History

Before Independence on 14th August 1947, the Reserve Bank of India (Central bank of India)
was the central bank for what is now Pakistan. On 30 December 1948 the British Government's
commission distributed the Bank of India's reserves between Pakistan and India - 30 percent (750
M gold) for Pakistan and 70 percent for India.

The losses incurred in the transition to independence were taken from Pakistan's share
(a total of 230 million). In May, 1948 Muhammad Ali Jinnah (Founder of Pakistan) took
steps to establish the State Bank of Pakistan immediately. These were implemented in
June 1948 and the State Bank of Pakistan commenced operation on July 1, 1948

State Bank
State Bank of Pakistan is the Central Bank of the country. While its constitution, as
originally laid down in the State Bank of Pakistan Order 1948, remained basically
unchanged until 1st January 1974 when the Bank was nationalized, the scope of its
functions was considerably enlarged. The State Bank of Pakistan Act 1956, with
subsequent amendments, forms the basis of its operations today.

Under the State Bank of Pakistan Order 1948, the Bank was charged with the duty to
"regulate the issue of Bank notes and keeping of reserves with a view to securing
monetary stability in Pakistan and generally to operate the currency and credit system
of the country to its advantage". The scope of the Bank’s operations was considerably
widened in the State Bank of Pakistan Act 1956, which required the Bank to "regulate
the monetary and credit system of Pakistan and to foster its growth in the best national
interest with a view to securing monetary stability and fuller utilization of the country’s
productive resources". Under financial sector reforms, the State Bank of Pakistan was
granted autonomy in February 1994. On 21st January, 1997, this autonomy was further
strengthened by issuing three Amendment Ordinances (which were approved by the
Parliament in May, 1997) namely, State Bank of Pakistan Act, 1956, Banking
Companies Ordinance, 1962 and Banks Nationalization Act, 1974. The changes in the
State Bank Act gave full and exclusive authority to the State Bank to regulate the
banking sector, to conduct an independent monetary policy and to set limit on
government borrowings from the State Bank of Pakistan. The amendments in Banks
Nationalization Act abolished the Pakistan Banking Council (an institution established
to look after the affairs of NCBs) and institutionalised the process of appointment of the
Chief Executives and Boards of the nationalised commercial banks (NCBs) and
development finance institutions (DFIs), with the Sate Bank having a role in their
appointment and removal. The amendments also increased the autonomy and
accountability of the Chief Executives and the Boards of Directors of banks and DFIs.

Like a Central Bank in any developing country, State Bank of Pakistan performs both the
traditional and developmental functions to achieve macro-economic goals. The traditional
functions, which are generally performed by central banks almost all over the world, may be
classified into two groups: (a) the primary functions including issue of notes, regulation and
supervision of the financial system, bankers’ bank, lender of the last resort, banker to
Government, and conduct of monetary policy, and (b) the secondary functions including the
agency functions like management of public debt, management of foreign exchange, etc., and
other functions like advising the government on policy matters and maintaining close
relationships with international financial institutions. The non-traditional or promotional
functions, performed by the State Bank include development of financial framework,
institutionalisation of savings and investment, provision of training facilities to bankers, and
 provision of credit to priority sectors. The State Bank also has been playing an active part in the
process of islamization of the banking system. The main functions and responsibilities of the
State Bank can be broadly categorised as under.

Functions
Under the State Bank of Pakistan Order 1948, the state bank of Pakistan was charged with the
duty to "regulate the issue of bank notes and keeping of reserves with a view to securing
monetary stability in Pakistan and generally to operate the currency and credit system of the
country to its advantage".

A large section of the state bank's duties were widened when the State Bank of Pakistan Act 1956
was introduced. It required the state bank to "regulate the monetary and credit system of Pakistan
and to foster its growth in the best national interest with a view to securing monetary stability and
fuller utilisation of the country’s productive resources". In February 1994, the State Bank was
given full autonomy, during the financial sector reforms.

