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Chief guest address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the launch of the Human Development Report of South Asia, organised by Mahbubul Haq Center for Human Development, Islamabad, 30 May 2005. | Ishrat Husain: The health challenge in Pakistan - prognosis and prescription Chief guest address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the launch of the Human Development Report of South Asia, organised by Mahbubul Haq Center for Human Development, Islamabad, 30 May 2005. * * * There is a strong theoretical and empirical evidence that Economic growth causes improvements in human development which, in turn, increases economic growth. The improvement in health results in enhancement of basic capabilities that adds value to human life. The transmission to growth takes place through impact on worker productivity, through demography and through trade and investment. Health has a positive effect on poverty reduction too. Poor households are hit by major illness and fall into poverty trap. Lower earnings due to withdrawal from full time employment increases the risk of illness for the rest of the households. Risk of falling below poverty becomes acute in case of death of the bread winner of the family. Thus, investment in health, particularly preventive health such as availability of clean drinking water and sanitation can contribute to growth and minimize the risk of falling below the poverty line. There is no doubt that Pakistan’s social indicators are not something we can feel proud of. Pakistan’s competitiveness in the future knowledge based economy of the world will critically depend upon how well we are able to harness and increase the productivity of labor force for meeting future challenges. It is no longer a cliché that those lag behind in human development are going to become marginalized. It is all the more surprising to note this poor state of affairs at a time that there is almost unanimity on the intellectual front and broad consensus on the political front on the importance of human development in attaining national prosperity. Both the economists and non-economists have converged their views on the critical role education and training, health and nutrition play in economic development. Those on the left, those in the center and conservatives also have identical views though due to different reasons. All political parties in Pakistan are committed to human development as a policy objective. Why is it then that the progress in this area has been so unsatisfactory and what can be done to remedy this situation? In my view there are four cogent reasons for lack of progress in human development in Pakistan. First, there is a structural ambiguity in the allocation of responsibilities between the Federal, Provincial and local governments in the whole endeavour of human development. The overlap and duplication in the policy making and implementation have created a lot of confusion, waste of efforts and inadequate outcomes. There are too many players moving in different directions. There is a need for clear definition and delineation of responsibilities between the various tiers of the government and accountability of results. At the same time there are areas such as regulation of private institutions in education and health that are begging for action by the government and there is nobody in charge. These gaps, ambiguities and lack of defined responsibilities have given rise to weak governance in this sector. Second, at each tier of government there is a bundling of policy, executing and regulatory functions within the Education and Health Ministries and Departments. This concentration of powers impairs the capacity of the departments to deliver the services. There is an urgent need to entrust the policy making functions to the Ministries and departments, executing and implementing responsibilities to fully empowered agencies and the regulatory duties to independent regulatory bodies located outside the ministries and departments. This unbundling of functions will help strengthen the capacity of government to deliver these social services in an effective manner. Third, the management of education, health and other human development policies, programmes and projects is far from being satisfactory. We assume that technical experts and specialists in their areas, such as education and health, can fit in very easily in the managerial positions. Little do we realize that all successful institutions in the world have properly trained and experienced hospital administrators, educational administrators, financial managers, supply chain and logistics specialists. On the other hand, here in Pakistan we have unqualified and inexperienced persons aspiring and competing for these positions simply because they carry privileges, perks and power. Why should highly qualified surgeons fight with each other to become Medical Superintendents or hospital administrators? Administrative positions carry a lot of prestige and power which the professional positions do not and hence we have serious misallocation of resources. We lose first rate surgeons and doctors end-up with third rate administrators who rely upon the office clerks, superintendents and accountants for advice and decision making. No wonder we have such an awful record on delivery of services. Fourth, there is too much bureaucratic strangulation in the business processes and at the same time too little accountability. The plethora of rules, regulations, reports etc. stifle initiative and innovation and encourage apathy and inaction among those who wish to play by the book. But those who are dare devils use the opaqueness of the same rules and regulations and diffused nature of supervision to appropriate resources for their own enrichment. The rules have become a block against collective good but an easy path for individual good. That is why the medicines for the hospitals are procured at highly inflated prices and resold in the open market through a network of connected medical stores while the poor who are entitled to these medicines free of cost have either to pay for