The banking sector has become an integral part of the country’s financial services industry. The sector has witnessed phenomenal growth in all fields, including the deposit base, outreach and use of technology in the 64 years since independence.
The sector achieved the growth even at a faster pace since 1990 after the banking reforms taken place.
“Pakistan’s banking sector reforms, which were initiated in the early 1990s have transformed the sector into an efficient, sound and strong banking system,” said Dr. Ishrat Hussain, Director, IBA and former governor, the State Bank of Pakistan (SBP).
Presently, 35 local and foreign banks are operational in Pakistan with total branches of 9,483 across the country. The deposit base of the banking sector stood at Rs5.449 trillion by December 31, 2010.
At the time of independence, the presence of financial institutions was fairly low. According to a report, total 487 offices of scheduled banks in the territories now constitute Pakistan.
As a new country without resources it was difficult for Pakistan to run its own banking system immediately, so it was decided at the Partition that the Reserve Bank of India should continue to function in Pakistan until September 30, 1948 and Pakistan would takeover the management of public debt and exchange control from the Reserve Bank of India on April 1, 1948.
“By June 30, 1948, the number of offices of scheduled banks in Pakistan declined from 487 to only 195, because registered banks transferred from Pakistani territories to India,” according to a report on “Analysis of banking sector in Pakistan”.
At that time there were 19 non-Indian (foreign banks) and only two Pakistani banks (Habib Bank, Australian Bank). On July 1, 1948, of the total bank deposits of Rs1.1081 billion held in Pakistan, as much as 73 percent was held by foreign banks whose activities were largely confined to foreign trade.
In the first 18 months of the operation of the State Bank of Pakistan, 51 new branches were opened in both East and West Pakistan of which 28 were Pakistani banks; 12 Indian banks; four exchange banks; and seven were newly-formed NBP of which six were in East Pakistan.
By December 1949, there were 35 scheduled banks in Pakistan of which four were Pakistani banks; 23 Indian banks; and eight were exchange banks.
In mid 50’s the food shortage compelled the government to embark upon agricultural credit and the Agricultural Development Bank was setup to attend to agricultural finance. All these measures, and the devaluation of Pakistani rupee on August 1, 1955, had a very favourable effect on the commodity market and the balance of payments position in 1955/56, development of agriculture largely depends on agricultural finance, but the scheduled banks were not very willing to undertake this risky venture.
Therefore, the SBP sponsored to establishment of Agriculture Development Bank to attend exclusively to agricultural finance. Moreover, the functions of the State Bank were also broadened by facilities for both agriculture and industry. All these measures had positive effects on Pakistan’s economy during 1956/58.
In 1958 the government liberalised imports, which increase the demand of funds, so in 1959/60 two more Pakistani banks, Eastern Merchantile Bank Limited and the United Bank Limited were established and scheduled and more Pakistani banks continued to be established, which included Commerce Bank Limited and the Standard Bank Limited.
By June 1965 the number of scheduled banks stood at 36. In 1964 the NBP also came forward and established a people’s credit department to allow credit facilities to small borrowers.
Although there was development in this sector after independence, there were many weaknesses in this system.
Banks were opening branches only in developed areas, they were ignoring backward areas. People of rural areas were not getting banking facility.
The money market was not very much developed, so the banks were not getting sufficient information and, therefore, they were not advancing enough loans. Banks were issuing loans to manufacturers and businessmen. They were ignoring agriculture, mining, fisheries and transportation. These were a few of the weaknesses in this sector and the government efforts were not fruitful. So in 1974 banks were nationalised.
Nationalisation of banks was considered necessary so that the nation as a whole could benefit from the better channeling of resources. The government of Pakistan decided to nationalise all scheduled banks, as well as the State Bank of Pakistan through the Ordinance of Nationalised 1974. All this was done on January 1, 1974.
The banking sector has witnessed a remarkable change during the last decade, which Dr Ishrat Hussain summarised as 80 percent of the banking assets are held by the private sector banks and the privatisation of nationalised commercial banks has brought about a culture of professionalism and service orientation in place of bureaucracy and apathy.
The banks that were losing money due to inefficiencies, waste and limited product range have become highly profitable business. These profits are, however, being used to strengthen the capital base of the banks rather than paying out to the shareholders.
The minimum capital requirements have been raised from Rs500 million to Rs6 billion over an extended period in a phased manner.
The consolidation of the banking sector into a fewer, but stronger banks, will lead to better management of risk, according to Dr Ishrat.
The banks that were burdened with the non-performing and defaulted loans have cleared up their balance-sheets in an open transparent, across-the-board manner.
Contrary to the popular myth the main beneficiaries of the write-offs of the old outstanding and unrecoverable loans have been from almost 25 percent to 6.7 percent by December 2005.
Small individual borrowers’ ratio of non-performing loans of the commercial banks to total advances declined.
The quality of new assets improved as stringent measures are taken to appraise new loans, and assure the underlying securities. Online Credit Information Bureau reports provide updated information to the banks about the credit history and track record of the borrowers.
Loan approvals on political considerations have become passe. Non-performing loans account for less than three percent of all the new loans disbursed since 1997.
The human resources base of the banks has been substantially upgraded by the adoption of the principles of merit and performance throughout the industry. Recruitment is done through a highly competitive process and promotions and compensation are linked to training, skills and high performance.
The banks now routinely employ MBAs, MComs, Chartered Accountants, IT graduates, economists and other highly educated persons rather than Clerical and Non Clerical Workers.
Competition among the banks has forced them to move away from the traditional limited product range of credit to the government and the public sector enterprises, trade financing, big name corporate loans, and credit to multinationals to an ever-expanding menu of products and services. The borrower base of the banks has expanded four fold in the last six years as the banks have diversified into agriculture, SMEs, Consumers financing, mortgages, etc.
Along with strong regulation, supervision and enforcement capacity of the State Bank of Pakistan a number of measures have been taken to put best corporate governance practices in the banking system. ‘Fit and proper’ criteria have been prescribed for the Chief Executives, members of the Boards of Directors, and top management positions. Accounting and audit standards have been brought to the International Accounting Standards (IAS) and the International Audit Codes. External audit firms are rated according to their performance and track record and those falling short of the acceptable standards are debarred from auditing the banks. These practices were put in place in Pakistan long before the scandals of Enercon, World Call and Pramalat had shaken the corporate world.
The foreign exchange market that was highly regulated through a system of direct exchange controls over suppliers and users of foreign exchange has been liberalized and all purchases and sales take place through an active and vibrant inter-bank exchange market. All restrictions have been removed with full current account convertibility and partial capital account convertibility. Foreign investors can now bring in and take back their capital, remit profits, dividends and fees without any prior removal and directly through their banks. Similarly, foreign portfolio investors can also enter and exit the market at their own discretion.