PAKISTAN has completed the first phase of the ‘financial sector reforms’ and is now implementing the second generation of reforms covering 2005-10. The previous Governor of the State Bank of Pakistan (SBP,) Dr Ishrat Hussain while giving an appraisal of these reforms, attempted to answer the question: how do these reforms serve the interest of the common man as a consumer, depositor and businessman?
The areas covered included; privatization of NBCs, corporate governance, capital strengthening, improving asset quality, liberalization of foreign exchange regime, consumer financing, mortgage financing, legal reforms, prudential regulations, micro-financing, SME financing, taxation, agricultural credit, Islamic banking, E-banking, human resources, credit rating, supervision and regulatory capacity and payments system.
The only reference to bank depositors is, “One of the adverse effects of lower interest rates has been the erosion of rate of return on bank deposits. Small depositors who keep their saving in the banks have been hurt as they hardly get any decent return these days. As interest rates move up in the economy, it will be depositors who will get the benefit while borrowers will have to pay a higher price.”
Earlier, addressing the annual general meeting of the IBP on November 17, 05, Dr Ishrat had bemoaned the banks’ treatment of depositors and warned them to improve it in terms of return.
The real rate of return on deposits has become negative in a big way. It was so at 7.38 percent in June 05. The return on bank advances has gone up, as a result of tight monetary policy, but very little benefit has accrued to depositors. Banks’ own spread has increased by almost two to 7.26 per cent, or 2.5 times the return to depositors.
In spite of slackening of inflation and a small nominal increase in return on deposits, the negative real rate for the current year, as of February 06, works out to 5.67 per cent.
The SBP’s present Governor, Dr Shamshad Akhtar, at the outset of her tenure, has noted the current negative real rate of return on deposits and said at a recent investors conference—Expo 20006: “The scheduled banks have to show maturity by raising deposit rates so that their clients, who are presently having negative return, could benefit.”
The SBP as the guardian of the financial system, is to be even-handed in its policies and redress, if any injustice emerges to hurt a vulnerable group in the economy. Unfortunately, the bank, wittingly or unwittingly, plays a major active role in systematic exploitation of bank depositors.
First of all, instead of being the lender of last resort to ease the temporary liquidity problem of banks, the bank has become a primary source of capital injecting money on a massive scale by way of investment and loans to financial institutions and financing fiscal deficit.
Since the end of FY 04, when tight monetary policy was initiated, the bank been responsible for one third of the increase in money supply during this period ending February 06. On overall basis, the bank accounts for more than a quarter of outstanding total money supply.
In June, 04, the ratio was 15.8 per cent. It is significant that the money injected by the bank now exceeds currency in circulation. The artificial increase by the central bank in loanable funds ultimately depresses the rates of return to savers, making a mockery of what is claimed as market-determined interest rates.
Further, by denying an opportunity to banks to invest in government securities, the SBP reduces the income of banks, which is to be shared with their depositors. Instead of increasing, in line with their deposits and SLR, banks’ investment in government securities, which had been increasing, has declined by 12 percent since June 04.
The bank controls the structure of public debt keeping it short-term by not issuing long-term debt. Some time the auctions are scrapped by the bank by meeting the unfilled requirement of fiscal deficit, the bank helps the fiscal position of the federal government not only by keeping the cost of debt servicing low but by also yielding non-tax revenue by surrendering the surplus profit as a nationalized institution.
The bank’s holding of federal government securities, mostly TBs, has shot up from Rs110.3 billion in 03 to Rs553.6 billion at the end of February 06. In the process, the Bank creates serious distortions in the economy discouraging saving. This is not just a conjecture. It is an actual worrisome aspect of the economy.
Domestic savings have been traditionally quite low but during the last three years, despite impressive rates of economic growth rate, this rate declined from 18.1 per cent in FY 02 to 13.2 per cent in FY 05. The drop in household savings has been far more pronounced, from 16.8 in FY 03 to 10.8 per cent FY05.
Last but not the least, the formula prescribed by the bank for distribution of banks’ income between banks and their depositors is heavily weighted in favour of banks to the utter disadvantage of the depositor. Banks’ equity is given a weight of five but no weight is given to deposits.
Banks’ return on equity (after tax), which was negative by Rs3.9 billion December 1999 had become positive by Rs22.1 billion in June 05.There can be no justification for discrimination against deposits in regard to income distribution. This is simply unjust. The need for equitable distribution cannot be over emphasized.
Banks add insult to injury by totally denying any return to small depositors. They have fixed the amount of balance below which they give no return. The limit is not standardized but depends on the sweet will of banks. The limit is quite high for a poor country like Pakistan. For instance, National Bank of Pakistan (NBP), a nationalized bank, has fixed it at Rs20,000, equivalent to six months’ per capita income in the country.
Foreign banks’ limits are much higher. Even above that limit, the rates are graduated, higher the balance greater the return, or inversely the smaller the balance lower the rate of return. By the NBP criterion, there were 6.9 million personal deposit holders representing 41.3 of the accounts in that category, and accounting for deposits of Rs55.8 billion got no return for FY 05. The actual loss is manifold, if other banks’ higher thresholds, which in some cases are in hundred thousands, are taken into account.
Banks also go a step further when they also set the limit of minimum balance to be maintained to avoid substantial service charges imposed on monthly basis. Small depositors’ tale of woes cannot be complete without mentioning the withholding tax (WT) of 10 per cent on return on despots regardless of the amount paid or the position of the depositors whether he or she is rich enough to be subjected to income tax or not.
Those otherwise subjected to income tax are able to get relief by adjusting this payment in their total liability. Interestingly enough, the rate of tax in the first income tax bracket is five per cent, half the rate paid by a poor small depositor. In short, WT on return on banks deposits flouts all established canons of taxation and mocks at the very rudimentary concept of equity.
Mention may also be made of Zakat deduction at 2.5 per cent above the Nisab from those Muslims who do not evade it through declaration of their Fiqah or withdrawal of deposits prior to the declared date of deduction.
It would be stating the obvious that the treatment small depositors get from banks is shabby, to say the least. No wonder, they are now quite disillusioned and are actually withdrawing from them. The number of small deposit accounts less than Rs20,000 each has fallen from 11 million to 6.9 million and the amount of the deposits from Rs102 billion to Rs56 billion over five years. The ratio of total personal accounts to population, instead of increasing due to education and urbanization on top of rapid population growth, has remained low at 10.9 per cent in 05.
The SBP would do a great favour to savers in general and bank depositors in particular, if it recognized the ground reality of development of Pakistan that has taken place over more than half a century, give up the relics of the early 50’s and let the market mechanism have a chance to operate un-hindered. Gone are the days when, in absence of vibrant private sector and hardly any financial institutions, the SBP had to assume an unorthodox active developmental role.
Private enterprise and the financial system are now fairly well developed to meet the current requirements. The bank better stop pumping its money into an economy, which is already awash with liquidity. The present subordination of monetary policy to fiscal policy to serve the narrow interest of reducing debt servicing burden and the central bank underwriting fiscal deficit needs to be reconsidered in view of its long term-deleterious effects on the economy as a whole.
The traditional lacklustre domestic saving and its recent declining trend, despite economic growth, is enough of a manifestation of the current state of basic health and prospects of the economy.