Commercial Banking in Pakistan
Commercial Banking in Pakistan
A commercial bank is an financial institution which serves as a mechanism for transmission of money and as a financial intermediary.
The history of commercial banks can be divided into 4 eras.
- A large number of privately owned banks dominated the market.
- These banks were sponsored by large business houses who used these banks for their own funding needs.
- Their scope of operation was restricted to major urban cities.
- All commercial banks were nationalized in 1974.
- Fifteen privately owned banks were consolidated into four nationalized commercial banks namely Habib Bank Ltd., United bank Ltd.; Muslim commercial bank Ltd.; Allied bank Ltd.
- Rapid branch expansion was under-taken to improve the coverage of banking services.
- The politically motivated heavy lending aggravated the risk and earning scenario of the commercial banks.
80’s Post Nationalization
- Foreign banks consolidated their position in the market at the expense of inefficient Nationalized Commercial Banks.
- Profit and loss sharing scheme was introduced.
- Financial market expanded as brokerage houses, leasing, modarbas, investment banks entered the market.
- The private sector was allowed to enter into the banking business.
- Muslim Commercial Bank and Allied Bank of Pakistan were privatized.
- Prudential regulations were introduced.
- The ceiling was replaced by CDR.
- Later on CDR was abolished.
- Foreign and private sector banks started emphasizing on retail banking.
The Evolution of Banking system in Pakistan
he banking system of Pakistan evolved out of the crisis that followed the partition of India. It had been decided before partition, to keep Pakistan’s monetary system under the control of the Reserve Bank of India until September 30, 1948. But after partition, there was outright hostility from India in the form of cutbacks on Indian scheduled bank offices in Pakistan ( from 487 before partition to 195 as on June 30, 1948) and a rush on banks to transfer funds and accounts. All this compelled Pakistan to establish indigenous banking system on war footings. The Australasia Bank was already functioning in Pakistani territory and the owners of Habib Bank, established in 1941, were successfully persuaded to bring their offices from Bombay to Karachi.
Lack of cooperation from the Reserve Bank of India Precipitated the creation of the State Bank of Pakistan on ist July 1948 despite reservations expressed by foreign experts about its viability in the absence of adequately trained staff. The National Bank of Pakistan was established in November 1949 as a first step towards creating a national banking system. Many of the banks showing unsatisfactory performance were stopped from accepting deposits whole others brought into liquidation. Steps were also taken to create money market in the country. The banking sector proved vigilant in the management of crisis-like situations such as the non-devaluation decision of the GOP in 1949, as well as in grabbing the opportunities offered for example by the Korean boom.
A down turn in commercial activities after the Korean war paved the way for shifting of accumulated resources to industrialization and culminating in the establishment of specialized credit institutions. The Development Finance Corporation had already been established in 11949 which was converted into IDBP in 1961. The Agriculture Development Bank was also established in 1961 to provide inputs/ machinery loans and to a smaller extent agro-based industries. Other development finance institutions established subsequently were NIT (1962) , Equity Participation Funds (1970) , SBFC (1972), NDFC (1973), BEL (1979) , Pak Kuwait Investment Company (1979) , Pak Libya Holding Company (1980), Suadi Pak Industrial and Agricultural Investment company (1981) and Regional Development Finance Corporation (1985).
A major event in the history of banking system in the country occurred on January 1st 1974, when all the 13 domestic banks were nationalized and merged into five nationalized commercial banks. The recent economic reforms have also transformed the banking sector as NCB’s are being privatized and a number of new banks have been set up in the private sector.
* source “Capital Markets in Pakistan” by M.B. Abbassi.
** source: Investment and Marketing August 1996
|ABN AMRO BANK Netherlands|
|American express Bank America|
|ANZ Grindlays Australia|
|Bank of America America|
|Banque Indosuez France|
|Emirates Bank Intern. UAE|
|Habib Bank AG Zurich Switzerland|
|HongKKong Bank HongKong|
|Pan African Bank Nigeria|
|Standard Chartered U.K|
|Bank of Tokyo Japan|
|Bank of Ceylon Sri Lanka|
|Fysal bank Bahrin|
|Hong Kong and Shenghai China|
* SOURCE “”citibank report”
|Muslim Commercial Bank|
|Allied Bank Of Pakistan|
|National Bank of Pakistan|
|Bank of Khyber|
|Bank of Punjab|
The branch network of the local banks is spread all over the country as compare to the foreign banks whose network is restricted to the urban areas only. Because of their strong branch network the local banks enjoy a distinct upper edge over the foreign competitors.
TYPES OF PRODUCTS
We have categorized the products according to the two main functions of the commercial banks.
- Products related to the transmission of money function of commercial bank.
