Muhammad Aurangzeb joined HBL on April 30, 2018, as the President & CEO. Prior to this responsibility at HBL, he was the CEO of JP Morgan’s Global Corporate Bank based in Asia, with a rich international banking experience of over 50 years in other senior management roles at ABN AMRO and RBS based in Amsterdam and Singapore. He is the only Pakistani to be invited to the exclusive membership of the Global CEO Council organized by WSJ/DowJones group. He is also Chairman of the Pakistan Banks’ Association, and Council Member at the Institute of Bankers Pakistan. He received his BS and MBA degrees from the Wharton School (University of Pennsylvania).

BR Research recently sat down with Aurangzeb to discuss the outlook for Pakistan in general, and banking industry in particular. The discussion ranges from monetary policy to the IMF program, and from financial inclusion to structural issues. Below is an edited excerpt of the conversation.

BR Research: Let’s start with the overall macro side of the economy. What’s your view on the overall macro side of the economy in the outgoing fiscal year and the outlook for the coming here?

Muhammad Aurangzeb: Obviously over the last five to six weeks, the outlook has changed quite significantly. I think having an IMF SBA which spans over nine months and three administrations is actually a very good outcome. From my perspective, and I’ve always been in that camp and also from the Pakistan Bankers’ Association (PBA) perspective, there was no Plan B. That’s why the IMF is called the lender of the last resort, right?

The real thing, under the fund program are the structural benchmarks. And we don’t have to go back into history that much. Even in the last two years, what Shaukat Tarin, Miftah Ismail and Ishaq Dar signed, I believe there is not a massive difference.

I mean you have to expand the tax net and bring in retail and real estate etc. You have to deal with the circular debt, where you can differ in is the how part of it. There are no second thoughts that the circular debt has to be addressed, but only tariff increases won’t cut it.

What I am trying to say here is that it is essentially the same discussion year after year after year, so there’s no dearth of policy prescriptions. We know exactly the “what and why”; it is the how part of it. And we just don’t get to do it.

To answer your question, I think we are in a much better place than we were six weeks back. But the reality is that there is no automatic switch from stabilization to growth. It will undoubtedly take time but if we start implementing, it can yield results sooner than later, as we have seen even in the case of Sri Lanka.

So, I think we have got a breather, but I am again in the same camp that whichever administration comes in after the elections, they will have to negotiate another program, and that program will have to have, maybe three years, and maybe even a slightly larger program than what we have right now. We just have to follow through on what we have signed up for.

BRR: For that we have to change the habit of the last at least 15 years because we’ve been signing programs back and forth. Without structural reforms, the IMF program will always be just another breather. How do we go about this one differently?

MA: This time around maybe our hand is forced. And therefore, whichever administration comes in, we’ll probably have to now do it. And I say it in the sense that even our friendly countries have taken a backseat and that cushion is now gone unless there is the IMF in the equation. I do think the Fund is going to be a bit more rigorous in terms of the follow-ups. We must view it from the perspective that this is the right thing to do for the country.

I’m just now putting it as and from the PBA and banking industry perspective.

We are weaving it into our conversations with clients, especially import based subsidy supported businesses that this is not going to be the case going forward because Islamabad now has nothing to give.

So, as I said earlier that there is no automatic switch from stabilization to growth, there is no overnight switch to take you from import-based to export-based. But you have to at least start moving in that direction and start having a mindset because from my perspective, the private sector will have to take the lead.

BRR: But the private sector doesn’t seem ready. They keep asking for more and more. You see the newspapers, there’ll be a half page appeal every week, from the textile guys, fertilizer guys and you name it. Either they want a subsidy of some sort on energy or tax breaks or concessionary finance. We have seen this for so many years, my fear is that at the slightest hint of a relief in for instance, oil prices, we’ll drop the anchor. Does that concern you at all? Between fiscal and external imbalance, what concerns you more?

MA: I think these issues cannot be viewed in isolation because these things are intertwined in the sense that our GDP growth is so import dependent, that by October 2021, we had to go back to the Fund, as we ran out of dollars. We must work on both fiscal and external sides, and they are interrelated. On the fiscal side of things, of course the revenue line is the biggest issue that needs addressing.

You know you can keep on coming back to the same sectors and even back to the salaried class. The retail, real estate, and property sectors, have to come into the picture. You have to expand the net. And then there are expenditures, on which the whole State-Owned Enterprises is a big drag. We have to take the privatization route for the SOEs, and if the SIFC is the way to go, at least to get this going from government-to-government perspective, maybe that is the catalyst that it needs.

