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MONEY AND BANKING ASSIGNMENT
PRESENTED TO:
Sir Zahid Iqbal
GROUP MEMBERS:
Zainab Salman Roll No 19
Zunaira Mumtaz Roll No 22
Maryam Majid Roll No 39
Fatima Khalid Roll No 52
BBAE (2009-13) 4
th
SemesterInstitute of Business Administration,
University of the Punjab
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SUMMARY OF 10 YEAR PLAN OF BANKING REFORMS
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Summary
A growing and dynamic banking sector is essential for economic growth in Pakistan . Many
important structural reforms already have taken place in Pakistans financial sector but many more
remain to be implemented.
Our Banking Sector has gained profitability and strength. Deposit base(Rs 4.1 trillion) and banksaggregate profitability(Rs 63.3 billion in 2005 to Rs 73.3 billion by 2007) rose, banks net non performing
loans lowered but along with these achievements, many challenges are faced by the banking sector,
and this paper maps out a strategy for banking sector reforms over the next decade. This strategy is
formulated by the State Bank of Pakistan.
In June 2008, Pakistans financial sector assets totaled to Rs 7.6 trillion. On a net basis the
amount of financial assets is substantially smaller. Among different segments of the financial sector, the
banking sector has grown most in relative terms. The overall assets of the banking sector have also
increased from Rs. 3.6 trillion in December 2005 to Rs. 5.5 trillion by June 2008, but some liquidity
problem has been seen in the second half of 2008. Although financial assets have grown in nominal
terms, but they have not grown that much in relation to the real economy as measured by GDP.
Some important constraints that limit the scope for banking sector development in the absenceof further reforms are: (1) Large segments of the economy still remain underserved by the formal
financial system (2) There is a need for further improving the investment infrastructure and incentives
for the Non-Resident Pakistanis (3) Lack of consumer protection and low level of financial literacy (4)
Keener competition in consumer lending that policy makers expected from the privatization of banks
have yet to materialize for the benefit of the real economy (5) Small numbers of weak banks in the
market (6) There is a need reconsider DFIs ownership structures (7)Competition and continuous market
innovations raise challenges for SBP (8) Banks and NBFIs have been developing conglomerate structures
but it does introduce new systemic risks as well as regulatory and supervisory challenges (9) There is a
need for financial safety net to deal with contagion and systemic risks (10)The financial sector needs to
become more diversified and the financial infrastructure needs to be improved.
Financial sector growth and real economic growth reinforce each other thus a faster growth of
the financial sector might result in increased and sustained economic growth. There is an enormouspotential for financial sector growth in Pakistan but if it is to be developed, then other financial
institutions also need to be developed. The growth of our financial system should also be based on
private sector intermediation. Not only the assets of our banking sector are expected to increase but
this will lead to an increase incredit to the private sector. If opportunities are utilized then the banking
sector has the capacity to support every type of economic activity. Increases in financial assets and
credit to the private sector are some of the targets of reforms but this is not possible unless these
banking sector reforms are accompanied by reforms to the debt and equities markets.
The 10 year Banking Sector Reform Strategy (BSS) that has been developed by SBP with external
technical assistance is based on: (i) an extensive study of the banking and financial sector to identify
issues limiting this sectors development (ii) Pakistans forward looking economic development strategy;
and (iii) experiences of other emerging countries.The broad objectives of the BSS are to make the banking sector: (i) more responsive to the
needs of the economy and thus help achieve a more rapid and sustainable economic growth; (ii)
financially stronger and stable (iii) Better regulated and supervised (iv) More efficient and stable.
Banking sector growth and development are only possible if macroeconomic and political stability is
there.
The BSS focuses on reforms in ten key areas. These key topics are to:
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Create a more diverse banking sector. Banks are more suitable to deal with smaller and start-up
companies and with the household sector therefore their focus should shift from large to small
companies to diversify risk, whereas larger companies should be financed away from banks.
Implement a financial inclusion program for banks. The formal sector includes different types
of banks and other types of financial institutions, but There is a large number of companies mainly SME
yet to be included in the formal financial sector. The number of depositors living in rural areas is very
small; this has held back the growth of savings and access to credit. As a solution to these issues SBP has
developed a comprehensive Financial Inclusion Program (FIP) to meet the needs of underserved
economic subsectors, including outreach programs to meet the requirements of the agriculture,
housing, SME and microfinance sectors.