- Products related to the financial intermediary function of the commerical bank.
- TRANSMISSION OF MONEY PRODUCTS.
Checking account/ Current account
Any person can open a current account. Usually interest is not paid on these accounts but some bankks have started paying interest on them. There is no restriction on the amount and the timing of withdrawal.
The client gives an instruction to the commercial bank for the repetition of an act at a specified interval. This is called standing instruction or standing order. For example a client may give standing instructions to its bank to make payment of its utility bills when they are received.
When a debit card holder uses his debit card his account is immediately debited. They are different from charged card and credit card. A charge card holder can use the card upto a pre-set limit and at the end of the month the bill is sent to her who then makes the payment.
Credit card has a certain credit limit. The holder of the card can use the card and at the end of the month the holder just has to pay the minimum balance. The rest attracts rate of interest ; hence in a way it is a loan.
They are also part of the transmission mechanism of the commercial banks. The use of travelers checks ensures the safety of funds. At the time of the encashment of the TC’s the holder signs the TC’’s which are matched against his specimen signature. At the establishment of the authenticity of the signatures the payment is made to him.
People from time to time feel the need to remit and receive money within and outside the country. Commercial banks provide this facility through their corresponding relationships with other banks safely and smoothly.
Automatic Teller Machine
It is one of the most innovative service offered by commercial banks like Citibank and MCB. Through these machines with the help of a card people will be able to deposit or withdraw money without having to visit their respective bank branches.
- FINANCIAL INTERMEDIARY PRODUCTS.
These can be categorized into two.
Saving account: Different banks open savings account with different amounts. There is a limit to the amount and the number of times of withdrawal.
Fixed Deposit account: it is also called term deposit. It is a kind of a contract under which a certain amount of money is placed in a fixed income bearing deposits for a specified period of time called the maturity date. Encashment before the maturity date is penalized.
Two important assets of a bank are investments and loans. Investment is done with excess cash. It depends upon the treasury as to how does it invest the excess liquidity in T-Bills, Government security and other investments. The banks asset loans gives rise to CREDIT PRODUCTS. In credit products we have:
- Secured Fix-term Loans
- Secured Over Draft.
- Any other Secured lending.
- Trade Finance.
- Corporate Finance.
In case of secured lending the bank has 100% tangible security for the loan. However, there are partially secured lending too. That is the bank does not have 100% tangible security to back them. Such loans are known as “loans guaranteed against customer’s guarantee and certain margins” . e.g. Pak Suzuki Motors Co. Ltd. Can get loan against the guarantee of its parent company.
Over Draft is a facility provided by the commercial banks to its certain customers to draw an excess amount of money than the amount available in the account. A certain rate of interest is charged on the excessive amount.
Another loan related product is trade-finance. On the export-side there is pre-export finance and on import side there is loan against imported merchandise or hypothecation of goods.
Secured Over Draft
Banks provide the facility of drawing in excess of their deposits to the customers against some collateral or security.
FOUR MAJOR ACTIVITIES OF A COMMERCIAL BANK
- Deposit Mobilization
- Lending activities
- Trade Finance
- Corporate Finance activities
Deposit is the back-bone of the banking system. Deposits are the main source of funds for a bank. The importance of deposits can be realized from the fact that the very definition of the banks starts with the accepting of deposits. The first pre requisite for a bank is the acceptance of deposits and then utilizing those deposits judiciously and thus paying a reasonable return to the depositors as well as meeting the reserve and withdrawal requirements. In mobilizing deposits the bank should consider two things:
- Average cost of deposits
- Average return on re-investment of deposits.
A prudent bank-manager will always try to maintain a deposit mix which would keep his average cost of deposits within safe limits so as to maintain the profitability, viability and liquidity of the bank. A commercial bank has to keep 5% of its deposits as cash reserves and 25% in the form of government securities. This means that only 70% are left for profitable lending. Out of these 70% of deposits there is a 35% cap on lending to the private sector. ************************
|BREAK-UP OF DEPOSITS IN TERMS OF DIFFERENT SEGMENTS OF COMMERCIAL BANKS|
The Pakistani commercial banks at the moment are mobilizing the following types of deposits. The following deposits are various mixes of current, saving and fixed accounts.