BRR: But privatization is not even in the plans. You see the budget; you see the IMF program as well. There are no privatization proceeds budgeted for this year. I think that is off the table for at least a year.

MA: You are right, but I can’t see that as a sustainable thing. These things are interlinked, for example, the circular debt which was once confined to the power sector has now also infiltrated the gas sector. Until and unless you do not structurally reform the distribution, generation, and transmission sectors, it will not go away. If you ask me, the privatization flows should have been there in the budget, while the commercial flows can take some time.

On the external front, you will have some bilateral flows coming in, but as far as issuing bonds in the capital market is concerned, this is not the time. For commercial debt, funded facilities coming back from the Middle Eastern banks might happen at the far end of the fiscal year. The only positive thing that we have seen so far out of that is the confirmation lines have started getting restored. Earlier, the confirmation was at an exorbitant rate. I am not saying everything is open, but availability and the rates have certainly improved.

BRR: Now that the IMF SBA is here, how do you see the IMF’s broader guidance on monetary policy? They haven’t shied away from giving a particular direction. They are talking about positive real interest rates; how far will that go on a forward-looking basis?

MA: While I have said that a lot of stuff that the Fund is saying or doing, we should own it as a country because that is the right thing to do. On the policy rate, their orthodoxy, in my personal view is probably going too far.

There is a direct correlation between demand management and the credit outlay. We all talk about supply side factor being the major reason, and inflation being supply-side induced, that is where I disagree with the IMF’s orthodoxy on monetary policy guidance. The dynamics of emerging markets in general, and Pakistan specifically are different. This is one area where I do hope the policymakers will take up with the IMF.

BRR: Isn’t it also ironic that the IMF advocates the independence of the Central Bank and then goes on almost dictating the monetary policy?

MA: See, academically speaking and from an orthodox policy viewpoint, it works in different countries. But in markets such as ours, the supply side factors are huge, and I do hope the IMF does come around to realizing that. Of course, it will be the MPC’s decision and I think they are inking it more to the core inflation.

BRR: But even the central bank also keeps sort of changing the goal post over the years. Sometimes it suits quoting the national inflation, and at times they’ll mention the core inflation. So, what should be the inflation metric that the SBP should be looking at? And how do you see the likely increase in interest rate affecting the overall banking sector, especially the credit off-take and obviously the NPLs?

MA: This is an important point from the from the banking industry perspective because in terms of the corporate and commercial sector, which are sort of the big companies, by and large they have tailwinds. The balance sheets are strong, and they are relatively under-leveraged, but the SME and other sectors are reporting NPLs as high as 25 percent, which is not sustainable.

There is always a criticism on commercial banks when it comes to advances to the private sector, but the reality is that the demand has gone down. And I can appreciate the reasons that if someone has equity funds available, it will not make sense to borrow from banks at current rates. But by and large, the banking sector NPLs are not going to be a massive drag, particularly in the corporate commercial sector.

As for the consumer portfolio, I believe the informal economy is helping us to a great extent. There is more than Rs8 trillion of cash in circulation, which keeps the repayment schedules going, and therefore we are not seeing any large NPLs in our credit card portfolios.

Having said that, had the Fund program not come through, things would have been far worse. A major impact of the IMF program, I’m not saying floodgates have opened, but the supply chain disruption due to import restrictions has been reduced to a great extent.

Had this continued for another four to six months, then I would have certainly seen stress coming through in the companies and therefore in the banking portfolios.

BRR: I’m sure you get asked this a lot, but the sector’s ADR (Advances-to-Deposit Ratio) has been in the 40s for at least 4-5 years and it barely touched 50 last year largely due to the SBP’s conditionality. Is there a genuine lack of credit appetite out there or banks are generally happy investing in sovereign papers?

MA: If I look at our entire spectrum of clients, it is the government itself, public sector, private sector, corporate, commercial, SMEs and then we have individuals.

Let’s come to the to the government side because this comes under the heaviest scrutiny that banks are happy investing in risk-free government papers. I think in the in the longer term we have to think through what the root cause of the problem is. The root cause is the fiscal indiscipline of the government. You have insufficient revenues, and expenditures are always on the rise.

Ultimately, you need to reduce that borrowing need, then the banks won’t go in. Let’s assume the banks collectively say in the next auction that we are not participating in the auction. So, what happens? They don’t get the borrowing and in the short term where are they going to pay the salaries of the government employees etc.? It is easy to say that the whole situation is bank-led, and banks are the ones who want to do it.