The protection of consumers and financial literacy in Pakistan is slowly improving. To accelerate
this process several reforms are being introduced. For consumer protection SBP has issued guidelines
related to problem resolution in 2004, an online complain system has been introduced, consumers are
made aware of the complain process, half yearly review on complains is issued, rules and laws have
been introduced that will protect consumers against fraud or unfair contracts, etc. To increase financial
literacy SBP has introduced Financial Literacy Program (FLP) aimed at families, adults, children,
entrepreneurs, etc. so that they can manage their own finances and also SBP requires the support of not
only banks but also of NGOs and organizations like the National Institute of Banking and Finance(NIBAF) and Institute of Bankers Pakistan (IBP).
To consolidate banking sector SBP now requires that the Minimum Capital Requirement (MCR)
of the Banks should increase to Rs.6 billion by 2009 and up to Rs.23 billion by 2013. This has forced a
large number of small banks to merge and hence there is a decline in the number of commercial banks
from 41 to 23. SBP is also encouraging NGOs to restructure as Microfinance Banks (MFB) e.g. KASHF
Foundation as KASHF Microfinance Bank. To fulfill the gap between banks and MFBs, the commercial
banks that are unable to meet the MCR may be converted into institutions that will serve SME business.
Commercial Banks that are owned by the federal or provincial government will be merged, recapitalized
or liquidated if they are unable to meet the MCR. Due to weak performance the SME Bank is being
privatized, the HBFC restructured prior to privatization and the IDBP will be available for sale. Zarai
Taraqiati Bank Ltd. (ZTBL) needs financial and operational restructuring. The average risk-based capitaladequacy ratio (CAR) for all commercial banks have increased and therefore strengthened the banking
sector. SBP has increased the CAR from 8% to 10% in 2009 which has forced small banks to merge. The
development of a liquidity management framework will enable SBP to modulate short-term liquidity in
order to ensure stable conditions in the short term money market and for this purpose Specific Treasury
Bills will be created.
To analyze competition, SBP has examined the market structure of the banking sector, including
the number of banks, concentration indicators, contestability, and performance measures such as
margins or profitability and it has concluded that the banking sector is monopolistically competitive. This
is true in case of low- banked areas, where the big banks dominate due to their branch networks,
economies of scale and relationships built over the years. SBP has also included that banking sector is
reasonably competitive. This is due to increase in number of new Islamic Banks (IB) and MFB. Since
2000 the market shares of five biggest banks have declined and their market share has been captured by
the next five banks. So, to increase competition the actual behavior and conduct of banks are reviewed,
entry of new banks is encouraged and non-bank financial intermediaries are promoted.
The interest rates and competition govern a market-based financial system. Large banks had
market power which has caused real returns to be negative but now with the increase in competition
Weighted Average Deposit Rate (WADR) has increased. High interest rate spreads have allowed the
largest banks to keep their funding costs down and generate substantially higher profits than banks
without branch networks. In early 2008 the banks offered approx. 2% p.a. on saving deposits and to deal
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with this SBP introduced a minimum deposit rate of 5% p.a. for all PLS savings product. Due to this
interest rate spreads have also lowered. Explicit interest rates are not known to the depositor and
therefore interest rates are non-transparent and so a market cannot be competitive. This requires
financial literacy. To increase transparency SBP is of the view that there should be differentiation
between Islamic and conventional deposits, restriction on banks to change lending rates, presentation
of rates in annualized percentage rates (APR) and requirement to publish their deposit rates on saving
deposits in the newspapers.
In order to strengthen the regulatory framework the new Banking Act (BA) has been drafted
that will protect and supervise the banks. It also states SBP as the sole supervisor of banking sector.