PLS. SAVING ACCOUNT
This account offers the facility of making frequent withdrawals and it has full check-writing facility. It s based on the Islamic concept of profit and loss sharing as compared to interest. Although it is a saving scheme it does not have any restrictions on withdrawals. Profits are paid on half-yearly basis on June and December. Unlike current accounts they do however have minimum deposit requirements.
|NAME ANNUAL YIELD MINIMUM DEPOSIT|
|Citibank 8-9 Rupees 500,00|
|Standard Chartered 11.3 Above Rs. 25 million|
|ABN Amro 11 250,000|
|Faysal 9.75 25,000|
|Habib 8.5 100|
|United 6 100|
|Muslim Commercial 8.4 100|
|Allied 8 100|
|NBP 8.7 100|
|Askari 9 100|
|Indus 11 100|
|* PAGE August 3-9, 1996|
The rates of the Private banks are comparable with the foreign banks but are remarkably higher than the nationalized banks. the minimum deposit requirement of foreign banks has limited its market to the top tier clients.
HIGH YIELDING RUPEE TRANSACTION ACCOUNT
The minimum deposit requirements are higher than the regular PLS. account. Profit is calculated on either average or in some cases minimum daily deposit. Profit is usually paid on monthly cases. However, in some cases it is paid on quarterly and even half-yearly basis. These accounts are subject to zakat and withholding tax. They function mostly as rupee checking account and offer a combination of profit and liquidity. These accounts suit to those who have a high volume of transactions. In many such accounts, if depositors maintains deposits above a certain limit they are provided certain services free of charge.
|HIGH YIELDING RUPEE ACCOUNT WITH PROFIT|
|ON A DAILY PRODUCT BASIS|
|NAME ANNUAL YIELD MIN. DEPOSIT|
|Citibank Profit Plus 8.9 500,000|
|Standard Chartered super save 11.3 Above 25 million|
|Faysal Bank Rozan Munafa 11.28 200,000|
|Faysal Bank Rozana Munafa Plus 11.8 500,000 for ind|
|10 million for corp.|
|MCB Khushhali Buchat 8.4 2500|
|Askari Special Deposit 11.25 10 million and above|
|Indus Super Saver 14.0 200,000|
*PAGE Aug 3-9, 1996
The lowest rate is offered by Citibank and the highest minimum deposit requirement s of Standard Chartered. The most attractive scheme in terms of a mix of high yield and minimum deposit is of Faysal Bank.
RUPEE CAPITAL GROWTH CERTIFICATE
These are offered by a few banks and financial institutions. These have a maturity of five years. These certificates offer the doubling of the initial capital or deposit at the end of the term if the investment is not enacted during this period. Premature encahsment is normally permissible after one , two or three years without any penalty. It is subject to zakat and withholding tax which is calculated and charged on maturity.
|CAPITAL GROWTH CERTIFICATES|
|NAME ANNUAL YIELD MATURITY MINIMUM INVESTMENT|
|Platinum Dep. Growth cert. 16 5 years 100,000|
|MCB Capital Growth Doubling of inv. 5 10,000|
|Union Cumulative Cert. Doubling of inv. 5 10,000|
|TOTAL BANK DEPOSITS ON JUNE 30, 1996 808.60 BILLION (Rupees)|
|PAKISTANI BANKS 79.93 %|
|FOREIGN BANKS 20.07 %|
MONTHLY INCOME SCHEMES
The target market for this scheme are those who require a regular fixed income from their investment.
|MONTHLY INCOME SCHEMES|
|NAME YIELD MATURITY MINI INVESTMENT MONTHLY|
|Habib Bank 16.5 5 years 10,000 137.5|
|Allied Bank 10 25,000 291|
FOREIGN CURRENCY ACCOUNT
The foreign currency accounts were initiated in 1992. The basic purpose was money laundering. Bring your foreign dollars to Pakistan and we will not ask you any questions. It can be opened in four major currencies
DM ,DOLLAR, GBP, YEN.
|SBP’S MAX RATES FOR FCY DEPOSITS|
|$ Pound DM Yen|
|1-3 month 6.0000 6.8438 3.6875 1.0625|
|3-6 months 6.0625 7.0000 3.7500 1.0625|
|12 months 6.2500 7.3125 3.8750 1.1250|
|*PAGE , Nov. 16-22 1996|
According to the SBP requirements the commercial banks surrender all the FCY deposits at the prevailing rate to the SBP. The SBP in return gives them PKR. The SBP also charges a Forward Cover Fee which is 4.75% for dollars and gives them the guarantee that after the specified period of time they will get back the deposits at the rate at which they surrendered.
|FORWARD COVER FEE CHARGED BY SBP|
|JUNE 1, 1995 JAN 31,1995 BEFORE JAN 31|
|DOLLAR 4.75 4.75 4.75|
|GBP 3.90 3.50 2.50|
|DM 6.50 5.50 3.00|
|YEN 9.80 9.00 6.00|
According to statutory regulations a commercial bank is required to keep five percent of its Demand and Time Liabilities in the form of cash in a non-interest-bearing account with the State bank of Pakistan and 25% in the form of government securities. The remaining 70% it can lend out.
