A liquidity package worth Rs 270 billion was made public, how successful has this been in alleviating recent liquidity issues?
Salim Raza: “There exists no liquidity stress in the banking system of Pakistan today. Last year, in September, the usual post-Ramadan liquidity shortage was aggravated due to a number of global, domestic and industry specific factors, specifically, the news of failure of some global financial giants, the closure of the capital market and the intensive rumour mongering. The banks and SBP took timely measures for stemming the liquidity problem, which was averted successfully. After the liquidity injection and other regulatory measures, the liquidity situation eased out, the deposits started returning to the system and ADR of the banking system declined. While SBP had to inject liquidity into the system during September and October 2008, SBP resorted to net mop-up as situation improved keeping short term interest rates allied to its Monetary Policy. At present, the banking system is maintaining liquidity in excess of the required Cash Reserve Requirement (CRR) and Statutory Liquidity Ratio (SLR). The excess liquidity maintained with SBP is 70% of the required liquidity (Position as of October 03, 2009).”
What are your views on the recent consolidation in the banking sector?
SR: “The on-going consolidation generally had a favourable impact on the banking sector since this consolidation has not been done at the expense of competition. Merger and Acquisition (M&A) transactions have largely been among small and medium sized financial institutions, which has not only strengthened the capital base of our banking system but also helped to improve competition by reducing the concentration. Increase in capital requirement was one of the regulatory measures which prompted these M&A and ensured consolidation. As a result of this, our banking system is now enjoying healthy capital base and greater resilience.
Various concentration measures point towards increased competition in the banking sector:
-Specifically, the share of big five banks has declined from 63% in year 2000 to 54% in 2008.
-The share of second tier big five banks has increased from 13% in 2000 to 22% in 2008.
-The share of third tier five banks has also increased from 8% to 12% in the same period. Concentration indicators such as the H-index and coefficient of variation also indicate a decline in concentration.
With this consolidation going on, SBP is well on its way to create a well-capitalized and strong banking sector to efficiently cater to the needs of the growing economy.”
What future banking sector reforms do you believe are required?
SR: “The banking sector constitutes the core of financial sector in Pakistan. It has witnessed significant growth in recent years and continues to have an enormous growth potential. In recent years, a wide range of important structural reforms have already taken place but more reforms are needed for the banking sector to grow into its full potential for supporting strong and sustained economic growth and development.
The following are some of the important areas for future reforms:-
To implement a financial inclusion program for banks to meet the needs of underserved economic subsectors, including outreach programs to meet the requirements of the needy sectors and population. To achieve this, we issued licences to two microfinance banks, namely, Kashf MF Bank and NRSP MF Bank. Kashf MF Bank has already started operations. Similarly branch network in rural areas is being regularly widened. Besides, branchless banking initiative is also underway.
To strengthen consumer protection through new legislation, codes of conduct and new institutional arrangements, and improved financial education through educational outreach programs.
To introduce a framework for consolidated supervision and reorganize the regulatory architecture to allow better regulation and supervision of financial groups and conglomerates.
To provide a strong legal reform through reformulation of: a) Banking Act, b) Amendment for Consolidated Supervision, c) Deposit Protection Fund Act, and d) SBP Act.
Other areas for banking sector reforms include: (a) Strengthen competition and efficiency in the banking sector, (b) Developing a financial safety net for protection of small depositors, (c) Deepen financial intermediation and (d) Development of the financial infrastructure, especially payment systems, as well as human resources, credit information, credit ratings, land and property registries and minimize procedural delays in the legal system to improve the efficiency of financial sector transactions.”
Do NPLs pose a significant risk to the banking sector?
SR: “For any banking system the key risk is the credit risk and the same is true for Pakistan. Since 2008, the credit risk of our banking system has increased as reflected in the increasing infection ratio. However, it is still in a manageable range.
As you know that credit flow is a function of economic performance. With the recent slowdown in economic activity, GDP growth for the FY09 was 2% and is estimated to grow by 3.3% in FY10, the demand for credit from various sectors and particularly from private sector has reduced significantly. This low level of economic activity is affecting the performance of the businesses and hence their repayment capacity. The result is surge in infection ratio, which increased from 7.2% in CY07 to 11.5% in Jun-09. Therefore, this increasing credit risk is the key risk of the banking system today.