On January 21, 1997, this autonomy was further strengthened when the government issued three
Amendment Ordinances (which were approved by the Parliament in May, 1997). Those included
were the State Bank of Pakistan Act, 1956, Banking Companies Ordinance, 1962 and Banks
Nationalisation Act, 1974. These changes gave full and exclusive authority to the State Bank to
regulate the banking sector, to conduct an independent monetary policy and to set limit on
government borrowings from the State Bank of Pakistan. The amendments to the Banks
Nationalisation Act brought the end of the Pakistan Banking Council (an institution established to
look after the affairs of NCBs) and allowed the jobs of the council to be appointed to the Chief
Executives, Boards of the Nationalised Commercial Banks (NCBs) and Development Finance
Institutions (DFIs). The State Bank having a role in their appointment and removal. The
amendments also increased the autonomy and accountability of the chief executives, the Boards
of Directors of banks and DFIs.

The State Bank of Pakistan (SBP) has four major functions to perform under the
law:

• ensuring soundness of the financial sector.

• maintaining price stability with growth.
• prudent management of the exchange rate.
• strengthening of the payment system.

Regulation of Liquity

The State Bank of Pakistan has also been entrusted with the responsibility to carry out monetary
and credit policy in accordance with Government targets for growth and inflation with the
recommendations of the Monetary and Fiscal Policies Co-ordination Board without trying to effect
the macroeconomic policy objectives.

The state bank also regulates the volume and the direction of flow of credit to different uses and
sectors, the state bank makes use of both direct and indirect instruments of monetary
management. During the 1980s, Pakistan embarked upon a program of financial sector reforms,
which lead to a number of fundamental changes. Due to these changed the conduct of monetary
management which brought about changes to the administrative controls and quantitative
restrictions to market based monetary management. A reserve money management programme
has been developed, for intermediate target of M2, that would be achieved by observing the
desired path of reserve money - the operating target.

REGULATION AND SUPERVISION

One of the fundamental responsibilities of the State Bank is regulation and supervision of the
financial system to ensure its soundness and stability as well as to protect the interests of
depositors. The rapid advancement in information technology, together with growing complexities
of modern banking operations, has made the supervisory role more difficult and challenging. The
institutional complexity is increasing, technical sophistication is improving and technical base of
banking activities is expanding. All this requires the State Bank for endeavoring hard to keep pace
with the fast-changing financial landscape of the country. Accordingly, the out dated inspection
techniques have been replaced with the new ones to have better inspection and supervision of
the financial institutions. The banking activities are now being monitored through a system of ‘off-
site’ surveillance and ‘on-site’ inspection and supervision. Off-site surveillance is conducted by the
State Bank through regular checking of various returns regularly received from the different
banks. On other hand, on-site inspection is undertaken by the State Bank in the premises of the
concerned banks when required.

To deepen and broaden financial markets as also to diversify the sources of credit, a number of
non-bank financial institutions (NBFIs) were allowed to increase substantially. The State Bank has
also been charged with the responsibilities of regulating and supervising of such institutions. To
regulate and supervise the activities of these institutions, a new Department namely, NBFIs
Regulation and Supervision Department was set up. Moreover, in order to safeguard the interest
of ultimate users of the financial services, and to ensure the viability of institutions providing these
services, the State Bank has issued a comprehensive set of Prudential Regulations (for
commercial banks) and Rules of Business (for NBFIs).

The "Prudential Regulations" for banks, besides providing for credit and risk exposure limits,
prescribe guide lines relating to classification of short-term and long-term loan facilities, set
criteria for management, prohibit criminal use of banking channels for the purpose of money
laundering and other unlawful activities, lay down rules for the payment of dividends, direct banks
to refrain from window dressing and prohibit them to extend fresh laon to defaulters of old loans.
The existing format of balance sheet and profit-and-loss account has been changed to conform to
international standards, ensuring adequate transparency of operations. Revised capital
requirements, envisaging minimum paid up capital of Rs.500 million have been enforced.
Effective December,1997, every bank was required to maintain capital and unencumbered
general reserves equivalent to 8 per cent of its risk weighted assets.