Basel -2 , comprising ,standardized approach to credit and operational risk was made obligatory
in 2008 for commercial banks along with Basel -1 of 2007 which had already caused certain challenges in
the integrated risk management and collateral management policies. However bank CARS could not be
lowered down without moving to its advanced approaches .For this state bank of Pakistan has required
all banks to review management system and capabilities .Liquidity risk in domestic banking is another
issue to be reviewed by the Basel committee. S.B.P would get any such regulations, implemented with
all its framework under the rule based approach and develop best practices among banks under the
principle based approach. Again S.B.P would ensure balance among these two philosophies. State bank
should also adjust its supervisory role under the legal and regulatory framework. Inordinatecompensation packages for senior executives of banks have been a major issue since global financial
crisis. Regulatory guidelines of state bank would help in framing performance based packages. there is a
successful trend among todays bank of financial conglomerations of multinational business such as
investment brokerage, asset management and insurance .technology measures such as electronic
payments have added much to the marketing and efficiencies in service delivery .so, for the
consolidated supervision of conglomerates, S.B.P has developed framework for the transparencies in
structural ownership of the consolidated units , with reference to proper criteria, negation of
commercial enterprises definition of investments restriction over cross shareholdings and determining
bank and non bank activities .S.B.P would also set rules for board of management with at least one
outside director and a single auditor. However, under the based care principles, S.B.P being leading
supervision should have licensing power for banks and holding companies. With the privatization ofmost banking sector, certain safety measures have to be developed. Under the act of nationalization of
1974 all depositors are protected by government .but this not applicable in private owned banks. Even
the state owned national bank of Pakistan comprises private shareholders, so the rule needs
amendment to provide limited protection to depositors. So a depositor protection fund is likely to be
established, separately by S.B.P to be managed by a board with fixed premium by bank, in order to make
instant payments to depositors in case of bank closure. Presently, S.B.P with its on and off site
monitoring mechanisms provides liquidity for temporary solvent banks, on a limited scope under the
act. So S.B.P should be given broad powers of liquidity with a fair amount of discretion to deal with even
the abnormal situation. S.B.P is seeking legal powers and making rules for the borrowing banks. Removal
of available banks due to insolvency unprudent pricing or risk management taking practices etc woul
strengthens the system. The exit process would treat unprotected depositors and creditors, raise the
value of assets reduce systemic risk. This law would also ensure that the S.B.P decisions are not put on
hold or set aside by courts. The D.P.S, LOLR and bank exit will be managed by S.B.P. the managers and
supervisors would share data confidentially and on timely basis with the help of coherent team of
professionals. S.B.P would handle individual bank problems on its own but would keep the Govt.
Informed for possible solvency support. But in case of outright crisis, Govt. would be involved for a
broader policy coordination framework.
To Strengthen SBP autonomy, accountability and governance, many aspects of the SBP Act have
become outdated and require reconsideration. It is important that the law give SBP a clear focus and
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necessary powers to ensure monetary and financial stability. There is consensus that changes to the SBP
Act are needed. Modern laws give autonomy to central banks and make them accountable. The new SBP
Act would complement the new Banking Act discussed above. The new SBP Act would strengthen SBP's
ability to conduct an independent monetary policy. The new SBP Act would define SBP's role in other
areas of the financial sector reform agenda. To Develop a More Balanced and Diversified Financial
System The financial sector in Pakistan is too bank-centered and there is a need to develop other
financial intermediaries and markets. The development of non-bank financing will require a combination
of official policies, market competition and business opportunities. Non-bank financial intermediaries
have substantial growth potential. With the exception of mutual funds, the growth of most NBFIs has
been anemic in recent years. The equity market has provided little new corporate financing in recent
years. It has tremendous scope to grow, as indicated by the fact that its market capitalization in relation
to GDP is less than half the size of that in its peers in other EMCs. Private debt securities have the
biggest growth potential, as seen from the above comparisons with other countries. The basic structures
for issuing and trading private securities already exist but need to be updated and strengthened.
Government financing in the domestic debt market and through NSS needs to be reviewed to make it
more efficient and market-based. The above reforms in the broader financial system require actions by
the SECP and GOP. In the Infrastructure under control of SBP the wholesale payment system is being
upgraded and renewed. The retail payment system is next in line to be modernized. The electronicCredit Information Bureau (ECIB) of SBP has already helped strengthen credit risk management in all
financial institutions. In Infrastructure outside the direct control of SBP the Human Recourse Baseneedsto be developed to meet the needs of an expanded financial system. SBP is planning to take some
initiatives to support a broadly based effort to train financial sector professionals. Credit Rating Agencies
need to be promoted. Land and Property Registries need modernization. The Judicial system needs
reform for the efficient functioning of the financial system.
Annexure A table 1 shows Number and Ownership of Banks. The data concludes that since 1997
-2008 All banks which includes commercial banks (largest 10, Islamic, MBF and other) and specialized
sum up to 46 which includes your public sector banks, local private banks and foreign banks. This
number has decreased to 39 in 2008 and Annexure A table 2 gives the indicators for banks since 2000-
2008.Annexure B shows McKinsey Definition of Financial Assets .The global capital market is defined
as the cumulative collection of markets where global capital supply is matched by global capital demand
through bank and securities market intermediaries. The data base covers more than 100 countries. Debt
securities are further divided into private and government. The database includes GDP data for each
country to allow calculation of the value of financial assets relative to the size of the underlying
economy. To measure bank intermediation, the value of deposits rather than the value bank loans are
used because of difficulties in measuring lending volumes on a comparable basis in all countries.