them or go without them. The paradox is that those who are well to do and highly influential or capable of doing damage get the services at no cost to themselves but the poor who cannot afford these services and for whom the allocation are made by the government are deprived. Access to services is rationed not by price but by the status. What can be done to remedy this situation? Human development expenditures should be allocated in an integrated and holistic manner. Safe drinking water, more literate women and cleanliness in the neighborhoods will have high pay-off and avoid increased expenditures on curative health, population and nutrition programs. Under the present fragmented and compartmentalized system the cost effectiveness of each rupee spent out of the budget on vertical programs is quite low. Professional managers and administrators should be appointed to run the health and education programmes and institutions. Second, devolution of financial and administrative powers to the lower tiers of government should be made a priority in the real operational sense. The present situation where the doctors and other staff are appointed and transferred by the Provincial governments while the health facilities are managed and operated by the local governments has to be resolved immediately. The resource allocation, both human and financial, should be made commensurate with the responsibilities and accountability clearly defined. Linkages between different human development components and the synergies from implementing vertical programmes in the health sector can be achieved only at the local level. Third, it is not necessary that the government should be both financier as well as provider of services. Not-for-profit organizations, community and civil society organizations and private sector have proved to be more adept at managing and delivering the services. Competition should be encouraged among the most efficient service providers by linking government per capita grants for the poor population with the effective outreach and delivery of services to the poor. This system will automatically overcome the problem of rationing that favors the elite over the poor and also ensure that only the target population is subsidized by the government. Government will continue to formulate policies, develop health infrastructure and health personnel and oversee and regulate the non-governmental providers. Finally, the elected representatives of an area should assume an active role as watchdog to make sure that the poor segments of the population are treated well at the government facilities. Instead of focusing their attention on the postings and transfers of individual officials they will win popular support if they redress the grievances of their electorate in accessing basic services provided by the government. This vigilance will keep the officials on the right track while endear the elected representatives to their electorate. Monitoring and evaluation of various programmes and projects will have to be carried out separately in a systematic way. | state bank of pakistan | 2,005 | 6 |
Presidential address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the pre-budget seminar held by the Pakistan Observer, Islamabad, 28 May 2005. | Ishrat Husain: Distributing benefits of growth to the majority Presidential address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the pre-budget seminar held by the Pakistan Observer, Islamabad, 28 May 2005. * * * The major recurring themes in the popular discussion on the economy have been shifting over the last six years. In the earlier years of the Musharraf period it was widely believed that the country was going to default on its external obligations. When this did not happen there was a loud consensus that Pakistan would not be able to comply with the stringent conditionalities of the IMF and would, sooner or later, get off the track. Since the country successfully completed the programme, the concern was raised that we had emphasized too much on macroeconomic stabilization such as large foreign exchange reserves while growth rates remained quite weak. Now that the growth rates have risen consecutively for the last three years, there is an anxiety that the benefits of growth are confined to a small minority of the population and are not being shared widely. It should be admitted at the outset that the incidence of poverty in the country is quite high i.e. almost one-third of the population is living below the poverty line and unemployment and underemployment levels are also high, particularly among the urban educated youth. But, it must be realized that there is a well established empirical regularity in economic development – whenever economic growth rates are low, poverty and unemployment are high. Conversely, whenever a country records high growth rate, there is a general tendency for the level of poverty and unemployment to decline. This is also borne out by the past economic history of Pakistan. For thirty years i.e. between 1960 and 1990 Pakistan’s economic growth rate was an impressive 6 per cent per year and the incidence of poverty went down from 46 per cent to 18 per cent of the population. This happened at a time when there was no explicit policy emphasis on poverty targeted interventions and social indicators were not improving. But during the 1990s when the growth rate fell to 3 to 4 per cent per annum, poverty resurfaced and by the end of the decade it was up once again reaching 33 per cent. As the first three years of the present decade were devoted to putting the economy back on track after the crisis of 1998, growth rates remained low and poverty and unemployment remained high. It is only in the last three years that we have witnessed growth rates of 5.4 per cent, 6.6 per cent and more than 8 per cent. If growth remains on this trajectory and poverty targeted interventions including investment in human development are implemented, there is no doubt in my mind that we would once again see a reduction in poverty and decline in unemployment rates. What is the basis of this assertion? Higher growth rate in real terms means that all households