KINDS OF LENDING
- Cash Finance
- Over Draft
- Purchase and Discounting of Bills
- Concessionary Financing
It is a very common form of borrowing by commercial banks. It is made available either by pledge or hypothecation of goods, produce or merchandise. In cash finance a borrower is allowed to borrow money from the banker at a certain limit either at once or as and when required.
This is the most common form of bank lending. When a borrower requires temporary accommodation, her banker allows withdrawals on her account in excess of the balance which the borrowing customer has in credit and an over draft thus occurs. This accommodation is generally allowed against collateral securities. When it is against collateral security it is called secured over draft. And when the borrower cannot offer any collateral security except her personnel security the accommodation is called a clean overdraft.
When a customer borrows from a bank a fixed amount, repayable either in periodic installments or in lumpsome at a fixed future time, it is called a loan. When the bankers allow loan to their customers against collateral securities they are called secured loans and when no collateral security is taken they are called clean loans.
Purchase and Discounting of bills
Commercial banks in Pakistan purchase and discount bills as a part of financing function.
These schemes consist primarily of three categories.
- Mandatory Credit
- Refinance Schemes.
- Commodity Operations.
It consists of loans to agriculture, tobacco marketing, small businesses and small industry. These loans are usually made available through big five commercial banks along with agricultural development bank and cooperative bank. Private banks and foreign banks are not involved in these loans. During 1993-94 commercial banks disbursed Rs. 13.7 billion loans against their target of Rs. 17 billion. The rate of return is not fixed like export refinance. Generally considered high-risk area with high rate of default.
These schemes fall into two categories:
- Export re-finance
- LMM – Schemes for financing locally manufactured machinery for both local and export sale.
These loans are made available to all scheduled banks and are determined on the basis of 3.75 times on the basis of their equity or the actual limits as requested by them whichever was less.
Govt. Commodity operations
GOP borrows from the big five commercial banks for the purchase of different commodities such as cotton, wheat, rice sugar on seasonal basis.
Securities for advances
The commercial bank lends money in the form of clean advances against promissory notes and secured advances against tangible and marketable securities. The common securities for bank’s advances are as follows:
- Bankers lien
- Advances against Stock Exchange securities
- Immovable Property
Lien is the bankers right to hold property until the claim on the property is paid. The bankers look at their lien as a protection against loss on loans or over draft or any other credit facility. In ordinary lien the borrower remains the owner of the property but the actual or constructive projection remains with the creditor though she has no right to sell it. However, it does not apply to a banker’s lien, as it is an implied pledge, and the banker has a right to sell the securities after a reasonable notice.
When property in the goods is charged as security for a loan from the bank but the ownership and possession is left with the borrower, the goods are said to bee hypothecated. The essence of hypothecation is that neither the property in goods nor the possession in them passes to the lender, but the security is granted by means of a letter of hypothecation which usually provides for a banker’s charge on the hypothecated goods.
When an applicant for advance cannot offer any tangible security, the banker may rely on personal guarantee to protect herself against loss on advances or over draft.
Advances against immovable property.
The most common form of immovable property against which bankers are willing to make advances is land. Before granting loans against land they should ascertain the correct value of the property.
Loans against Stock Exchange Securities
Prudential regulations promulgated in 1992 have assigned certain regulations for granting loans against Stock Exchange Securities. This section will be covered in more detail in the part of prudential regulations.
|LENDING RATES IN TERMS OF CUSTOMER BASE|
|CLIENT CATEGORY LENDING RATES|
|MNC, Top tier local corporate, Public sector 14-18|
|Second tier, small and medium sized established|
|local corporate 17-20|
|Upcoming business enterprises 18-22|
Global Security Report, July 1995
TRADE FINANCE ACTIVITIES
- Bank Guarantees for import and Exports
- Export refinance Opening of LC’s
Opening of LC’s
International trade involves numerous factors such as payments for imports in the exporter’s country. A system represented by Letter of Credit protects importers and exports against unwanted risk. There are many kinds of L.c.’s such as
- Revolving Credit
Since a letter of Credit is opened only for the importers, with established credit standing, the exporter is sure of receiving the price of her commodities. Also the importer does not run any risk about the payment before the receipt of goods because the payment under a letter of credit is made only against the delivery of shipping documents to the opening bank or its agent or correspondent. Also both importer and exporter can get financing activities against letter of credit.
The commercial banks provide pr-shipment or post shipment activities covering some of the risks involved in the financing of exports.
The policy provides bankers who become the policy holders with an unconditional guarantee against losses resulting from pre-shipment advances .
