The importance of Financial Institutions (FIs) cannot be overemphasized. Financial Institutions perform the important function between providers of investable funds (depositors, securities holders etc.) and the users of such funds (namely businesses). Any economy can’t progress without its financial sector facilitates its business activities consistently, and in the case of a developing country like Pakistan, these FIs act as a necessary source for economic growth as well. The State Bank of Pakistan has played two very important roles as the financial sector.
Firstly it ensures soundness of banks and DFIs with a view to maintain financial stability; secondly it pursues a developmental objective under which it facilitates financial markets developments and enhancement of access to finance. The banking system, which contributes 88 percent share of the total financial sector and the share of non-bank financial institutions, is approximately 12 percent. The Banking sector of an economy is generally the most significant player and performs three primary functions which include the facilitation of the payment system, mobilization of savings, and allocation of loanable funds. Historical perspective:
The current structure of the financial sector in Pakistan is the result of several policy shifts and developments. The eras of financial sector developments in Pakistan can broadly be segregated into 1947–70, 1971–90 and 1991 to date period. Period of 1947 to 1970
In 1947 the banks services were adversely affected and in June 30, 1948, the number of branches of scheduled banks came down to only 81 in the area of Pakistan. However, commercial banking made tremendous progress and achieved phenomenal growth and there were 14 scheduled Pakistani commercial banks with 3,323 branches all over Pakistan and 74 branches in foreign countries. Development Financial Institutions (DFIs) played an important role in the early industrial development of Pakistan from the 60s up to about the mid of 80s. These DFIs were major source that gives development funds to the private manufacturing sector and achieving socio-economic objectives. Period of 1971 to 1990
All 14 Pakistani commercial banks were nationalized and merged into 5 banks from January 01, 1974, and the financial aspects of the country changed significantly. The experiment of nationalization, however failed to give the desired results, as political interference in lending decision. The efficiency of the banks was affected severely, and at the end of 1980s, the banking sector in Pakistan had become unsuitable for adequately meeting the growing financial needs of the country.
Period of 1991 to date
After realizing the weaknesses in Pakistan’s financial system, a broad based program of reforms was framed for the financial sector in the early 1990s. The reform agenda included among others financial liberalization and deregulation. The State Bank of Pakistan played a pioneering role in these reforms, and has championed the developments in the financial sector. Some of the major steps taken by the SBP under these reforms are as follows: For privatization of nationalized commercial banks, the Government injected Rs. 30.7 billion to offset the losses incurred by these banks and recapitalized them. Professional bankers were appointed as Chief Executives and persons from the private sector were nominated on the Board of Directors and ultimately the banks were privatized. Besides the privatization, fresh licenses were also issued to private sector sponsors to set up new commercial banks.
The legal and regulatory framework was strengthened significantly, and State Bank powers under the Banking Companies Ordinance were enhanced in order to make it an effective regulator. In April 2011, the amendments in the BCO were carried out which further reinforced SBP’s role as regulator of the banking sector. The prudential regulations and various guidelines issued by SBP provided the essential impetus for prudent operations of the banks and DFIs. Foreign direct investment in the banking sector was made more viable; and since liberalization, large numbers of reputable foreign shareholders have invested in locally incorporated Pakistani banks. The Capitalization of the banks has been enhanced steadily over the years. The minimum paid up capital (net of losses) was set at Rs.1 billion in 2003, increased to Rs2.0 billion by 2005, Rs6.0 billion by 2009, and Rs.10 billion to be achieved by 2013. Over the years the monitoring of banks and DFIs has also improved.
The on-site inspection and off-site surveillance has increased the level of supervision of SBP. The SBP also undertook massive capacity building during the late 1990s and early 2000s to upgrade the level of expertise of its officers. Merit-based recruitment, competency-enhancing training, performance-linked promotion, and induction of skilled human resources are now regular feature of SBP’s corporate strategy. The IMF and World Bank in their banking sector assessment of 2004 state Quote: “far reaching reforms have resulted in a more efficient and competitive financial system. In particular, the pre-dominantly 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”.
