Pakistan Banking Sector

1. ECONOMIC OVERVIEW:
Pakistan’s economy has been predominantly agrarian. Since Pakistan came into existence, the contribution of the agricultural sector to the GDP has declined gradually from over 50 percent in 1949-1950 to about 22 percent in the fiscal year 2009-10 (July 2009-June 2010). However, agriculture still remains the major sector of the GDP composition. Other economic sectors include industry and services, contributing to the GDP about 25 percent and 53 percent respectively. Since its independence in 1947, Pakistan has transformed itself from a low skilled agrarian economy to a semi-industrialized economy. On the other hand, Pakistan has a long way to go in economic and social development as a large portion of its 180 million inhabitants is still living below poverty line. During the last decade, economic developments in Pakistan have been – to a significant extent influenced by the Government’s Program for poverty reduction and the development of markets and the real economy. Following the liberalization of markets and the implementation of economic reforms, the following developments in the economic and social sector have been identified: High GDP growth resulting from output and sales growth;

Monetary stability;
Developments of money and securities markets;
Improvements in the standard of living and poverty reduction (based on economic growth); Development and reinforcement of the banking sector and enhancement of its role in the social and economic development of the country.

However, the economic development has been slowed down since 2008, as the macroeconomic situation deteriorated significantly owing to adverse security developments, large price increase of some commodities such as oil and food, global financial turmoil, and national political and security issues. Other challenges being faced by Pakistan’s economy include energy deficiency and growing population etc.

Furthermore, recent unprecedented floods and torrential rains (July-August 2010) in the country to some extent have intensified the effects of an already fragile macroeconomic environment. Currency: Pakistani Rupee (Rs.) is the official currency of the country. The notes are in denominations of 5000, 1000, 500, 100, 50, 20 and 10, while coins are available in denomination of 5, 2 and 1.

Rupee CHF parity/Exchange rate: 1 CHF = 92.47 Rs. as on February 25th 2011. Download from: www.osec.ch

2. OVERVIEW OF FINANCIAL SECTOR:
A sound and well functioning financial sector is essential to support economic growth of a country. Pakistan possess a wide range of financial institutions; commercial banks, specialized banks, national savings schemes, insurance companies, development finance institutions, investment banks, stock exchanges, corporate brokerage houses, leasing companies, discount houses, microfinance institutions and Islamic banks. They offer a whole range of products and services both on the assets and liabilities side.

Prior to 1971, the primary focus of the Governments was on developing commercial banks in the private sector and creating development institutions backed by Government. The private sector development, however, almost closed during the period 1971-1990, due to the nationalization policy of the Government. During this period, the banking sector came under the Government’s control. Since 1990s, the Government has followed more liberal and market-based reforms. The current structure of the financial sector in Pakistan is the result of several policy shifts and developments. Like many other developing countries, Pakistan also undertook the process of financial restructuring through reforms in early 1990s to establish a more market-based system of financial intermediation and Government financing, conduct the monetary policy more efficiently through greater reliance on indirect instruments and increase the contribution to the rapid development of the stock markets.

During the last few years, financial markets and institutions in Pakistan have witnessed significant changes in terms of consolidation as well as diversification. Since 2000, more than 40 transactions of mergers and acquisitions have been executed within banks and between banks and non-bank finance companies. On the other hand, a number of banks/development financial institutes as well as their holding groups have expanded their activities into the areas where the banks hitherto were either not allowed or not interested. These include insurance, asset management, brokerage, leasing and other non-banking finance services essentially through separate entities. Along with financial services, various groups that control different banks have also stakes in non-financial/real sector of economy.

In the World Economic Forum’s “Financial Development Report 2009”, Pakistan has been ranked 49 out of 55 countries. Under Factors, Policies and Institutions pillar, Pakistan ranks 52nd in institutional environment, 50th in business environment and 48th in Financial Stability. In the Financial Intermediation Pillar, Pakistan ranks 46th in banking, 51st non-banking and 25th in Financial Markets. Under Financial access, Pakistan ranked 50th.