Exporters trading with overseas buyers on cash against documents or credit items who do not have general overdraft facilities usually require advances against shipping documents and bills of exchange. In such cases the exporter often finds it inconvenient to provide the security required by his bank. This scheme ensures the exporters against risks from the date of delivery of documents to the date of ultimate payments by the overseas buyers.
CORPORATE FINANCE ACTIVITIES
- Private Placement
- Advisory Service
- Syndicated Loans
It is an undertaking by a bank that in case of less subscription of shares in the primary issue the bank will be responsible for the balance amount. The bank charges a certain fee for this service
Instead of going to the general public, sometimes in case of the floating of a company, the placement is made to a handful of companies or individuals.
The commercial bank also gives advisory service in case of certain issues like the launching of TFC’s.
One lead bank becomes an agent of the borrower and invites other banks to participate in the loan.
SOURCES OF FUNDS
Like any other business a bank can raise its finances from two sources i.e. equity and debt. Debt can be further categorized into interbank borrowing and deposit mobilization. 80% of the funds are raised through deposit mobilization. The amount of equity is the major determinant of the Liabilities of a bank. The equity is a sort of leverage. The capital adequacy ratio for different banks is different:
This means that the nationalized banks can get loans nearly 33 times their capital whereas the foreign banks can raise liabilities only upto the extent of 13 times. This gives a significant advantage to the nationalized banks over the foreign banks.
According to the prudential regulations no banking company incorporated in Pakistan can commence business unless it has a minimum equity of 300 million PKR.
Inter bank borrowing
Another source of funds for the commercial banks is the inter bank operations. This brings us to the role of commercial banks in the money market. Money market is the market of instruments of less than one year maturity . the instruments used in the Pakistani money market are
- Federal Investment Bonds
- Term Finance Certificates
The segments of the money market
Repo: repo stands for repurchase agreements. It is a collaterized lending against government securities. When a bank runs short of funds it asks another bank for funds against the govt. Securities and agrees to return the money at a specified time in the future.
Call: Call is basically uncolletarized lending . it is also called clean lending. Loans are granted which are not backed by any security. There is a great risk of default in the call transactions.
Security lending: It is a mix of call and repo. Here, the bank first receives the money on call and the money so generated is used for the purchase of government securities to be used as a collateral in the repo transaction.
Ceiling: these transactions are no more in the Pakistani money market.
|FEDERAL INVESTMENT BOND RATES|
|3 YEARS 13 %|
|5 YEARS 14%|
|10 YEARS 15%|
|These rates have not changed since their inception in 1991.|
The T-bill rates started from 6 % in 1991 to presently more than 15 %.
THE USES OF FUNDS
The commercial banks use their funds in the following categories:
- Short term loans repayable at short notice
- Investment in Govt. Securities
- Loans and advances
- Purchase and Discounting of Bills.
SOURCES OF REVENUE
These fall into two categories.
- Interest income
- Fee income
The interest income is the largest contributor to the gross revenue of a bank. A bank’s interest income is basically generated from its SLR assets (Treasury based interest income) and from its high yielding assets which include loans and advances.
|LOAN CATEGORIES MARK-UP|
|Prime 14 %|
|Credit cards 30|
|Commodity operations 14|
|*source BSJS, june 07, 1995|
|Feb. 26, 1991 10 %|
|March 25, 1991 12|
|October 10, 1991 13|
|Jan 15, 1992 14|
|DEC 9, 1992 15|
|August 15, 1993 17|
|March 01, 1994 15|
|Feb. 01, 1995 15.5|
*source BSJS, 1995
Commercial banks are very careful while advancing loans and credits to different sectors of the economy. The rates vary according to the risk profile of the client. Higher the risk, higher the lending rates. The cap of 17.5 % on lending rates was removed in march 1995. However, it does not mean that the lending can be at any rate of interest.
|BREAK-UP OF REVENUE 1993 (Rupees in million)|
| Interest Fee Others|
Nationalized 38299 (83 %) 6758 (15%) 978 (2 %)
|Privatized 10789 (83%) 1752 (13%) 424 (3%)|
|Private 3581 (83%) 670 (14%) 63 (2%)|
|* SOURCE GLOBAL SECURITIES 1995|
|INTEREST INCOME (Rs. IN MILLION) 1995|
|Name Interest Income Commission Income Other Income|
|Citiobank 3852 1014 (2)|
|Standard Chartered 1661 523 3|
|ABN Amro 1310 1960 0|
|MCB 11126 1426 267|
|ABL 5163 817 122|
|HBL 18809 3418 647|
|UBL 8548 1816 4999|
|Askari 1265 292 22|
|Indus 136 22 60|
|*source BSJS, 1996|
It arises from two sources:
- Trade related fee income
- Corporate Finance related fee income
Trade related fee income
- For issuing L.c.’s.