But in the medium-term, it is important to have fiscal discipline, so that the borrowing requirement goes down. On the private sector side, demand has gone down because people are thinking that at 25 percent, is that a viable business?

BRR: Yes, but the rates have only been up in the recent past. What about yesteryears where the ADR stayed in the mid-40s? As you said, there is a willing borrower out there, maybe that is why banks don’t mind. Do they?

MA: Yes, that is also there. Risk-free investment will always be a lucrative proposition. But if you look across the spectrum, there are banks which are at 70-80 percent as well. Bear in mind, banks do step up when a genuine private sector credit need arises. Having said that, where we do need to do more is the SME space.

You won’t hear from corporate and commercial, by and large, of incidences of banks refusing loans. But on the SME, as an industry, we absolutely need to step up. And it is mostly the “S” part of the SME that needs more attention. The first big problem from the banks’ end is the mindset of secured collateral-based lending, at all costs. We have to start moving in the direction of cash flow-based lending.

The SBP had introduced a scheme that ensured a partial guarantee from the central bank, and banks were not supposed to ask for collateral. One big issue is the lack of policy consistency in Pakistan. The scheme was initiated by one administration, and stopped when the other came. We, at HBL, decided to stay the course. A lot of other banks have also stayed on course, and we need to stay the course. It takes a lot of effort because you have to really understand the dynamics of distributors and vendors supply chain. Once you understand the dynamics, it is a doable model.

Now the flip side of this is that the sector is yet to go towards documentation because either you don’t have audited financials, or the available financials are fudged. That is where banks are reluctant and ask for collateral. But I do think that is where the banks need to step up more and move in that direction.

BRR: You talked about SME lending, which is a key part of priority lending. Agri is another vital component of priority lending, but often keeps getting neglected. What is your take on that?

MA: We are the largest agriculture finance bank as HBL. But we were also missing a trick as the largest financing bank, because most of the banks are focusing on the crops, while 60 percent or more of the country’s agriculture, GDP is achieved via dairy and livestock.

We started to tap these two years back, and that’s where the numbers are going to come in. Secondly the industry’s focus has traditionally been on larger farmers, and we need to change that. The only way the whole situation becomes bankable at the small farmer level, when you factor in dairy and livestock. That is what makes it sustainable. And some of the banks have actually realized that and started moving in that direction and others will surely follow.

BRR: Are you venturing into dairy and livestock?

MA: We are now well into it, as our book was static at around Rs30-40 billion for a long time, and that has just touched Rs60 billion, and is going to go further up. We have ventured into dairy and livestock and electronic warehouse receipt financing. If you think through the farmers’ lens, they have to sell the crop immediately on reaping, because they operate through middlemen [aarthis]. Now they can store their produce in the warehouse and sell it when they have better rates.

We have just received approval from the State Bank, a license to set up a separate subsidiary, which we will call HBL Zarai. The SECP approval is still due on our end to get in compliance before incorporating the company. HBL Zarai will shift the pilots with small farmers over the last two to three years done under the HBL umbrella to its books. We engaged with small farmers and to reduce the role of aarthi we offered them input bundles, crop experts, and assured off-take.

The results of these pilots are very encouraging, where average yields have gone up considerably. And the money that has gone into the pockets of the small farmers has gone up by 100 percent, reducing aarthis’ role where the implied interest rate exceeds 70 percent in some cases. We have involved Princeton University in the US in validating the pilot results. To scale up, all non-financial services will be under HBL Zarai.

BRR: I have a question on the currency in circulation, the growth of which has surpassed deposit growth for a long time and is one-third of the deposit size. How big the problem is that and how do you see that?

MA: I am very clear that we should absolutely declare war on cash. Yes, it helps us in the short-term but unless we move in the direction of structural change, we will have this problem. And the whole digital piece is going to be very important, like the POS infrastructure. I do think that’s it’s a very critical thing that we need to embrace more and more.

BRR: Do you recommend currency demonetization at any point to tackle this?

MA: It’s a difficult one. It’s a very sensitive one. India did it and there is a view that it was the right idea, badly executed. This is being debated in various forums but is something on which I do not have a firm view yet.

BRR: A recent PwC report has shed details on numbers that accounts held by businesses have gone down 31 percent in the last five years. How do you explain this?

MA: This is where the digital thing has really made stuff fly, not incrementally, but exponentially. I will give you HBL’s example. It took us 70 years till 2018 to get a client base of 12 million. We closed our client base at the end of 2022 at 32 million – with an almost identical number of branches.