in the economy with the exception of those not in labour force or not fully employed receive higher incomes after adjusting for inflation. Of course, these higher incomes accrue in proportion to the assets held by different income groups. Top 20 per cent of the population receives almost 50 per cent of the national income. So they receive higher incomes than the bottom 20 per cent who get only 7 per cent of the national income. But still this segment of the population is recipient of additional income generated as a result of faster growth compared to a situation where growth is low or stagnant. Higher incomes translate into increased demand for goods and services. This puts pressures on prices in the short run as there are too many people chasing a limited supply of goods and services. But higher prices also signal to the producers that there are shortages and they should enhance their production so that they can meet these shortages. To increase their production, they have to invest in new plants & machinery and employ more people. As more people find jobs, they are moved out of the ranks of unemployed and unemployment rates decline. As incomes accrue to these previously jobless or underemployed households they are lifted out of poverty and hence the incidence of poverty falls. This is exactly what happened in Pakistan until 1988/89 and that is what is happening at present. Sixty per cent of our population relies on agriculture directly or indirectly. Those engaged in agriculture are not employed in the strict sense of terms as we think about employment in factories, firms, government departments, etc. In agriculture, higher incomes accrue to the landholders through higher output prices and higher productivity. Farm labour also benefits as the demand for their services also rises and poverty declines in rural areas too. Part of this income finds its way into demand for consumer goods. Manufacturers seeing this upsurge respond by first increasing utilization of existing capacity and then expanding capacity through new investment. That is why we have seen double digit growth in investment, manufacturing production and sales and high overall growth rate of GDP. But it must also be admitted that poverty is not only a phenomenon of low incomes but that of powerlessness, state of helplessness and lack of access and opportunities. In Pakistan, literacy rate is about 50 per cent and there is a high correlation between poverty and literacy. Those who are poor are preponderantly illiterate. Therefore, intensified efforts for education and literacy will certainly help in alleviating poverty. The educational system which is usually leveler of incomes has created inequities in Pakistan. The children of the well-to-do families study in English Medium Schools go abroad for higher education and return to occupy high positions in the country. The children of the poor families remain illiterate or go to madarsah or attend Urdu Medium Schools and generally become clerks. This is not fair at all. We should have a system whereby those who are bright and talented but do not have means to attend the best educational institutions should be given scholarships by the government. It is gratifying to see that the talented students from backward areas of FATA have been able to get into the State Bank of Pakistan by dint of their merit and not sifarish. Drop out rates in our educational system are extremely high, the quality is poor and the skills imparted at government schools and colleges are highly irrelevant to the demands of the economy. The output from such educational institutions is, therefore, relegated to the ranks of the unemployed. While the economy has serious shortages of technical and professional manpower, we have surplus of ordinary BAs and MAs who do not have employable skills. This imbalance is one of the major factors for high unemployment among the urban educated youth. Gulf States and Malaysia are also looking for engineers, architects, technicians, mechanics, para-medical staff, nurses, etc. but we do not have adequate numbers available in the country. Access to health facilities is also highly differentiated and parallels the story of educational facilities. The government-run hospitals, clinics and dispensaries are in terrible shape, devoid of basic drugs and equipment. The doctors manning these facilities concentrate on private practice and are indifferent towards the patients from the poor households. The drugs supplied by the government for free distribution are sold in the market to earn private profits while private patients have to fend for themselves. Access to thana, kutchery and tehsil is also heavily tilted against the poor. They have to either seek the assistance of an influential person or offer bribes to get redressal of their grievances. As most of the time they do not have adequate financial resources, they resort to the first option. They, therefore, fall in the trap of patron-client relationship or mai-bap relationship that makes them permanently subservient to the well-to-do and influentials of their areas. They lose their autonomy and the decisions are made on their behalf by these elite groups. This loss in autonomy is translated into electoral support at the time of the elections for this elite class. Thus, powerlessness and loss of autonomy perpetuate poverty even when incomes may rise in the short run. This state of affairs will continue to prevail until we bring about major reforms in our institutions particularly Civil Service, Judiciary and Police. Their orientation and mind set have to change and their performance should be evaluated on the basis of their providing access to the poor and common citizens. In essence, it is a matter of good governance not only at the highest level but at all levels of the public institutions – legislature, judiciary and executive. The legal system and financial rules in the bureaucracy are also highly complex and full of obfuscations. Even if some well-meaning top officials are committed to bringing about some changes, the administrative machinery down the hierarchy is so cumbersome and anachronistic and the financial rules are so