- For issuing Bank Guarantees
- Commission charged on inward and outward remittances
- Exchange commission in trade transactions
Corporate Finance related Fee income
- Under Writing Fee
- Advisory Fee
- Arrangement of Syndicate loans
Being non-fund based in nature there is no default risk in corporate finance related fee. Also it places less burden on the bank’s financial resources.
The central bank of Pakistan is the over all controlling and supervising agency for nearly all aspects of banking operations. SBP is responsible for licensing, directing, supervision, control and inspection of banks. In addition there arc two other parallel supervisory bodies i.e. Pakistan Banking Council and Federal Finance Ministry.
Under the banking companies ordinance 1962, as amended from time to time, at the end of each calendar year, every bank in Pakistan must prepare a balance sheet and Profit and loss account in respect of all businesses transacted by it during a year.
Banks must submit to SBP their accounts within three months from the closing accounting year. The accounts of the domestic banks should include the consolidated global position of the bank; in case of foreign bank, It must relate to all businesses transacted through its branches in Pakistan.
The activities of the commercial banking sector are dictated under banking ordinance 1962 and a set of prudential regulations initiated in 1992.
STATUTORY LIQUIDITY RESERVE REQUIREMENT SLR
Banks are required to maintain reserves with the SBP in the form of Govt. Securities and cash. This mandatory reserve requirement is calculated as a certain percentage of demand and time deposits of banks.
Cash Reserve Requirement 5% of DTL excl. FCY deposits.
Govt. Securities 25% of DTL
The cash reserve requirement is non-interest bearing. The govt. Securities are the STFB and FIB’s. However all of this 25% cannot be in the form of Fib’s. There interest income from these securities is charged to the Treasury fees.
CAPITAL DEPOSIT RATIO
The ratio of capital to deposit liabilities differs among different banks.
Big five greater than 3% of global assets.
Foreign Banks greater than 7.5% of total DTL.
New Private Banks greater than 10% of DTL.
The basic purpose of the prudential regulations introduced in 1992 was to safe-guard banks and depositors and to create a healthy and efficient financial system. In general the industry has viewed the prudential regulations positively, but also caution the need to timely update the regulation in the light of any new development that may emerge.
Prudential regulations on the scope of banking activities.
The banking companies ordinance plays a certain restrictions on loans and advances, which prevents banks from
- Making any loans or advances against the security of its own shares.
- Granting unsecured loans or advances to, or making any advances on the guarantee of any of its directors.
Any of the family members of any of its directors.
Any firm or Private company in which the bank or any of its directors or their family members is interested as director, proprietor or partner.
Any public limited company in which the bank or any of its directors is substantially interested.
MAIN ENTRY REQUIREMENT
The subscribed capital of the bank should not be less than one half of the authorized capital and the paid-up capital should not be less than one half of the subscribed capital. Capital should consist of ordinary shares only and the voting rights of any one shareholder should be strictly proportionate to the contribution made to paid-up capital. The voting rights of any one share holder, except those of the federal or the provincial government should not exceed 5% of the total voting rights of all share holders.
In practice no banking company incorporated in Pakistan can commence business unless it has a minimum paid-up capital of PKR 300 million. All foreign banks having operations in Pakistan are required to maintain paid-up capital of PKR 5 million or 7.5% of their DTL which ever is higher.
Any Pakistani incorporated bank wishing to open a new branch must first obtain the approval of SBP. Approval is also required for foreign banks to expend the existing bank branches.
PROVISION FOR BAD AND DOUBTFUL ACCOUNTS
Prudential regulations provides the following guidelines.
Loan loss provisioning for classified credits where a 2% provision is required for loans which are 90 days overdue. A 25% provision for credit which are 180 days overdue. A 50% provision for loans which are I year over due. And a 100 % provisioning for loans which are more than 2 years overdue.
HANDLING DISTRESSED BANKS
The SBP may apply to the federal government for an order of moratorium in respect of a bank. During the period of moratorium, the bank should not make any payment to any depositors or discharge any liabilities or obligations to any other creditor. Subject to the federal govt. Sanction, the SBP may reconstruct the bank or arrange for its amalgamation with another bank. This has been the case with Mehran bank which was absorbed in NBP in February 1995. If the bank is unable to pay its debts and its continuance is prejudicial to its depositors the SBP may apply to the High Court for its winding up.
DEPOSIT PROTECTION SCHEME
There is no Deposit Protection Scheme in existence in Pakistan at the present time.
SALIENT PROVISIONS OF PRUDENTIAL REGULATIONS
PER PARTY EXPOSURE LIMIT
- Upto 30 % of unimpaired capital and free reserve’s.
