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Deficiencies in the banking system.

Banks bad loans have ballooned as the domestic economy decelerated in response to the crisis in global financial market and recession in developed economies.

Coming to the rescue, the central bank has relaxed rules relating to classification of bad loans that would contain growth of bad debts for the time being. For sustainable growth, the banking system needs to overcome its structural deficiencies.

"Going forward, we must expand the deposit base and penetrate into newer areas of lending and keep our operational cost low," says president of a local bank.

"We need to mitigate risks associated with market volatility which is becoming more intense and we need to build up support services like asset valuation, customs clearance, transportation custody and litigation to cut our costs. Only then we'd be able to squeeze banking spread and offer better returns to depositors."

Senior bankers admit that the growth rate of bank deposits is lower than required and there is a need to kick-start lending to the private sector to facilitate economic growth.

Deposits of banks increased to Rs4. 162 trillion in September 2009 showing a year-on-year growth of 10 percent better than 9.15 per cent a year before but far below an average growth of 18.5 percent between 2002 and 2007.

Deceleration of deposits' growth can be attributed, to some extent, to a decline in GDP growth rates but primarily it reflects banks' failure to offer reasonable rates of return and flight of capital in the wake of the war on terror and a general breakdown of law and order. Average deposit rate of banks stood at 6.3 per cent in September 2009, down 150 basis points from 7.8 percent in September 2008.

During this period, the State Bank had made a few policy rate cuts to stimulate economic growth and that is what bankers cite as a reason for the decline in deposit rates. But interestingly, the average lending rate of banks showed only a 10 basis points decline during the period under review falling from 13.8 to 13.7 per cent. As a result, the banking spread or the gap between lending and deposit rates widened from 500 basis points in September 2008 to 740 basis points in September 2009.

The spread had come down to 500bps in September 2008 mainly because earlier the State Bank had made it mandatory for banks to offer at least five per cent annual return on bank deposits--and the central bank had issued this instruction under immense public pressure.

A huge increase of 240 bps in the spread within a year clearly shows banks have tried to make up for their falling incomes by squeezing deposit rates instead of boosting non-interest income or finding fresh areas of lending where higher mark-ups could have been charged or, adopting right business strategies to ensure uninterrupted flow of repayments.

Banks' failure in achieving a handsome growth rate in deposits coupled with the government's inability to mobilize the required amount of money through National Saving Schemes (NSS) keep domestic savings- to- GDP ratio at low levels.

Savings to GDP ratio stood at 13.4 percent in FY08. It improved marginally to 14.3 percent in FYQ9--thanks to an increase in public savings--but was still too low to facilitate the government in reducing its external borrowing requirements. The tax- to-GDP ratio has already come down to 10 percent necessitating reliance on foreign sources of funding.

The low rates of return on bank deposits and only marginally higher returns on NSS keep a large chunk of money outside the documented economy as is evident in declining household savings amidst a nominal growth in overall savings to GDP ratio.

Household savings parked mostly in short to medium- term bank deposits or in NSS, fell from 13.1 percent of GDP in FY08 to 11.2 percent in FY09.


Businessmen reveal and bankers admit that the bank's failure to offer reasonable returns on deposits have led to haphazard investment by people in areas like the stock market, real estate, gold and once again in hard currencies. It has even contributed to capital flight and rising undocumented investment abroad. Banks remained focused on quick profit-making in the first seven years of this decade which eventually landed them in a situation where they failed to expand deposit base on the one hand and find ways of least risky yet highly profitable areas of lending. This too was a key factor behind ballooning of bad loans.

Loan defaults remained high in the last fiscal year also due to a slump in domestic economy that had an adverse impact on corporate profitability as well as on consumption demand. Another factor behind high rates of loan defaults was that in the preceding years banks had made excessive imprudent lending, particularly in consumer sector to earn unusually high margins. As a result, banks' overall non-performing loans grew to Rs398 billion or 11.5 per cent of their overall loans in June 2009.

Now banks -face a two-pronged challenge: they need to raise more deposits by offering adequate returns to depositors which is difficult if they do not sacrifice short-term growth in interest rate income. And they also need lending more to the private sector for achieving larger and gainful employment of funds amidst government's efforts to cut its bank borrowing. In the last fiscal year, banks had made net fresh loans of Rsl8 billion only to the private sector and they remained reluctant to lend to the sector till the end of the first quarter of this fiscal year.

"However, hanks have made net fresh loans of Rs54 billion between September 26 and October 24,2009," pointed out head of credit department of a large local bank. This has reduced net bank credit retirement by the private sector from Rs95 billion to Rs41 billion. "One hope that the overall private sector credit off-take would turn positive in the second or third week of this month," he added citing financing of cotton ginning and sugarcane crushing as demand boosters and the relaxation won by banks from the SBP in provisioning of bad loans as a. catalyst.

Bankers say, the nascent recovery in manufacturing sector seen in the first two months of this fiscal year and agreements signed last month between domestic banks and the Asian Development Bank under a billion-dollar Trade Finance Facilitation Programme is likely to enhance private sector lending. The agreements with Bank Altaian, Faysal Bank, Habib Metropolitan Bank and United Bank follow similar agreements signed in mid May with five other banks namely National Bank, Habib Bank, Allied Bank, Bank Al-Habib and Meezan Bank. The agreements should help direct much needed finance to exporters and importers.
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Title Annotation:Banking
Author:Aazim, Mobiuddin
Publication:Economic Review
Geographic Code:9PAKI
Date:Jan 1, 2010
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