The "Rules of Business" for NBFIs became effective since the day NBFIs came under State
Bank’s jurisdiction. As from January, 1997, modarbas and leasing companies, which are also
specialized type of NBFIs, are being regulated/supervised by the Securities and Exchange
Commission (SECP), rather than the State Bank of Pakistan.

EXCHANGE RATE MANAGEMENT AND BALANCE OF PAYMENTS

One of the major responsibilities of the State Bank is the maintenance of external value of the
currency. In this regard, the Bank is required, among other measures taken by it, to regulate
foreign exchange reserves of the country in line with the stipulations of the Foreign Exchange Act
1947. As an agent to the Government, the Bank has been authorised to purchase and sale gold,
silver or approved foreign exchange and transactions of Special Drawing Rights with the
International Monetary Fund under sub-sections 13(a) and 13(f) of Section 17 of the State Bank
of Pakistan Act, 1956.
The Bank is responsible to keep the exchange rate of the rupee at an appropriate level and
prevent it from wide fluctuations in order to maintain competitiveness of our exports and maintain
stability in the foreign exchange market. To achieve the objective, various exchange policies have
been adopted from time to time keeping in view the prevailing circumstances. Pak-rupee
remained linked to Pound Sterling till September, 1971 and subsequently to U.S. Dollar. However,
it was decided to adopt the managed floating exchange rate system w.e.f. January 8, 1982 under
which the value of the rupee was determined on daily basis, with reference to a basket of
currencies of Pakistan’s major trading partners and competitors. Adjustments were made in its
value as and when the circumstances so warranted. During the course of time, an important
development took place when Pakistan accepted obligations of Article-VIII, Section 2, 3 and 4 of
the IMF Articles of Agreement, thereby making the Pak-rupee convertible for current international
transactions with effect from July 1, 1994.

After nuclear detonation by Pakistan in 1998, a two-tier exchange rate system was introduced
w.e.f. 22nd July 1998, with a view to reduce the pressure on official reserves and prevent the
economy to some extent from adverse implications of sanctions imposed on Pakistan. However,
effective 19th May 1999, the exchange rate has been unified, with the introduction of market-
based floating exchange rate system, under which the exchange rate is determined by the
demand and supply positions in the foreign exchange market. The surrender requirement of
foreign exchange receipts on account of exports and services, previously required to be made to
State Bank through authorized dealers, has now been done away with and the commercial banks
and other authorised dealers have been made free to hold and undertake transaction in foreign
currencies.

As the custodian of country’s external reserves, the State Bank is also responsible for the
management of the foreign exchange reserves. The task is being performed by an Investment
Committee which, after taking into consideration the overall level of reserves, maturities and
payment obligations, takes decision to make investment of surplus funds in such a manner that
ensures liquidity of funds as well as maximises the earnings. These reserves are also being used
for intervention in the foreign exchange market. For this purpose, a Foreign Exchange Dealing
Room has been set up at the Central Directorate of State Bank of Pakistan and services of a
‘Forex Expert’ have been acquired.

DEVELOPMENTAL ROLE OF STATE BANK

The responsibility of a Central Bank in a developing country goes well beyond the regulatory
duties of managing the monetary policy in order to achieve the macro-economic goals. This role
covers not only the development of important components of monetary and capital markets but
also to assist the process of economic growth and promote the fuller utilisation of a country’s
resources.

Ever since its establishment, the State Bank of Pakistan, besides discharging its traditional
functions of regulating money and credit, has played an active developmental role to promote the
realisation of macro-economic goals. The explicit recognition of the promotional role of the
Central Bank evidently stems from a desire to re-orientate all policies towards the goal of rapid
economic growth. Accordingly, the State Bank with a well-recognised developmental role has
combined the orthodox central banking functions.