- Fund based facility can extend upto 20 % of unimpaired capital and free reserves or Rs. 12 million whichever is higher.
- Exposure must not exceed ten times the borrower’s paid-up capital and reserves.
- Deposits with banks under lien, or face value of FIB lodged as collateral is now deducted at 90 % to compute PPEL…
BANK EXPOSURE LIMIT
- Contingent liabilities will be less than ten times the paid-up capital and general reserves. Guarantees not appearing in Pakistani account books maintained by a foreign bank are not counted in determining exposure.
- Unsecured advances upto 50,000 per borrower can be given. Advances given to employees of the bank in accordance with their entitlement shall be excluded in this calculation.
- If exposure is less than 500,000 the prudential regulations do not apply. Above Rs. 500,000 upto Rs. 2 million accounts to be signed by borrower.
- Above Rs. million upto Rs. 10 million accounts to be signed by borrower and by internal auditor of the bank.
- Above Rs. 10 million accounts to be audited.
SHARES AND SECURITIES
- Share floatation advances to be secured.
- No lending against UN-quoted shares.
- No lending against NBFI shares.
- No lending against shares of associated concerns.
- Financing against listed shares is subjected to the following margins:
- where the market value is less than the preceding 12 months average market value.
- 40%where market value exceeds the preceding 12 months average market value but does not exceed twice te preceding 12 months average market value.
- A debt-equity ratio of 60:40 or as prescribed by government for existing shortfall to be attended as given till 1998.
- Asset revaluation allowed in accordance with international accounting principles.
- As from 30-06-1995 7:1
- As from 30-06-1996 8:1
- As from 30-06-1997 9:1
- As from 30-06-1998 1:1
Also, lease rentals receivable within the next 12 months are to be treated as current assets and current maturity of long term debt not yet due are to be excluded from current liabilities.
Competition in the commercial banking industry has intensified after the process of deregulation and de-nationalization in 1991. Basically the commercial banks face competition from tow fronts.
- Non-Commercial Banking institutions.
- Within the commercial banks itself.
They also face competition from the less conventional modes of financing such as corporate bonds, TFC’s, Warrants, and Convertible bonds as corporations look for innovative ways to finance their operations.
NON-COMMERCIAL BANKING INSTITUTIONS
These include Development Finance Institutions, leasing companies, Investment Banks, brokerage houses and Modarbas.
Development Finance Institutions
Seven major DFI’s offer direct competition to commercial banks in lending activities. These institutions have only a cash reserve requirement of 1 %. They , therefore, have a clear edge over commercial banks in respect of credit capacity.
They deal in long-term financing. The rates offered by the investment banks on their deposits far exceed those offered by the commercial banks. However , since, the investment banks have not acquired the critical mass in their operations, that is medium to long-term fund raising, the competition from them is partially dwarfed by the fact that they do not lend in the long run and divert a large portion of their investment towards in capital markets. Consequently the investment banks have earned spreads in the range of 2 to 3 % as compared to 4 to 5% for commercial banks.
The major source of funding for leasing companies is via credit lines established by international lending agencies. At present most of the lending agencies have exhausted their credit limits for Pakistan. The leasing companies have therefore turned to local markets for relatively expensive sources of funds such as bank-borrowing and Certificates of Investment. Thus in deposit mobilization the leasing companies offer competition to commercial banks. To counter this the sponsors of some commercial banks like Askari, Prudential, Union have floated their own leasing companies.
However as far as lending is concerned, leasing companies offer little direct competition to commercial banks because leasing companies are in the business of providing long-term funding whereas long-term loans constitute a marginal share in total advances extended by the commercial banks because commercial banks avoid long-term loans because of mis-match problems.
The above case also holds for Modarbas which operate in the same fashion as those of leasing companies.
They also have offered considerable competition to the commercial banks in the area of corporate finance. However they offer direct competition mainly to foreign commercial banks as these brokerage houses are very active in the area of corporate finance. The local commercial banks do not have the requisite technology, experience and qualified man-power to enter into corporate finance deals.
COMPETITION WITHIN THE COMMERCIAL BANKS
Within the commercial banks the competition is among the private, foreign, privatized and nationalized banks.
Since 1991 when the process of deregulation and liberalization started 13 commercial banks have entered in the commercial banking industry. Most of these private banks have performed well and have shown high growth rates in the initial stages of their inception.
- Their target market is strong and medium-size enterprises which are the back bone of the economy.
- Rapidly growing branching network.
- Lack of credibility especially after the Mehran Bank Scandal.
- The private banking sector as against NCB has a very poor and legal protection against the default of the borrowers.