Everything is mobile first, and I also have to give full credit to the State Bank that has helped the entire industry develop all the branchless banking via agents. And that has really transformed banking. To me, digital is not an end itself, it’s the means to the end. And that is financial inclusion.

The entire banking industry is moving in that direction, and we welcome the new digital banks, which have got licenses. The digital agenda takes care of client convenience of course as the Gen-Z and don’t want to actually come to the branches, etc. Technology is also helping in other ways, to reduce the cost of delivery for the banking industry.

One initiative which is being taken under the PBA platform is that a number of banks in the industry are now moving into centralized KYCs. We will have bots in repetitive processes, to create compliance alerts, data retrieval and data analytics. Only decision making will be dealt with at the human level.

We are now coming up with E-KYC, for which we have tried the functionality under the PBA umbrella. Now, if you have an account with one bank and you give your consent, that bank will upload your KYC details on this portal to the other bank. We are hoping that by the end of this year or early next year, this will be in place. The Central Bank has been providing us the guidance and they actually want this to happen as of yesterday. Can you imagine the convenience that will come through, as that is one of the major pain points for the customers?

BRR: Why is Pakistan’s adoption of mobile banking still one of the lowest in the region? Is it because we started late?

MA: You can say we started late, but as far as banks are concerned, every single bank today has mobile functionality with varying degree of APIs and sophistication. But customer behavior plays a key role in technology adoption. The behavior changed dramatically during Covid, as people were still banking without visiting the banks. Now you will see the growth will be exponential, and not incremental.

The other thing which we have to continue to invest in, and we think from an industry perspective, is the cyber part of it because that’s the flip side of digital.

BRR: Do you think you need to come with the sort of rewards for merchants and customers? This paper-based transaction is again more than 1/4th of your overall transactions. Does tax evasion also play a role in there because a lot of merchants want to stay away from this system?

MA: I won’t say that this is the entire story, but this is a factor. For example, the central bank wants the POS infrastructure to be expanded, but that worries a lot of merchants. When we talk about digital Pakistan, then we have to work around the entire ecosystem.

BRR: Do you see the banking sector transitioning completely into Islamic banking mode, as per the Shariah Court’s decision within the stipulated time?

MA: From my perspective, all banks are moving in that direction to the best of their ability. This year we’ll do more than 100 Islamic branches, up from 20-25 branches we had been doing earlier. Next year we’ll probably go for 150, so we will from our perspective and for most of the banking industry, I think everyone is trying to get there within that stipulated time frame. Whether we can all get there in totality is still difficult to say because there is an entire ecosystem. To completely step out of conventional, whether it’s our international financing or domestic borrowing, will take some time. A lot of work is being done under different forums. I, as the chairman of the PBA, am part of that forum because we will have to start looking and moving towards the Sukuk like structures because you run out of infrastructure, bridges, roads, airports and so on. It is the entire ecosystem, and from the banking industry side may we are all supportive.

BRR: Now that the IMF SBA is in place, it talks about all concessionary finance schemes and their future. It has been a pattern that private sector credit goes up when concessionary schemes are in place and dies down in their absence. Do you think your customers are hooked up to cheap credit and that this will further dent genuine credit demand growth?

MA: From what I understand is that the Fund is saying the concessionary finance should be phased out or should not be there, and it cannot be done through the SBP. But it can be done through other specialized institutions, like ExIm banks. As part of our structural reform, we should think through that as we as we go forward, but in the in the short term, with the given policy rate is, people will continue to shy away from credit.

BRR: Let’s assume the policy rate was 10 percent today. Would you still see a big dent due to concessionary finance taken away?

MA: We will have to wean out of it gradually, whether it is the subsidies coming from Islamabad or subsidies coming through financing. There is no automatic switch, but we have to move in that direction that when the rates are more normalized, then the businesses need to look at their IRRs, and if the NPVs are positive, I think people will go for that.

BRR: Lastly, a hindsight question. Do you think TERF was done right? Did we think it through back then, as we see capacities being underutilized today because working capital financing is not there?

MA: As you just said, hindsight is a wonderful thing. There is no doubt that the banking industry was very clearly told that the counterparty risk is the banks’. We were never asked by the SBP at any point to lend or not lend to a particular borrower. Secondly, why TERF only? There were other schemes too where payroll financing was offered to keep employees in jobs. You should also look at the context of what happened in other countries. There is a criticism on the allocation, which is a fair question and should be responded to, as to how the banks selected their clients. One must not forget the doom and gloom of that time as well. From the PBA perspective, I think this was the right thing to do to provide incentivization to keep the industry moving.