The World Bank has advised the Government to control liquidity in the banking system, as credit growth was witnessed in areas where banks were relatively inexperienced. According to its aide memoire, "the increased liquidity in the system has led to a rapid expansion of credit to the consumer sector that could be problematic if corrective measures were not taken".
The World Bank has also suggested that the banks strengthen their credit appraisal since much of the credit growth was in areas where banks had little expertise. "There is also a need for close monitoring by the regulator to ensure that the rapid credit growth does not compromise credit quality and undermine the banks' balance sheets".
The irony of it is that free flow of credit to various sectors, particularly consumption loans, was indirectly the result of reform process undertaken in the financial sector with the assistance of the World Bank.
The advice of the World Bank that rapid expansion of credit to the consumer sector could, in future, become a problem for the banks, in our view, is quite valid. Also, the suggestion that the banks need to strengthen their credit appraisal mechanism and must not compromise the quality of their assets is beyond any question.
Commercial banks in Pakistan previously used to devote almost all their resources to "productive sectors" of the economy like manufacturing, industry, business, agriculture and services and had hardly any inclination or experience in advancing consumption loans except to their own employees against ironclad guarantees.
It was only in the last few years that the trend of advancing consumer loans gained momentum. To quote the latest figures, the scale of consumer loans expanded by 27 percent to Rs 67.2 billion during July-March, 2006, as compared to the corresponding period last year.
These consumer loans were acquired to finance a large range of products, including automobiles (Rs 23.2 billion), followed by personal loans (Rs 21.5 billion), credit cards (Rs 10.4 billion) and house building (Rs 10.1 billion).
Such a sharp increase in credit for consumption purposes in such a short period of time is, of course, not advisable if the banks are not able to simultaneously develop systems which could guarantee proper quality of assets and save them from recovery problems later on. There are already some complaints about non-recovery of loans advanced for purchasing cars and other durables.
There are also other compelling reasons to contain the growth of consumption loans within reasonable limits. In order to enhance the productivity of the economy, a higher percentage of our financial savings needs to be diverted to the productive sectors to enable the country to reduce imports and expand its export potential.
The inordinate increase in consumption loans, leading to strengthening of demand, has obviously the opposite effect. Also, conspicuous consumption, which may partly be the result of consumer loans, could result in more social tensions by making the rich-poor divide more glaring.
All of this suggests that our financial system needs to tread carefully while partaking of the bonanza of advancing consumption loans and adopt a more careful approach.
The example of other countries often given by our policy makers is not very appropriate due to the vast difference in the fundamentals of the economy and regulatory mechanism of the banks.
Developed countries often need to push up their consumption levels to increase capacity utilisation and foster growth, while in Pakistan the foremost requirement is to boost saving and investment and increase installed capacity.
Economy of scale does matter for any industry to be competitive at the international level. At present, we are encouraging loaning for cars and motorcycles so that our engineering industry can grow to the point of becoming a world class exporter.
This diversification will reduce our dependence on textile sector for export earnings. However, for the financial system to grow, we need more financial instruments. Securitization of risk will reduce the banks' exposure. Derivatives are the tools most widely used for shifting the risk from banks' balance sheets to insurance companies.
This enables the banks to reduce their provisioning requirement and allows them to expand their advance portfolio. But for this to happen issuance of long term government bonds with regularity is very essential. Unfortunately, the present government has a myopic view of reduction in debt servicing cost. The debt management office of the government missed the boat when interest rates took a nosedive from 14 to two percent.
The government could have locked in Rs 150 billion in long term funding at six percent. Instead, it chose to shift its debt portfolio from long term to short term, as the Treasury Bills' yields fell below two percent. It, of course, kept the fiscal deficit below 4.5 percent.
This was the easier option. The difficult but more sustainable tools were raising of tax to GDP ratio and reducing the current expenditure through restructuring of the government into a lean but more efficient force. It would have involved laying off an army of peons, clerks, etc between Grade 1 and 17. That would have been politically unpalatable though.
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