- Equity constraints. I.e. difficulty in raising equity.
- Lack of technology and professional skills.
- Inadequate correspondent banking arrangement.
- Marketing experience.
- Trained staff.
- Latest technology.
- Upper income group clients which carry a lower default risk.
- Resource rich.
- International presence.
- Restricted network of branches which is a major constraint over deposit mobilization. Over the past years the margins for the foreign banks have fallen as the cost of holding foreign deposits increased sharply because of cyclical rise in American interest rates and the SBP increase in forward cover fees from 3% to 4.7%.
- The new strategy of the foreign banks is therefore attracting new deposits. Stiff competition is going on within the foreign banks to attract the rupee deposit holders.
- Faysal Bank Rozana Munafa Plus.
- Standard Chartered Super Save.
- Hong Kong Bank Profit bearing Checking Account.
- Societe General’s month to month profit pack.
- ANZ’s high performance account.
- Citibank profit plus.
- These are various high yield incentives to attract rupee depositors. However the private banks are also following the same strategy like the
- The Indus super-saver.
- The Platinium money-multiplier.
- The Askari special saving account.
- Union super-saving scheme.
- The foreign banks are facing a tough competition from the above schemes of the private banks. This competition is substantiated due to the restricted branch network of the foreign banks. However in terms of the quality of service and professionalism the foreign banks have a clear edge over the domestic banks.
FIVE LARGE RETAIL BANKS
NBP, HBL, ABL, MCB, UBL . these five banks as against the focused approach of the foreign banks cater to all segments of the society and dominate the retail side of the business. These large five commercial banks account for 79% of the industry’s assets and a network of over 5000 branches all over Pakistan. All these five major banks are represented abroad. HBL has 65 units abroad including two subsidiary and two affiliated companies. NBP 24, UBL 28, MCB 4 and ABL 7.
|Name of Bank||No. Of |
|Staff||Assets US $ 1994|
(April 1996, Capital Intelligence Report)
- From the table as it is evident that they have a huge network of branches which enables them to dominate the retail sector of the industry.
- Huge resources
- All segments of the society are their target market.
- Huge bad debts and poor credit portfolio.
- Over staffing
- Low level of automation.
- High administrative cost (25% of average income as compared to 7% for private banks and 4% for foreign banks)
However, the two banks MCB and ABL after being privatized have shown substantial improvement in quality and professionalism. Especially MCB has become a force to reckon with and poses a serious challenge to the foreign banks. The MCB plans to set-up the most elaborate ATM in the country which will enable it to expand its distribution net-work.
The industry comprises of highly skilled workers. The minimum qualifications are graduates. The average wage is higher than the overall wages in the country.
The industry is a mix of capital and labor intensive. Since it is a service sector therefore only high skilled workers are accommodated in this sector. The sector also requires huge capital investment like ATM, and up to date computers to enjoy an upper edge on its competitors. There is a sound impact of improvement in technology on the industry. The foreign banks are maintaining their superiority by employing latest means of technology which the local banks have failed to provide.
FACTORS AFFECTING DEMAND AND SUPPLY
Following are the factors affecting the demand:
- Per Capita Income.
- Income Distribution.
- Branch Network.
- Saving rate.
- Marginal Propensity to consume.
- Lax regulatory environment.
- Interest rates.
- Monetary and Fiscal Policy.
- Trade Policy.
- Budgetary Deficit.
- Political stability.
The monetary and fiscal policies have a tremendous effect on the profitability of this sector. If the govt. Is observing a tight monetary policy then it will
Increases the Discount rate.
Increase the reserve requirement.
Carries out OMO’s.
Presently the GOP is observing a tight monetary policy. This will squeeze the spreads of this sector. Besides the growing competition has increased th cost of dposits which is also contribuin to the squeezing of their margins.
The fiscal policy has an impact on the profitability of the commercial banks to the extent that it leads to the contraction of demand in the real economy. The tight fiscal policy leads to the lower demand for bank’s loans and deposits.
The key to success in future will depend upon locating specialized niches. The commercial banks with good infrastructure and quality man-power will perform well. With competition getting increasingly fierce, return on deposits are on the rise but commercial banks will continue to enjoy their distinct advantages of cost-free current accounts, retail-banking activities and trade facilities which put them ahead of investment banks, Modarbas, leasing companies, brokerage houses. The competitive edge will lie with those commercial banks which have a strong management and group backing and access to a relatively lower cost of funds, extensive branch network and a well trained and experienced personnel.
API REPORT ON
INSTITUTE OF BUSINESS ADMINISTRATION
SUBMITTED TO: Mr. YAYHA FARROQUI
ERUM SALMAN SHAHRUKH
NOVEMBER 19, 1996