Annexure C shows objectives of draft Banking Act. The draft Banking Act has been prepared in
line with the Basel Core Principles. Detailed provisions regarding reorganization of problem banks has
been provided in the draft Act to avoid systemic risk. There is Framework for Payments System and e-
banking, Enforcement powers to check illegal banking and deposit taking. SBP's powers to issue
prudential regulation. A new part has been included in the draft Act which outlines framework for
conducting banking business based on Islamic principles. There is clear and transparent criteria have
been provided for entering into the business of banking. Detailed provisions regarding ownership and
management of banks have been provided in the draft Act. Detail of permissible and prohibited business
by banks has been further elaborated with power to SBP to declare any business as banking business.
Powers of SBP in relation to its assigned functions have been greatly enhanced based on international
best practices. Fit and proper criteria for Board members and Chairman have been provided in the draft
law which was otherwise applied through regulations. It Enables provisions for anti-money laundering
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have been provided in the draft Act. Provisions relating to inspection, audit and reporting have been
upgraded with enhanced powers of SBP to take action against banks, auditors. Provision relating to
deposit protection fund have been incorporated to protect the interest of depositors of banks. Legal
basis for cooperation between SBP and SECP has been provided. Regulatory powers of SBP have been
enhanced in all the regulatory areas under the draft Act. Schedules provide activities which bank can
undertake and penalties for violations of draft Act.
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ANALYSIS OF TABLE 2.5
MONETARY AGGREGATES
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Developments in Monetary Aggregates
The growth in broad monetary aggregate (M2) accelerated to 5.7 percent during Jul-Feb
FY10 from 2.0 percent in the corresponding period of FY09 (see Table 4.1). However, these
broad numbers do not capture the shift in composition of M2 growth after the first quarter of
FY10. While the growth in M2 during Q1-FY10 was driven largely by an improvement in NFA ofthe banking system, the sharp acceleration in M2 growth thereafter is explained largely by an
uptrend in seasonal credit demand from the private sector mainly visible in Q2-FY1).
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Moreover, during Oct-Feb FY10, the government borrowed more from the central bank
to meet budgetary expenses compared to Q1-FY10 (though monetization remained within the
quarterly target agreed with the IMF).
On the other hand, the improvement in NFA, visible since December 2008, has shownreversal October 2009 onwards.
Net Foreign Assets (NFA)
Net Foreign Assets (NFA)was driven largely by an improvement in NFA of the banking
system, the sharp acceleration in M2 growth thereafter is explained largely by an uptrend in
seasonal credit demand from the private sector mainly visible in Q2-FY10.
The trend improvement in NFA of the banking system, visible since December 2008,
reversed as pressures on external account re-emerged October 2009 onwards (see Figure 4.4).
As a result, the NFA of the banking system showed a depletion of Rs 80.7 billion in Oct-Feb
FY10.
The depletion in the NFA of the banking system during Oct-Feb FY10 was mainly evident
in the SBP NFA. The contraction in SBP NFA was despite the lower net intervention in the forex
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market as SBP completely shifted the financing of oil imports to the interbank market by mid
December 2009. Indeed, the increased repayment of official loans, particularly Sukuk bond in
January 2010, overshadowed the receipt of a second IMF tranche of US$ 374 million for
budgetary support in December 2009 as well as other official inflows.
The NFA of scheduled banks witnessed a depletion of Rs 21.4 billion during Jul-Feb FY10 incontrast to a net expansion of Rs 4.3 billion in the corresponding period a year earlier. The high
oil import payments fall in foreign investments inflows, substantially lower net inflows under
foreign private loans, and low retirement of foreign currency loans by traders were major
factors responsible for this reversal in NFA of scheduled banks. These factors were strong
enough to offset improvements arising from higher inflows under FE-25 deposits.
Net Domestic Assets (NDA)
The NDA growth changed dramatically after Q1-FY10. During Q1-FY10, NDA had a
negative contribution to M2 growth. However thereafter, NDA experienced a sharp increase,mainly due to:
(1) A strong rise in private sector credit, and
(2) Increased recourse of the government to borrow from the banking system (see
Figure 4.5