The scope of Bank’s operations has been widened considerably by including the economic
growth objective in its statute under the State Bank of Pakistan Act 1956. The Bank’s participation
in the development process has been in the form of rehabilitation of banking system in Pakistan,
development of new financial institutions and debt instruments in order to promote financial
intermediation, establishment of Development Financial Institutions (DFIs), directing the use of
credit according to selected development priorities, providing subsidised credit, and development
of the capital market.

The State Bank of Pakistan also performs both the traditional and developmental functions
to achieve macroeconomic goals. The traditional functions, may be classified into two
groups:

1. The primary functions including issue of notes, regulation and supervision of the financial
system, bankers’ bank, lender of the last resort, banker to Government, and conduct of
monetary policy.
2. The secondary functions including the agency functions like management of public debt,
management of foreign exchange, etc., and other functions like advising the government
on policy matters and maintaining close relationships with international financial
institutions.

The non-traditional or promotional functions, performed by the State Bank include development of
financial framework, institutionalisation of savings and investment, provision of training facilities to
bankers, and provision of credit to priority sectors. The State Bank also has been playing an
active part in the process of islamisation of the banking system.

Role in Banking Sector

The State Bank of Pakistan looks into alot of different ranges of banking to deal with the changes
in economic climate and different purchasing and buying powers. Here are some of the banking
areas that the state bank looks into;

• State Bank’s Shariah Board Approves Essentials and Model Agreements for
Islamic Modes of Financing
• Procudure For Submitting Claims With Sbp In Respect of Unclaimed Deposits
Surrendered By Banks/Dfis.
• Banking Sector Supervision in Pakistan
• Micro Finance
• Small Medium Enterprises (SMEs)
• Minimum Capital Requirements for Banks
• Remittance Facilities in Pakistan
• Opening of Foreign Currency Accounts with Banks in Pakistan under new scheme.
• Handbok of Corporate Governance
• Guidelines on Risk Management
• Guidelines on Commercial Paper
• Guidelines on Securitization
• SBP.Scheme for Agricultural Financing

It was felt and agreed between the Government and the State Bank of Pakistan that major deep
Rooted reforms had to be undertaken, as cosmetic changes have not achieved anything tangible.
As a regulator and supervisor as well as adviser to the Government, the SBP carried out
diagnostic studies, prioritized the constraints facing the banking sector, designed the reform
strategy and action plan, sought the assistance of the Government of Pakistan and international
financial institutions, monitoredthe progress and made policy, regulatory and institutional changes
to facilitate the process. Where does the Government come in the picture and what did it do? The
Musharraf GovernmentMade some critical policy decisions, i.e. they will not keep the banks under
Government ownership And control but privatize them. Politically tough problems such as
reducing the labor force and Closing down redundant and unprofitable branches were dealt with
boldly. The Government injected Rs. 30.7 billion to offset the losses incurred by these
nationalized commercial banks and recapitalizes them. Professional bankers were appointed as
Chief Executives and persons from private sector enjoying reputation of competence and integrity
on the Board of Directors. I must say that the Nawaz Sharif Government in 1997 had initiated
some of the reform measures by appointing Chief Executives, Boards of Directors on non-
political, nonpartisan basis for the first time.
That Government had also injected fresh equity to strengthen the capital base of the nationalized
Commercial banks. Both Sartaj Aziz Sahib and Ishaq Dar Sahib were very much committed to put
these banks on sound footing. They did away with the undue interference of labor unions in
decision making process of the banks, abolished the Pakistan Banking Council and gave
autonomy to the State Bank of Pakistan.
The point I would like to highlight in this context is that continuity of reforms and sound policies that
transcend political partisanship and survive political regime changes are good for the country and also for
these political parties.
What were the major reforms that had been implemented during the last seven years? I would not
gointo the details of each one of them, but summarize some of the salient features:

(i) Privatization of NCBs:

All the nationalized commercial banks, except one, have been privatized. As a consequence
their domination of the banking sector has been reduced from almost 100 percent in 1991 to
about 20 percent by June 2004. Even in the case of National Bank of Pakistan 23.5 percent
shares have been floated through Stock Market mainly aimed at small retail investors.

