Banking sector in Pakistan has experienced profound changes over last decade. Though in many columns we read about the growing and prosperous performance of the banking sector but one line that caught my attention was Asian Development Bank (ADB) warning stating (April 29, 2004) possible new Asian banking sector crisis, which actually goes out stating.
"India, Pakistan and Taiwan are at risk of a banking sector crisis unless the authorities push through reforms of the industry".
The main reason stated in this regard is the pressure of globalisation and ensuring liberalisation has exposed the shortcomings of the financial sectors of these countries including "low capitalisation ratios, limited expertise in risk management," rising bad loans and inadequate banking supervision and regulation.
According to the survey For Asia as a whole, the NPL levels among 19 developing member economies where data is available has fallen to about 17 percent as of end-2002 but this is still more than double those of Latin America and Eastern Europe.
The commercial banking sector in Pakistan has come of age and is now well equipped in terms of technology, skills and financial resources to play an effective role in financial intermediation.
With the privatisation of HBL, 80% of banking has now come under private management and the already competitive environment has become even more intense. Benefiting from the continuing consolidation process in large banks and the cautious stance of foreign banks, medium-sized private banks have managed to marginally increase their system share.
This has largely been due to continuing improvement in service quality and the expanding geographical outreach.
With declining spreads in corporate finance, banks are increasing their focus on other segments, principally the SME sector and consumer finance. While this shift is expected to preserve declining margins, it also exposes the banks to higher levels of risk.
The increase in risk appetite would obviously require more stringent risk management systems for preserving asset quality.
While there is a general improvement in risk management systems across the banking sector, there is less than adequate sensitivity about ensuring that the risk appetite remains consistent with the capacity of individual banks to manage it.
In this regard, the role of the regulators (SBP) becomes critical. In recent years, SBP has demonstrated its commitment and capacity not only at ensuring consolidation and orderly growth in the banking sector, but also introduction of effective risk management policies.
SBP has issued new Prudential Regulations covering (i) Corporate/Commercial Banking, (ii) SME Financing and (iii) Consumer Financing, which have come into effect from 1st January, 2004. A key element of these regulations, amongst others, is the mandatory requirement for a 5% general provision against all unsecured loans.
This regulation is primarily aimed at catering for the potential risk in consumer financing, particularly against issue of credit cards and personal loans.
The State Bank has also issued detailed risk management guidelines, which elaborate procedures for identifying, measuring, monitoring and managing credit, market, liquidity, country and operational risks.
Most recently, the SBP, being cognisant of the importance of a properly designed and implemented internal control system for an adequate risk management framework, has issued guidelines on internal controls.
These guidelines elaborate upon the different elements of an internal control system and provide guidance for its implementation, evaluation and reporting. Responsibilities of key players are also highlighted, particularly with regard to the responsibility of BOD for ensuring efficient internal control systems.
Banks are required to submit half-yearly progress reports regarding the status of compliance with the guidelines.
One of the objectives of these reforms and guidelines is to build up internal capacity of the banks for Basle II Accord, which the central bank intends to implement in due course.
In line with this, the SBP is proposing changes to the applicable regime of minimum capital requirement - the Capital Adequacy Ratio - to include capital charge for market risk, which comprises interest rate, equities investment position and foreign exchange risks. The market risk capital requirement would be calculated separately.
But despite the above mentioned qualitative changes in the operations of the banking system, the sector is still faced with a number of key issues and challenges.
SOME OF THEM ARE:
(i) Pakistan's financial sector is still not diversified enough as a major portion of the economy is still not monetized.
(ii) A number of players in the market are undercapitalised and may face serious difficulties in timely compliance of SBP's recent requirement of increase in paid-up capital from Rs 1.00 billion to Rs 2.00 billion by December 31, 2005 failing which the bank will be converted into a non-scheduled bank with restricted activities.
(iii) Despite all the fanfare and media blitz, agriculture, SMEs and housing sectors are still undeserved and have limited access to credit.
(iv) The retail banking model which is in fashion these days, demands a comprehensive branch network. Apart from raising deposits at lower costs, the key issue in the future banking model would be the distribution of retail products.
(v) Liquidity hang-over is still persisting compounded with scarcity of lucrative money deployment opportunities.
(vi) Additionally, the management of potential investment/portfolio losses is also likely to be a key factor affecting the performance of the banking sector in the short to medium term.
Going forward, performance prospects of individual banks would continue to remain a function of a number of bank-specific variables.
The asset size of the bank, its geographical outreach, the financial standing and credibility of bank sponsors, the quality of human resource and technological base are all key elements which would impact on performance prospects.
The impact of inclining trend in interest rates, though expected to be range bound, would generally be negative for the Banks owing to revaluation losses in short to medium term.
However, an increase in return on earning assets would be beneficial for the banks in long term.
The relatively smaller banks, who might not have succeeded in developing specific market niches, would continue to fight for survival and might well become candidates for acquisition by or merger with larger banks.
The medium size banks have already come out successfully in the fast evolving competitive environment, and seem well placed for sustaining their performance and asset quality.
However, they continue to face the threat of greater competition from the recently privatised large public sector banks like HBL and UBL.
There is, thus an increasing awareness that, in order to maintain their historic performance, they have to remain committed to continuous improvement in service quality as well as product innovation.
These factors would inevitably lead to greater efficiency in financial intermediation and provide a wider range of choice to banking customers.
Only efficient banks with competent management, a reasonably large network and with agriculture and consumer focus should excel in the future banking industry scene.
BANKING SECTOR PROBLEMS: Some of the problems & challenges faced by the banking sector are:
-- Low capitalisation.
-- Limited expertise in Risk Management.
-- Non-performing loans.
-- Declining/Shrinking spreads/margins.
-- Capital adequacy issues.
-- Limited access to credit for agricultural and SMEs loans.
-- Liquidity hangover.
-- Lending for speculative purposes particularly in the real estates.
-- Decline in Bond prices due to inclining trend of interest rates.
BANKING SECTOR PROSPECTS: Performance prospects of individual banks would be the function of following variables, among others:
-- Improved Customer Services orientations.
-- Product innovation.
-- Focus on Agriculture.
-- Focus on SMEs/Consumer Financing.
-- Upgraded Human Resources.
-- Sustained performance through operating efficiency.
-- Promotion of E-Banking wide use of Information Technology.
-- Stringent corporate governance standard.
-- Capacity building.
-- Development of market Niches.
(The writer is the Managing Director of Bank of Punjab)