Pakistan-based foreign bankers who have generally lived a cushy life in a country where the SBP lorded over a tight monetary policy, and a perpetual credit squeeze resulting in a perennial short supply of credit, while interest rates, for decades, remained astronomically high, and it was considered an act of great favour if one succeeded in borrowing from a commercial bank.

To illustrate the point, I still remember that commercial banks’ lending rates were as high as 22 to 25 per cent a year even until 1999. The businsses suffered. The credit ordeal was one of the key factors of shuttering down nearly 5,000 industrial units, and many more businsses vanished, as mostly fake, and some genuine borrowers, ate up nearly Rs300 billion in defaulted loans. Several of these huge credits were granted as political favours, while in other deals bankers themselves had enjoyed huge sums behind the cover of invisible borrowers.

Things reached a head when the recession-hit economy, worsened by political uncertainty and a frequent change of governments—and policies—, and large inflows of home remittances sent by overseas Pakistanis working in the Gulf, Saudi Arabia, Middle east and North America sharply rose. It meant a large and progressive build-up of liquidity with the banks. There simply were no takers as the lending rates stayed high. The credit targets, the SBP set for lending to the private sector, remained largely unutilised. The credit offtake, though, has just improved.

In fact, banks’ travails had started in May, 1998 when after eight years of dollarization of the economy during which most people converted their value-loosing rupees into dollars and deposited a total of $ 11 billion with banks in what was called Foreign Currency Accounts (FCAs). The FCAs were frozen, as successive governments had used up the greenbacks leaving hardly $ 400 million as SPB’s forex reserves. The banks until then had relied on lucrative dollar business, and cared little to mobilise, or invest, domestic rupee resources, in parallel with lack of high-interest credit take-off.

Shaukat and the SBP Governor Dr. Ishrat Hussain, are persistently urging both domestic and foreign-based banks in Pakistan to go for innovative ways in order to lend to the private sector. There are two main reasons for that: the government, does not require much borrowing—including through the instruments of TBs and PIBs—from the banks and interest rates are declining. In fact, the government will retire Rs. 29 billion of its debt to banks during this fiscal, and borrow nothing.The SBP has scaled down the expected private sector borrowing at Rs. 50 billion down from the earlier projection of Rs. 94 billion for 2003. Private businesses borrowed Rs. 77 billion during the first eight months of this year, but it has also started repaying a substantial part of these credits. Private sector credit take-off in 2002 was only Rs. 30 billion . No government borrowing and smaller private sector credit take-off means a further increase in the banks’ accumulating liquidity.

The banking sector, at the moment, is in an ideal situation to help the economy boost after it has been through years of stagnation that will be the situation if the financial sector, in particular, and the economy in general, were operating under a perfect market. Pakistan is not only an imperfect market in every sense—and in every sector or activity, its elite operators wish the government, and particularly its people and clients, to spoon-feed them.

That may not be possible even for the SBP that itself is loosing an estimated Rs20 billion this year on account of its support operations of keeping the rupee-dollar parity in a state of stability. The government, too, can hardly be of much help as it itself is slowly coming out of decades of huge budgetary deficit. The IMF and Islamabad’s other financial godfathers will not let it slip back into red, once it has attained a modicum of coming into black, even though it is partly thanks to 9/11 events, but mainly through the courtesy of the ever-neglected overseas Pakistanis whose remittances have played a great role in keeping the economy afloat.

Operational results for the calender year ended December 31,2002, just out, show good profits for almost all types of banks,ranging from Abu-Dhabi owned the United Bank Ltd. to the Faysal Bank and the Union Bank that have large Gulf-Middle East share-holdings to locally-owned the First Women’s Bank, the PICIC Bank, and the National Bank. But, during calender 2003 that started amidst interest rate cuts, profitability may never be the same again for this, as yet, robust sector.

What is the way out? Only one: the bank executives and their elite class has to come out into the open market, compete, and compete aggressively, produce new and innovative products, go into new fields that they have always shunned for their alleged high-risk and low creditworthiness. Because, isn’t banking, itself, the calling and profession of risk-taking?