(ii) Corporate governance:

Strong corporate governance is absolutely essential if the banks have to operate in a
transparent manner and protect the depositors’ interests. The SBP has taken several
measures in the last four years to put in place and enforce good governance practices to
improve internal controls and bring about a change in the organizational culture.

(iii) Capital strengthening:

Capital requirements of the banking sector have to be adequate to ensure a strong base,
ability to compete and withstand unanticipated shocks. The minimum paid-up capital
2 BIS Review 5/2005
requirements of the banks have been raised from Rs. 500 million to Rs. 1 billion and have
again been raised to Rs. 2 billion (by December 31, 2005). This has already resulted in
mergers and consolidation of many financial institutions and weeding out of several weaker
banks from the financial system.

(iv) Improving asset quality:

The stock of gross non-performing loans (NPLs) that amounted to Rs. 252 billion and
accounted for 22 percent of the advances of the banking system and DFIs has been reduced
to Rs. 225 billion i.e. 14 percent of advances. More than two-thirds of these loans are fully
provided for and net NPLs to net advances ratio has come down to as low as 5 percent for
the commercial banks. The positive development is that the quality of new loans disbursed
since 1997 has improved and recovery rate is 95 percent.

(v) Liberalization of foreign exchange regime:

Pakistan has further liberalized its foreign exchange regime and set up foreign exchange
companies to meet the demands of Pakistani citizens. Pakistani Corporate sector companies
have also been allowed to acquire equity abroad. Foreign registered investors can bring in
and take back their capital, profits, dividends, remittances etc. freely without any restrictions.

(vi) Consumer financing

By removing restrictions imposed on nationalized commercial banks for consumer financing,
the State Bank of Pakistan has given a big boost to consumer financing. Middle class
employees can now afford to purchase cars, TVs, air7 conditioners, VCRs, etc. on
installment basis. This, in turn, has given a large stimulus to the domestic manufacturing of
these products.

(vii) Mortgage financing:

A number of incentives have been provided to encourage mortgage financing by the banks.
The upper limit has been raised from Rs. 5 million to Rs. 10 million. Tax deduction on
interest payments on mortgage have been allowed up to a ceiling of Rs. 1 million. The new
recovery law is aimed at expediting repossession of property by the banks. The banks have
been allowed to raise long term funds through rated and listed debt instruments like TFCs to
match their long term mortgage assets with their liabilities.

(viii) Legal reforms:

Legal difficulties and time delays in recovery of defaulted loans have been removed through
a new ordinance i.e. The Financial Institutions (Recovery of Finances) Ordinance, 2001. The
new recovery laws ensures the right of foreclosure and sale of mortgaged property with or
without intervention of court and automatic transfer of case to execution proceeding. A
Banking Laws Reforms Commission is reviewing, revising and consolidating the banking
laws and drafting new laws such as bankruptcy law.

(ix) Prudential regulations:

The prudential regulations in force were mainly aimed at corporate and business financing.
The SBP in consultation with the Pakistan Banking Association and other stakeholders has
developed a new set of regulations which cater to the specific separate needs of corporate,
consumer and SME financing. The new prudential regulations will enable the banks to
expand their scope of lending and customer outreach.

(x) Micro financing:

To provide widespread access to small borrowers particularly in the rural areas the licensing
and regulatory environment for Micro Credit and Rural financial institutions have been
BIS Review 5/2005 3 relaxed and unlike the commercial banks these can be set up at district, provincial
and national levels with varying capital requirements. There is less stringency and more
facilitative thrust embedded in the prudential regulations designed for this type of institutions.
Khushali Bank and the First Micro finance Bank in the private sector have already started
working under this new regulatory environment. Khushali Bank has already reached a
customer base of 125,000 mainly in poorer districts of the country and its recovery rate is
above 95 percent.

