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Asia-PacificSeptember 2 2007

A new paradigm

Pakistan is implementing a new development paradigm for the country’s banking sector with the aim of bringing the country’s poor and rural population into the system, writes Dr Shamshad Akhtar.
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Best performing in Asia, Pakistan’s banks are dynamic and thriving. Their combined profitability for 2006 reached $1.4bn (relative to a loss of $48m in 2000), return on equity and assets are in the range of 24.2% and 2.1%, respectively, and non-performing loans are at an all-time low.

The transformation of banks and their outstanding performance stems from a combination of factors. The key driver of change was privatisation, and the induction of professional management. In recent years, an unprecedented wave of mergers and acquisitions has taken off as the banking sector consolidated in the wake of a ban on new bank licences and a rise in capital requirements.

Large corporate players, brokers and now the acquisition by foreign banks (including Standard Chartered Bank, ABN AMRO, Temasek Holdings, Samba and a number of international Islamic banks) have changed the ownership structure and the atmosphere of the banking system further. Both Industrial and Commercial Bank of China (ICBC) and Bank of Communication are now exploring the market. Two large banks have already floated global depository receipts (GDRs) at the London Stock Exchange, and the other two largest banks are also planning GDRs.

The leading sector in the country, banks now account for more than 30% of the market capitalisation of the Karachi Stock Exchange. Further synergies are emerging between banks and the capital market as banks are floating a number of asset management and other non-bank financial intermediaries. The credibility of the banking sector has been enhanced, given the strong governance and regulatory oversight of the central bank, the State Bank of Pakistan (SBP).

Pakistan’s banking sector is now positioning itself to serve the growing requirements of the country’s economy and population. In the past three years, private credit grew annually at a rate of 25% – much higher than historical trends. Equally impressive was credit diversification. Instead of serving only large corporate borrowers, commercial banks have now started to serve agriculture, small and medium-sized enterprises (SMEs) and the housing sector. The aggregate number of borrowers doubled to 5.5 million in the three years to December 2006.

Financial penetration

Amid these successes, there is scope and opportunity for the banking sector to grow because financial penetration is quite low. So far, only about 30% of adults in Pakistan have bank accounts – the number of borrowers constitutes only 3% of the population – and there are only 171 deposit accounts per 1000 people and 30 loan accounts per 1000 people. Agriculture and SME credit reaches only 1.6 million and 0.3 million borrowers, respectively, and outreach of the documented microfinance sector is 1.2 million.

The degree of financial exclusion is high and pervasive. It stems from geographical exclusion: 67% of the rural population is underserved by the formal banking system because only 6% of banks’ branch networks reach into rural areas, so remote and low population density areas do not have access to formal networks.

Exclusion is further exacerbated by:

  • Lending practices, issues of pricing, collateral or documentary requirements, prohibitive bank’s transaction costs, poverty, illiteracy and cultural-cum-language barriers prevent people from accessing financial services.

 

  • Inadequate database and information on borrowers, weak enforcement of contracts, alternate delivery channels, lack of suitable products – such as current accounts that do not offer an overdraft – and an easy route to borrowings prevent financial institutions from venturing into new areas.

 

  • Regulatory barriers, such as the money laundering guidelines that require proof of identification and which many vulnerable segments of the population find difficult to provide.

 

  • Lack of availability of a faith-based system of financial services, such as sharia-compliant financial services, excludes the population that does not subscribe to conventional banking services.

Inclusion strategy Given the nature and magnitude of financial exclusiveness, the SBP is developing a broad-based financial inclusion strategy, the major aim of which is to enhance financial penetration and outreach. The goal will be to enhance the coverage of the financial system through multiple and innovative approaches to provide holistic financial services. Over the next five years, the target will be to double the deposit base from the existing 26.6 million accounts to 53 million by 2012, and to double the number of borrowers with a focus on the number of agriculture, SME and household borrowers. Independent of this, a microfinance strategy – a central pillar of the financial inclusion strategy – aims to raise the number of microfinance borrowers from 1.2 million to 10 million.