However, since the banking system is profitable; it has generated profit before tax of Rs 47.7 billion for first half of the year 2009 and also the solvency of the system is continuously improving; CAR has increased to 13.5% in June 2009 from 12.3% in December, 2008, the banking system can absorb the effects of this increasing credit risk. Having said that, SBP is actively monitoring the level and trends of the credit risk of the banking industry, and is playing its role to manage this increase in credit risk.”
Pakistan is in the process of implementing international best practices like Basel II. How effective has this been in connecting Pakistan to the global banking sector?
SR: “Basel II is one of the major developments in the recent past. We have adopted standardized approach of Basel II. The purpose of implementing Basel II in Pakistan was 1) to align capital with the risk profile of the banks and hence improve the risk management systems of the banks 2) to align the capital requirement with the international standard. We are working with the banks for the smooth implementation of the Basel II.
The implementation of Basel II and adoption of other international best practices has benefited Pakistan’s banking sector in a number of ways.
-It has paved the way to institutionalize better risk management practices across the banking system.
-It has helped to have more competitive and better managed banks doing business according to market needs.
-These best practices have provided a level playing field to our banks and created an opportunity in the area of product development and implementation of more robust systems which eventually resulted in improved service standards.
-It helped attract foreign institutions to invest in Pakistan’s banking sector and also made off-shore expansion of local banks.
-As supervisor, it helped us in comparing our banking sector with that of other economies of the world.
-Finally, it is facilitating cross border sharing of knowledge and expertise relating to financial service industry.”
What are your views on Islamic banking in Pakistan?
SR: “Islamic Banking in Pakistan has made commendable progress in the last few years and has a great potential to grow even faster. Market share of Islamic banking assets has increased from 0.5 % in 2003 (the first Islamic bank started its operation in 2002) to 5.1% in June 2009 (in six years only).
If you undertake a cross country comparison:
-Bahrain: The market share of Islamic banks is 9.8% in 2008. It took period of around 30 years to reach to that level.
-Malaysia: As at the end of 2008, the share of Islamic banking assets in the total banking sector has expanded to reach 16.7%. This growth is achieved over a period of 25 years.
-Indonesia: Market share of Islamic banks is 2.3% as at the end of 2008 and it took them 17 years to reach at this level.
The number of branches has grown from 289 in 2007 to 515 in 2008, which are around 530 in June 2009. (viz. 6 Islamic Banks with 312 branches, 12 conventional banks with 138 Islamic branches and 78 Islamic windows, bringing the total to 528 by June 2009 with presence in over 50 cities & towns and covering all the four provinces of the country and AJK).
Future of Islamic banking in Pakistan is promising with anticipated high growth. The major driver of this growth is the untapped demand from the belief sensitive customer. Keeping abreast with the vision of developing Islamic banking as the banking of first choice and leading the global Islamic finance to achieve the overarching objective of equitable economic growth, banks and SBP are working hand to hand. For this we are also proactively collaborating (for developing domestic and global Islamic finance industry) with International standard setting bodies for Islamic financial infrastructure such as Islamic Financial Services Board (IFSB), International Islamic Financial Market (IIFM) & Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and also some central banks.”
SBP initiated the RTGS System last year on a pilot basis. When will it be implemented on a country wide basis?
SR: “Pakistan’s RTGS System known as PRISM (Pakistan Real Time Interbank Settlement Mechanism) was launched on 1st July, 2008. It was not a pilot project but a live system which is being used by banks in Pakistan to settle their inter-bank settlements payments. PRISM System since its inception is a fully functional Real Time Gross Settlement Mechanism offering features like Queuing, managing Payment Priorities and Gridlock Resolution. PRISM System currently has 40 Direct Members including all the Scheduled Banks (37) and 3 Development Financial Institutions.
PRISM System also offers settlement of Government Securities on DVP Model 1 basis besides offering Intraday Liquidity Facility (ILF) on fully collateralized basis. PRISM System currently allows settlement of Inter banks Funds and Securities transactions only, while regulatory framework to allow Customer Transfers (MT 103) is being developed. A number of initiatives relating to enhancing the use of RTGS are under way including giving the ability to banks to transfer funds on country-wide basis. This however, involves efforts to upgrade banks’ internal IT systems and business processes, especially those of large banks, so that they commensurate with the requirements of our RTGS system. SBP is working with various stakeholders to achieve this target.”
What are your views on Pakistan’s macroeconomic situation?