(xi) SME financing:

The access of small and medium entrepreneurs to credit has been a major constraint to
expansion of their business and up gradation of their technology. A Small and Medium
Enterprise (SME) Bank has been established to provide leadership in developing new
products such as program loans, new credit appraisal and documentation techniques, and
nurturing new skills in SME lending which can then be replicated and transferred to other
banks in the country. Program lending is the most appropriate method to assist the SME
financing needs. The new prudential regulations for SMEs do not require collateral but asset
conversion cycle and cash flow generation as the basis for loan approval. The State Bank is
also contemplating to develop capacity building among a select group of banks for SME
lending. This will revitalize the lending to SMEs particularly export oriented ones.

(xii) Taxation:
The Government has already reduced the corporate tax rate on banks from 58 percent to
41 percent during the last four years and it is envisaged that the rate will be reduced
gradually and brought at par with the corporate tax rate of 35 percent in the next two years.
This will, in turn, help in reducing the spread between the deposit rate and lending rate and
benefit financial savers.

(xiii) Agriculture credit.

A complete revamping of Agriculture Credit Scheme has been done recently with the help of
commercial banks. The scope of the Scheme which was limited to production loans for
inputs has been broadened to the whole value chain of agriculture sector. The broadening of
the scope as well the removal of other restrictions have enabled the commercial banks to
substantially increase their lending for agriculture by a multiple of four times compared to
FY 1999-00 thus mainstreaming agriculture lending as part of their corporate business.
Unlike the previous years when they were prepared to pay penalties for under performance
they have achieved consistently rising higher targets every year. The private commercial
banks have also agreed to step in and increase their lending to agriculture.

(xiv) Islamic banking:

Pakistan has introduced Islamic banking system to operate in parallel with the conventional
banking providing a choice to the consumers. A large number of Pakistanis have remained
withdrawn from commercial banking because of their strong belief against riba-based
banking. These individuals and firms - mainly middle and low class - will have the opportunity
to invest in trade and businesses by availing of loans from Islamic banks and thus expand
economic activity and employment. A full-fledged Islamic bank has already opened the doors
for business and several banks have branches exclusively dedicated to Islamic banking
products and services.
The State Bank of Pakistan has set up a full-fledged Islamic Banking Department and a
Shariah Advisory Board to help it in the promotion of Islamic banking in the country.

(xv) E-banking:
There is a big surge among the banks including NCBs to upgrade their technology and
on-line banking services. During the last three years there has been a large expansion in the
ATMs and at present about 700 ATMs are working throughout the country. The decision
4 BIS Review 5/2005
mandating the banks to join one of either two ATM switches available in the country has
provided a further boost. Progress in creating automated or on-line branches of banks has
been quite significant so far and it is expected that by 2005 almost all the bank branches will
be on-line or automated. Utility bills payment and remittances would be handled through
ATMs, kiosks or personal computers reducing both time and cost.

(xvi) Human resources:

The banks have recently embarked on merit-based recruitment to build up their human
resource base - an area which has been neglected so far. The private banks have taken lead
in this respect by holding competitive examinations, interviews and selecting the most
qualified candidates. The era of appointment on the basis of sifarish and nepotism has
almost come to an end as the private owners want to attract and retain the best available
talent which can maximize their profits. This new generation of bankers will usher in a culture
of professionalism and rigour in the banking industry and produce bankers of stature who will
provide leadership in the future.

(xvii) Credit rating:

To facilitate the depositors to make informed judgments about placing their savings with the
banks, it has been made mandatory for all banks to get themselves evaluated by credit
rating agencies. These ratings are then disclosed to the general public by the SBP and also
disseminated to the Chambers of Commerce and Trade bodies. Such public disclosure will
allow the depositors to choose between various banks. For example, those who wish to get
higher return may opt for banks with B or C rating. But those who want to play safe may
decide to stick with only AAA or AA rated banks.