outdated and restrictive that good policy intentions are seldom translated into action. What is the way forward to end this powerlessness and lack of access of the poor? Good governance should therefore start with a review of the structure, processes, practices and rules and regulations of our administrative machinery and then bring about revisions wherever required. There are some positive changes that are taking place or are underway. Devolution to local governments, civil service reforms, police reforms and judicial reforms are being implemented and the sooner they take firm root the encumbrances on the poor of this country will be eased. Media – both electronic and print – have become more vigilant. They should undertake more in-depth investigative reporting and expose the malpractices prevalent in the system and ensure that the poor have better access to delivery of public services and institutions. Non-government and civil society organizations have become quite active in the fields of education and health care. Some of them are providing quality services without imposing severe financial burden on the poor. Private-public partnership should be strengthened to scale up these activities whereby the government provides the facilities and finances while the private and not-for-profit sector delivers the services to the poor. Financial system is one of the most potent instruments for creating wealth and distributing benefits of growth to the poor. As financial sector has been restructured and competition introduced, there is a broadening of access for their products and services. Agriculture credit, consumer financing, SME loans, mortgages and microfinance are becoming quite widespread and the number of borrowers from middle and poor classes is gradually increasing. Although the number of beneficiaries is still between 2 and 2.5 million household, the State Bank of Pakistan is committed to double this number in the next five years. In addition, public accounts committees of the legislatures, independent regulatory agencies, the National Accountability Bureau, offices of the Auditor General of Pakistan, Chairman, Federal Public Service Commission, Wafaqi Mohtasib, Provincial Mohtasibs, Federal Tax Ombudsman and Banking Ombudsman are some of the elements that will improve governance in the country and take action against the misuse of office, misappropriation of funds, indulgence in corruption and also take actions for redressing the grievances of common people. Conclusion: The government has provided an enabling and conducive environment for growth of economic activities in the future and foundation has been laid which will result in economic prosperity and stability. In the short term, we have to fight against inflation because it has hit the lower income groups and fixed wage earners the most. It will take five to ten years of sustainable high growth rates of 6 per cent or above to bring the incidence of poverty down to 16-17 per cent from the present level and improve the standards of living of the majority of population. This is possible if the policies are consistent and continued, external environment remains favourable and there are no sanctions or discrimination against Pakistan, good governance is practised, institutions for delivery of basic services to the poor are devolved and strengthened but most important political stability is entrenched. All political parties should agree on a common agenda that economic policies would continue in the larger interest of the country whichever party comes to power. After all they are all agreed on the need for rapid economic growth, macroeconomic stability, poverty reduction, improvement in social indicators and prosperity for the majority of the population. Of course, there will be fine tuning, adjustments and adaptation during the course of implementation, but the vision and direction would remain unchanged. China has set its path to economic progress as far back as 1980 and there have been changes in the leadership of the Party but the direction and policies have remained the same. They have proactively managed the policies in light of changing external and domestic conditions. We can all see the spectacular results China has achieved in reducing poverty and bringing prosperity to the majority of their population. In Pakistan also, the policies have to be adjusted in the light of unforeseen or unanticipated events. When inflation was low, the benefits of financial sector reforms, liberalization and competition were passed on to the borrowers as a policy aimed at kick start of the economy. As inflationary pressures have intensified in the recent months, the higher interest rates will raise the rates of return to the bank depositors who have been suffering for the last four to five years. State Bank of Pakistan will do its best to bring inflation under control but is also requires supply-side interventions. In the medium term, the agenda for reforms is quite tall but I am confident that honesty, hard work, straightforwardness can push the country and individuals forward. Our own religion teaches us to help the poor and hungry residing in our neighbourhoods. Zakat system can transfer finances from the rich to the poor. If we follow these teachings of our religion we can provide stability to the social order and the future of the nation will become bright. | state bank of pakistan | 2,005 | 6 |