The principal approach and thrust of strategy will be to shift emphasis from directed and subsidised credit to adopting market-based approaches and best practices to promote the private sector in financial inclusion. Meanwhile, public expenditure will be supporting selective and targeted interventions to stimulate action and nurture institutions that leverage public-private partnerships with the aim of improving access to financial services for the poor.

Strategy components

Pakistan’s financial inclusion strategy has the following broad components:

  • A far-reaching microfinance development plan, prepared jointly by the central bank and the Pakistan Microfinance Network (PMN), which advocates enhancing scale from 1.2 million to 10 million. To realise this goal, the strategy will encourage a change of vision and mission of microfinance providers from being charitable and social service providers to striving for scale and sustainability. The microfinance industry will be steered to be financially and socially sustainable. Key measures taken include:

1. Introduction by the SBP of Microfinance Ordinance, 2001 and supportive Prudential Regulations and guidelines to allow setting up of national and regional microfinance banks (MFBs). Under this, microfinance will offer up to Rs150,000 ($3600) loans, engage in remittances businesses, etc. The policy, legal and regulatory matters for all microfinance institutions (MFIs) advocates a level playing field. 2. A five-year tax holiday to MFBs if they encourage MFIs to transform themselves into fully fledged banks. 3. Strategic entry of international players to encourage scale, efficiency and commercialisation of businesses by adopting best practices.

4. Provisioning of a liquidity window for MFIs/MFBs at competitive pricing with supportive credit enhancement.

5. Developing capacities of PMN to serve as a think tank, advocacy group and collate trends and analysis of industry.

6. MFIs are to leverage the network of 12,343 post offices for offering financial services. So far post offices manage four million savings accounts with 70% of such accounts holding savings of less than Rs10,000 ($165).

  • The expansion of branch networks to underserved areas. The annual branch licensing policy requires commercial banks with 100 branches or more to open at least 20% of their branches outside big cities and set up branches in Tehsil headquarters, where no bank branches exist.

 

  • Islamic banking, which appeals to sharia-compliant clients, is being promoted to cater for underserved sectors such as SMEs, agriculture and microenterprises. Besides the six fully fledged Islamic banks and permission to conventional banks to render sharia-compliant services, fully fledged Islamic microfinance banks would be also encouraged.

 

  • Commercial banks are required to offer basic banking accounts to facilitate and provide basic facilities to low income people free of minimum balance and charge limits.

 

  • An SME financing strategy advocates the promotion of credit guarantee schemes and venture capital funds, the establishment of SME training centres and capacity building of banks, SME loan officers, SME credit risk scoring and competitiveness benchmarking, and a triennial survey of SMEs to estimate their demand for financing. Banks are allowed to lend to SMEs ‘clean’ (that is, without collateral up to Rs3m).

 

  • Prudential regulations for agricultural financing and guidelines for livestock and fisheries financing; estimates of agricultural credit demand for complete value chain from production to export by the farmers/growers; and simplified and standardised loan documents, and three-year revolving credit schemes.

 

  • Bank-based exposure limits for housing finance have been relaxed and the House Building Finance Corporation (HBFC) is being corporatised to deal with the backlog and demand for new housing units in Pakistan – estimated at 19.3 million, including a backlog of six million low-income housing units. The HBFC, with government support, has announced the promotion of low income housing on sound banking principles.

 

  • Electronic banking has facilitated countrywide connectivity. Half the number of bank branches now engage in electronic fund transfer supported by the Payment and Electronic Fund Transfer Act 2007. The Regulatory Framework for Mobile Banking in Pakistan will allow the establishment of branchless, bank and non-bank focused models of mobile banking.

To implement the financial inclusion strategy, a development finance group has been established at the SBP with sector-specific departments to steer the agriculture, SME, microfinance, housing and Islamic finance services. Specific components of the financial inclusion strategy will help to broaden and deepen financial penetration across the country. Dr Shamshad Akhtar is governor of the State Bank of Pakistan.

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