(xviii) Supervision and regulatory capacity:

The banking supervision and regulatory capacity of the Central Bank has been strengthened.
Merit-based recruitment, competency-enhancing training, performance-linked promotion,
technology-driven process, induction of skilled human resources and greater emphasis on
values such as integrity, trust, team work have brought about a structural transformation in
the character of the institution. The responsibility for supervision of non-bank finance
companies has been separated and transferred to Securities Exchange Commission. The
SBP itself has been divided into two parts - one looking after central banking and the other
after retail banking for the government.

(xix) Payment systems:

Finally, the country’s payment system infrastructure is being strengthened to provide
convenience in transfer of payments to the customers. The Real-Time Gross Settlement
(RTGS) system will process large value and critical transactions on real time while electronic
clearing systems will be established in all cities.
These reforms will go a long way in further strengthening the Banking sector but a vigilant
supervisory
regime by the State Bank will help steer the future direction.

Outcomes:

What have been the results of the above reforms?

We have been working for the last five years to decrease the lending rates to the extent that
middle and low-income professionals, who have no other source than their monthly income, may
get a home or a car on installments from the banks. If he/she is a small entrepreneur he/she can
get loans from SME. Agriculture, the largest sector of economy, which the commercial banks had
neglected, has now begun to receive large allocations. The commercial banks are giving more
agriculture loans than the ZTBL. If this trend persists, the rural households will be able to intensify
the use of modern inputs and raise their productivity and income.
BIS Review 5/2005 5 Credit cards, debit cards, personal loans and consumer durable loans are
catching up fast.
Refrigerators, air conditioners, VCRs, Televisions are now available on credit. The consumers are
forced to save when a specific amount is cut from their salary every month to pay the installment.
Mortgage financing is one way in which wealth is created. For example, you bought an apartment
for Rs. 100,000 and paid Rs. 20,000 as equity and borrowed Rs. 80,000 from the bank. Next
year, let us say that the value of the same apartment rises to Rs. 120,000/-. Your loan is still Rs.
80,000, but your own equity has now doubled from Rs. 20,000 to Rs. 40,000. In this way, growth
of the middle class wealth takes place through judicious use of bank credit. As the lending rates
have come down drastically from 21% to 5% the banks find it profitable to extend the customer
base for mortgage and auto loans, agriculture credit, small business and consumers. For the first
time in the history of Pakistan, the middle class is beginning to benefit from the banking system.
Before these reforms only 400,000 farmers used to get loans from the Agriculture Development
Bank, but this year, more than one million farmers have been granted loans by the banking
system.For the poor, who don’t have anything to mortgage, we have established microfinance
banks where no collateral is required. They can get up to Rs. 20-25 thousand in micro loans.
Many people have availed this opportunity, some bought a cow, some bought a milch buffalo or
opened a small shop and female borrowers bought sewing machines. They have started income-
generating activities and recovery is no problem from the micro-finance banks. Approximately,
125,000 poor people have been given loans in the last two years.
The customer base of the banks has more than doubled during the last few years and covers
almost 2 million households in agriculture, SMEs, Micro finance, Credit Cards, consumer loans,
mortgage and auto loans, etc.
Another initiative taken by the State Bank of Pakistan was to revive sick units which were lying
closed due to unsustainable debt burden. Now these sick industries can be revived through a well
designed and transparent scheme. If the loaners pay 75% of the forced sale value to the bank,
then these units would be handed over back to the owners. They can run the units and create
employment opportunities. If it’s an export industry, it will increase exports. This scheme is for all
and sundry, across the board and round about 51,000 borrowers will be benefiting from it. The
banks will be able to clean up their balance sheets by transforming these stuck loans into paying
loans.Pakistan is one of the few developing countries where the public sector banks went to the
private hands in a very short span of time. The government only owns the National Bank, while
80% of the bank assets are in the private sector. And there is tough competition among the banks
as in the private sector everything is performance-based. Unlike the public sector or the
Government, any employee not producing results is fired because he affects profit of the
organization. The bankers these days go out of their cozy offices to market their financial
products and build up customer base. The seller market has changed into a buyer market. The