State Bank of Pakistan (the central bank of the country) is the sole supervisory and regulatory authority of Commercial Banks, Islamic Commercial Bank, Development Financial Institutions (DFIs), Micro Finance Banks and foreign exchange companies in Pakistan. The remaining financial institutions are monitored by other authorities, such as the Securities and Exchange Commission.

3. BANKING SECTOR:
Pakistani banking sector has witnessed drastic changes over a period of 63 years since country’s independence in 1947. Initially it suffered from acute shortage of resources and uncertainty due to prevailing political and socioeconomic conditions. Lack of trained human resource and professionals resulted into poor quality of products and services. State Bank of Pakistan was established as the Download from: www.osec.ch central bank on July 1, 1948 to control the financial sector. Subsequent amendments were made to extend the control and functions of SBP through State Bank of Pakistan Act 1956. SBP encouraged the private sector to establish banks and financial institutions in the country. It resulted into unhealthy competition and unlawful practices due to bribe and corruption during the decades of 1950s and 1960s.

In 1974, all the existing banks were nationalized by the Government. The performance of nationalized banks deteriorated due to government protection to employees, resulting into the provision of inferior products and poor services. It also discouraged the private investors and foreign financial institutions. The poor performance of nationalized banks caused the reforms/privatization of banking sector in early 1990s.

Today, the Banking sector of Pakistan is playing pivotal role in the growth of country’s economy. In accordance with the State Bank of Pakistan Act, the banking system of Pakistan is a two-tier system including the State Bank of Pakistan (SBP), commercial banks, specialized banks, Development Finance Institutions (DFIs), Microfinance banks and Islamic banks. As of June 2010, the banking sector comprised 36 commercial banks (including 25 local private banks, 4 public sector commercial banks and 7 foreign banks) and 4 specialized banks with a total number of 9,087 branches throughout the country. Among the banks, there are 6 fully fledged Islamic banks as at end of June 2010.

Source: State Bank of Pakistan
* Since December 2010, Atlas Bank Ltd. and Arif Habib Bank Ltd. have been merged and formed Summit Bank Ltd.

In addition to the above, the SBP has granted licences to the Industrial and Commercial Bank of China (ICBC) and Sindh Bank in December 2010. The ICBC aims to exploit opportunities in trade and project finance generated by a growing number of Chinese companies working in Pakistan while Sindh Bank aims to promote agricultural development and small scale businesses. Besides the commercial banks, 8 Microfinance banks and 7 Development Finance Institutions (DFIs) are operating in the banking industry of Pakistan. Due to closing down of a number of Development Financial Institutions (DFIs) during the last decade, the government is currently re-considering to set-up either an “Infrastructure Bank” or “Infrastructure Institution” as this is requirement of the country. The banks in Pakistan provide settlement and cash services to individuals and companies, including correspondent-banking. Banks also offer domestic and cross-border remittance services to the population. Furthermore, they provide depository services for the accounting and safekeeping of securities. During the last few years, banks have been paying great attention to the expansion of services rendered to households and the enhancement of their quality and efficiency. New forms and channels of making payments have also been introduced.

The services of State Bank of Pakistan include payments to banks, to and on behalf of the Federal and Provincial Governments, the Treasury and some other public institutes including collection of revenues etc., through its 16 field offices as well as through a countrywide network of currency chest/sub-chest branches of National Bank of Pakistan.

As mentioned earlier that the financial landscape of the country which was significantly altered in early 1970s has been transformed – through sector reforms initiated in the early 1990s – into an efficient, sound and strong banking system. The reforms have resulted in an efficient and competitive financial system. In particular, the predominantly state-owned banking system has been transformed into one that is predominantly under the control of the private sector. The legislative framework and the State Bank of Pakistan’s supervisory capacity have been improved substantially. As a result, the financial sector is sounder and exhibits an increased resilience to shocks. Today, almost 80 percent of the banking assets are held by the private sector banks and the privatization of nationalized commercial banks has brought about a culture of professionalism and service orientation in place of bureaucracy and apathy.