Present day scenario
Total assets of our banks amount to Rs7.7 trillion as of end June 2011. The deposits stand at Rs6.0 trillion, while Advances and investments of the sector are Rs3.8 trillion and Rs2.6 trillion respectively. In spite of the economic slowdown, the pretax profit of the banking sector for year 2010 was Rs105 billion and for the first six month of 2011 it was Rs77 billion. The banks stand at a healthy Capital Adequacy Ratio (CAR) of over 14 percent and have shown a steady increase in capital even in absolute terms, and equity of the banks is now Rs722 billion (June 2011). The gross non-performing loans which were low in 2007 (7.6%) are now at 15.3% as of June 2011. Thanks to our conservative provisioning regime, the net NPLs are still at a reasonable level at 5.5%, but we are aware that unless an economic turnaround is achieved within a reasonable time, the impact of high credit risk can cause serious problems, at least for some banks. Since FY07, banks in Pakistan have been able to withstand the headwinds from weakening macroeconomic fundamentals.
While they have remained largely insulated from the first round of shocks from the global financial crisis, we cannot ignore the adverse trends that have risen since then. The Global Financial Crisis (GFC) has continued despite the recovery efforts of advanced economies and has morphed from a financial crisis to a sovereign credit crisis with serious political implications. The regulatory focus in Pakistan has strived to prevent and mitigate the occurrence of these factors as the financial sector continues to evolve and progress. Our financial institutions and businesses must become more competitive and innovative, regulators like SBP and SECP must actively facilitate financial markets, and the Government should step up its function of providing infrastructure for growth, most crucially to meet the Energy demand of productive sectors. There is a huge surge among the banks to upgrade their technology and on-line banking services.
The ATM network has been expanding and on June 2011 there were approximately 5200 ATMs operating throughout the country. Utility bills payment and remittances would be handled through ATMs. The concept of branchless banking has opened a new avenue for efficient channeling of funds. The State Bank took the lead and introduced Branchless Banking Regulations in 2008. Since 2008, Branchless Banking has expanded steadily with increased participation of stronger as well as new players. At present, the agent network under the umbrella of branchless banking exceeds 20,000 that facilitate around 53 million transactions amounting to Rs196 billion (Sep-11). Overall financial penetration in Pakistan remains quite low. The number of borrowers of 3.8 million constituted only 2.3% of the population on December 2010.
Enabling regulatory environment has been provided for lending to SME, Agricultural and microfinance; thus banks and financial institutions are encouraged and enabled to expand their scope of lending and customer outreach. In 2010 & 11 Consecutively, Pakistan has been ranked First in a sample of 55 countries in the category of “overall regulatory framework and practices for Microfinance” by The Economist Intelligence Unit (EIU) of The Economist Magazine. The customer base of MFBs (Microfinance banks) has crossed 700,000 whereas that of MFIs has exceeded 1,300,000 in June 2011. At present 8 MFBs are operating in Pakistan, with total assets of Rs21.4 billion. The fundamental importance of the SME sector in the economic development of the country. While SME prudential regulations have been in place for years, we are in the process of reviewing and revising the same to make them more conducive for this sector. The economic slowdown has hit them particularly hard.
The advances to SME sector declined from Rs.383 billion in Dec 2008 to Rs.292.5 billion in June 2011. The loan infection ratio of SME sector has also risen and is around 16.8 percent. Pakistan introduced the Islamic banking system in 2003 to operate in parallel with the conventional banking, providing a choice to the consumers. A large number of Pakistanis have remained withdrawn from commercial banking because of their strong belief against riba-based banking. These individuals and firms now have the opportunity to invest in trade and businesses by availing of loans from Islamic banks and thus expand economic activity and employment. The total Islamic banking assets stand at Rs.560 billion (June 2011) which is 7.3% of total assets of the banking sector. More importantly, this sector has shown more accelerated growth as compared to other segments. Deposits grew by 15.9 percent while the overall deposit growth was 9.4 percent (June 2011 data). We are very optimistic about the prospects of IB system.