customer may choose the bank with best products and services. There was a time - only a few
years back - people used to go to the banks and the staff treated them shabbily, was generally
uncooperative and unfriendly. Now, they are after the customers. Cynics say that banking reforms
are also promoting consumerism but when you give loan to a consumer, he goes and buys a car.
But loan is given to a person who can demonstrate that he has sufficient disposable income to
repay the monthly installments after taking care of his family needs. Before 1999 only 30
thousand cars were produced but in the last fiscal 100,000 cars were being produced. 70% of the
parts and components for these cars are manufactured in Pakistan which is creating employment.
Those who are producing the auto parts have made an investment of millions of rupees and
generated new job opportunities. As they have attained economies of scale, Pakistani auto parts
are being exported to Dubai and other countries. The whole industry is benefiting from it. Very
limited numbers of air-conditioners were manufactured here but now they are produced in
hundreds of thousands, similarly several hundred thousands of refrigerators and television sets
are manufactured locally. If a company produces such products, they make huge investments in
industry, people are employed and incomes are generated. This is not consumerism; rather we
are stimulating demand in the economy by giving purchasing power to the people who can afford
to pay them not in one shot but in installments spread over several years. If domestically
manufactured goods are bought it’s boosting the industrial growth. How have we achieved 17%
industrial growth during the last fiscal year? The private sector is doing all this because they see
a rising demand for their goods. For the first time in the history of Pakistan, the private sector
received bank credit worth more than Rs. 325 billion. They used this money to invest in the
industry and expand their capacity. This is complete cycle - banks provide credit to consumers
who purchase goods with this money, the6 BIS Review 5/2005 manufacturers respond to this higher
demand by investing in new capacity and employing more people. As the new employees receive
income they also add to the demand for these goods. Similarly, the housing industry where steel,
cement, paint, timber wood, electric gadgets, etc. are used is creating many more jobs in this
sector. Unless there is credit available, except the millionaire/billionaire, the common man doesn’t
have enough money to build a house for himself. Credit increases his purchasing power. Home is
a basic need. He will cut his monthly expenses but pay installments to the bank to keep his
house. It will change his thinking. This is a kind of motivation for him. Everybody wants to have a
home and a car. The banking sector is catering to such needs allover the world.
One of the adverse effects of lower interest rates in the country has been erosion of rates of
returns on bank deposits. Small depositors who keep their savings in the banks have been badly
hurt as they hardly get a decent return these days. The Government, therefore, had to come up
with some scheme to safeguard the most vulnerable groups of our society whose only source of
livelihood is their savings. To compensate the senior citizens, pensioners and widows we have
launched “Behbood Scheme” through which they get 10.25% per annum. These returns are not
affordable by the Government as they have reduced their fiscal deficit and do not need this
money. Moreover, people used to misuse the saving schemes. They were in the habit of buying
national saving certificates and then getting loans against those certificates and again buying
more saving certificates. As interest rates move up in the economy, it will be the depositors who
will get the benefit while the borrowers will have to a pay higher price. This is the normal cycle
through which market-based economies work. If we have chosen to live with this type of
economy, we have to bear its costs along with its benefits. But it is our duty to protect the poor
and vulnerable groups of the society. Here the Behbood saving schemes, Bait-ul-Mal, Zakat,
Micro finance loans and Poverty Alleviation Funds come handy.
It can be seen from the above description and analysis that in the banking system the interests of
Depositors and borrowers are quite different. What we have been able to ensure is that
competition reduces inefficiencies in the system and the gains are passed on to both the
depositors and the borrowers. But, beyond this, there will always remain a tension between
depositors who want higher returns on their savings and the borrowers who want lower interest
rate on their loans.
To sum up, banking sector reforms have brought in competition within the system, improved
internal efficiency, reduced the lending rates significantly and broadened access to the middle
class. While these results are encouraging, a lot more needs to be done and, therefore, we have
spelled out the agenda for the second generation reforms in the financial sector covering the
period 2005-2010.