Banking Technology that was almost non-existent in Pakistan until a few years ago has revolutionized the customer services and access on-line banking, Internet banking, ATMs, mobile phone banking/ branchless banking and other modes of delivery have made it possible to provide convenience to the customers while reducing the transaction costs to the banks. The Credit Cards, Debit Cards, Smart Cards etc. business has also expanded.

The foreign exchange market that was highly regulated through a system of direct exchange controls over suppliers and users of foreign exchange has been liberalized and all purchases and sales take place through an active and vibrant inter-bank exchange market. All restrictions have been removed with full current account convertibility and partial capital account convertibility. Since 1st July 2008 Real-Time Gross Settlement (RTGS) payment system has been put in place. The RTGS in Pakistan has been named as Pakistan Real-time Inter-bank Settlement Mechanism (PRISM). Using this system, the banks holding accounts at SBP are able to operate their accounts in real time from their own premises via computerized network between SBP and the participating Banks.

Prior to the recent financial crisis, the excess liquidity and competition among the banks prompted them to move away from the traditional limited product range of credit to the government and the public sector enterprises, trade financing, big name corporate loans, and credit to multinationals to an ever-expanding menu of products and services. The borrower base of the banks expanded many folds as the banks diversified into agriculture, SMEs, Consumers financing, mortgages, etc. The middle class that could not afford to buy cars or houses/apartments as they did not have the financial strength for cash purchases had been the biggest beneficiaries of these new products and services. 3.1 Current trends in Pakistan’s banking sector:

Since late 2007, Pakistan faced a difficult macroeconomic environment, not as such due to the global crisis but rather due to a confluence of factors which had been brewing for a while, particularly due to the gradual build up of macroeconomic imbalances which led the country to embark on a macroeconomic stabilization program in November 2008 with the support of the IMF SBA. The Global Financial Crisis (GFC) had an indirect impact in Pakistan which became evident in 2009 and manifested itself in various forms in the real sector of the economy. However, as said earlier, the major challenges facing the domestic economy can only be partly attributed to the GFC. Indeed there was a decline in exports due to recession in economies which are Pakistan’s major trading partners, and there was pressure on capital flows where strained liquidity position in global financial markets impacted foreign portfolio investment.

However, factors such as the power shortages leading to under utilization of industrial capacity and rise in the cost of production, the long‐standing issue of inter‐corporate circular debt, considerable decline in foreign direct investment due to weak economic fundamentals, high inflation, security concerns and above all, the mounting fiscal deficit breaching previous records in the country’s economic history, all had a role to play in keeping the process of economic recovery in Pakistan weak at best. The leading evidence of these various pressures on domestic firms and industries is that their loan repayment capacity has been compromised, with a consequent rise of non-performing loans (NPLs) on the banks’ balance sheets.

Furthermore, due to the deteriorated fiscal situation, public sector borrowed heavily from banks for budgetary support, financing needs of Public sector Enterprises (PSEs) and commodity operations. Accordingly, there has been a shift in banks’ asset-mix towards credit to the public sector along with increased performance for top rated corporations – over Small and Medium Enterprises (SMEs) and consumer that are generally less resilient to economic slowdown and fragility in operating environment. The heightened credit risk is reflected in a noticeable and persistent increase in NPLs – doubling over two years by the end of calendar year 2009.

Nevertheless, it has tested the resilience of the banking sector in that banks have been forced to build contingency reserves and provide for infected assets. Such requirements have been affecting their dividend payments and consequently putting pressure on their share prices. 4. BANKING SECTOR ASSESSMENT 2009:

4.1 Assets structure of banking system:
Assets of the banking system have been growing at an average of 14.8 percent since Calendar Year (CY) 2001. At the end of the year 2009, the total assets of the banking system reached Rs 6.5 trillion a growth of 15.8 percent. The increase in the asset base has been a remarkable achievement, especially
given the growth of only 8.8 percent in CY 2008.