SR: “The current macroeconomic situation and outlook reveals a mixed picture of the economy. There are both positives and negatives. Our prime concern is inflation, which is moderating consistently. The CPI (YoY) inflation in September 2009 is 10.1 percent which is a considerable improvement over last year when inflation peaked to 25 percent in October 2008. Core inflation, as measured by Non food Non energy (NFNE) component of CPI, has also declined to 11.9 percent in September 2009 from a high of 18.9 percent in February 2009. Nevertheless, the pace of decline in inflation is less than expected.
Another positive is improvement in the balance of payment position. Supported by continued strong inflow of worker’s remittances, the significant fall in import growth has resulted in a modest surplus of $82 million in the external current account for August 2009. The cumulative July-August, FY10 external current account deficit of $527 million is much lower than our earlier projections. The external financial account has also substantially improved both due to higher investments and inflows from the IMF for budgetary support ($745 million) and allocation of increased Special Drawing Rights. With favourable revisions in the outlook of Pakistan’s economy by international rating agencies, portfolio inflows are now positive reaching $55 million in the first two months of FY10.
The negatives for the economy include the tenuous positions of fiscal and the real sector performance. Sustainable recovery of real sector of the economy is unlikely to revive without an environment conducive for business and availability of credit to private sector, which in turn depends on the elimination of electricity shortages among other factors. Stagnant private sector investment can hurt the potential output of the economy, adversely impacting inflation persistence. However, recent steps taken towards resolution of the circular debt issue could lead to the resumption of private sector credit in the coming months.
From a forward looking perspective, expected improvement in the external current account and emerging global economic recovery augur well for Pakistan’s economy. But, limited progress on electricity shortages and stressed fiscal position dilute some of the optimism. Similarly, inflation outlook is not completely benign yet as depicted by recent monthly trends. Under these circumstances, assessment of balance of risks continues to be somewhat uncertain.”
The SBP recently reduced its key policy rate by 100 basis points to 13%, what will be the effect of this measure in the short-term and long-term?
SR: “Given that SBP has kept its policy rate unchanged at 13 percent in the September monetary policy decision, this question seems a bit outdated. Earlier, the policy rate was reduced as there were positive indications in the form of declining inflation, improving balance of payments, consolidation of fiscal accounts and restrained government borrowings from SBP. The decision was expected to improve confidence in the economy and is reflected in consistent improvement in overall macroeconomic outlook later on. The latest decision to keep the policy rate unchanged is based on the mixed picture of actual developments and outlook of the economy as described earlier. The bottom line is that while the economy stabilizes, there are some risks to inflation. Moreover, uncertainty regarding the outcome of ongoing fiscal consolidation, resolution of electricity problem, and timing of official foreign inflows call for prudence at this time. These issues are likely to determine SBP’s policy trajectory in the coming months.”
The SBP will be increasing monetary reviews to six times a year as opposed to four times a year, what prompted this?
SR: “Rapidly changing economic environment increases uncertainty and could adversely impact the projected path of key macroeconomic variables, including inflation. Since monetary policy’s prime responsibility is to anchor expectations of inflation, it is important to address such considerations by taking preventive measures. Being cognizant of the fast changing domestic as well as global economic environment, SBP therefore took the decision to increase the frequency of monetary policy reviews. This step is expected to help SBP in anchoring market expectations in a better way by taking timely policy decisions.”
Regarding the introduction of an independent monetary policy committee on the lines of the Bank of England, what impact do you believe this will have?
SR: “An independent monetary policy committee with external members is a norm in central banks of developed and most of the emerging market economies. It helps in establishing the credibility of a central bank as an independent institution and making monetary policy formulation process more effective and transparent. The inclusion of external members is also designed to ensure that SBP benefits from the expertise and independent views related to monetary policy.”
Is the SBP thinking of any new measures to stimulate local businesses, similar to LLM and ERF schemes introduced in the recent past?
SR: “Recently SBP has taken following steps for the benefit of the exporters / industrial sectors:-
-Introduction of Scheme for Modernization of Cotton Ginning Factories. Similar scheme may be launched for other SME Clusters.
-Linkage of Enhanced Period of Finance with Higher Performance under EFS.
-Scope of Long Term Financing Facility (LTFF) Scheme Expanded Particularly in Development Categories.
-One-Time Opportunity to Refinance Outstanding Long-Term Loans Availed from Banks/DFI for Import/Purchase of Plant & Machinery (except textile).
-Allowed refinance for import of generators for sectors otherwise ineligible under LTFF.”