Address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the 11th Get Together of the Overseas Universities Alumni Club and the 21st Century Business & Economics Club, Karachi, 12 August 2005. | Ishrat Husain: Why privatisation is necessary for economic growth in Pakistan? Address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the 11th Get Together of the Overseas Universities Alumni Club and the 21st Century Business & Economics Club, Karachi, 12 August 2005. * * * The decade of 1970s in Pakistan witnessed a massive redistribution of national assets from the private owners to the state. The reason underlying the then Government’s thinking for this extremely radical action was that the national wealth was being concentrated in the hands of few families and the rich were getting richer and the poor getting poorer. It was asserted by the proponents of this strategy that the state control over allocation of the resources would promote the best interests of the poor. The intellectual support for this strategy was drawn from the success of the Soviet Union and the socialist economic model practised in that part of the world. Two decades later it turned out that these assertions and assumptions that drove this particular line of action i.e. nationalization was not only unrealistic and flawed but the consequences were exactly opposite to what the intentions were. The collapse of the Soviet Union and the bankruptcy of the socialist model eroded the ideological underpinning of this strategy and the actual results on the ground in Pakistan and almost all the developing countries shattered the ideal and utopian dreams of the proponents of this philosophy. Pakistan’s public enterprises including banks became a drain on the country’s finances through continuous hemorrhaging and leakages and a drag on the economic growth impulses. The poor instead of benefiting from the state’s control over these assets were actually worse off as almost Rs. 100 billion a year were spent out of the budget annually on plugging the losses of these corporations, banks and other enterprises. These public enterprises became the conduit for employing thousands of supporters of political parties that assumed power in the country in rapid succession and a source of patronage, perks and privileges for the ministers and the favoured bureaucrats appointed to manage these enterprises. These employees and managers had neither the managerial expertise nor technical competence to carry out the job. Instead of providing goods & services to the common citizens at competitive prices efficiently, the public enterprises turned into avenues for loot and plunder, inefficient provision of services and production of shoddy goods. It was a common knowledge that getting a telephone connection in Pakistan required years not months and that too with the help of sifarish and exchange of bribes. No wonder the country was able to install less than 3 million telephones in the entire 50 years of its history while under a deregulated and private sector driven environment an additional 6 to 7 million mobile phone connections were given to Pakistanis from all walks of life without any favour or discrimination in one year alone i.e. 2004. The hangover of the past in general and the lingering fascination for the socialist model among some of our intellectuals in particular continue to have a dominant influence on our thinking. Some of the resentment against private profit making is also quite legitimate and understandable. In the past, private entrepreneurs in Pakistan did not make ‘profits’ in the real economic sense of the word by earning a return on their investment in a competitive world. On the contrary, they earned ‘rents’ through the maze of permits, licences, preferred credit by the banks, subsidies, privileges, concessions and specific SROs granted to the favoured few. Naturally when one sees people becoming rich not through the dint of their hard work and enterprise but by manipulation, back door entry, connections, reciprocity, paying bribes, adopting extra legal means, bypassing the established rules and laws, getting scarce foreign exchange quotas, evading taxes, defaulting on bank loans and rigging the markets etc., we should not be surprised to see the venom against the so called ‘private profits’. The policy reforms introduced in Pakistan by the Nawaz Sharif Government in 1991 and more importantly followed by that strong citadel of socialist raj – India – were a watershed reflecting the new realities of economic life. These reforms, though quite extensive and diverse, could be summed up for the sake of simplification in three words – Liberalization, Deregulation and Privatization. The results of Indian reforms are quite evident before us. During the first 45 years of its independence until 1991, India was hardly able to achieve per capita income growth of 1 percent per year and the incidence of poverty remained persistently high. In the 12-year period since 1991, India’s average per capita income growth has been 4 percent per year, poverty has been declining ever since and has fallen below 25 percent. Pakistan, unfortunately, could not follow through these reforms in a continuous and consistent manner despite the fact that both Benazir and Nawaz Sharif governments were fully committed to these reforms. For example, 12 percent shares of PTCL were first sold to the general public in 1993-94 and it has been on the privatization agenda of every successive government since then. The short term political expediency may dictate a different behaviour at present, but I am quite sanguine that the PPP and PML(N) would have pursued the same path were they at the helm of the affairs. Thus, there is a broad political consensus in the country that privatization is in the larger national interest of the country. Privatization has to be seen in the overall context of the respective roles of the state and markets. The State has to be strong to combat the excesses of the market and cope with market failures. It is not that the state should play a lesser or reduced role but a different role in so far as it provides an enabling environment for equitable development and creates necessary conditions for growth through investment in human development and infrastructure. The government’s effective role in regulating and monitoring the market has to be strengthened to promote healthy competition and avoid the rigging of the market by a few. Markets are the best known vehicle for efficient allocation and utilization of resources and thus the decisions as what goods and services to produce, how much to produce, distribute and trade can be done well only by the private sector and not by the bureaucrats. This division and redefinition is also essential to reduce corruption and generate sustained and equitable growth in the country. Market-based competition, privatization of public banks and a strong regulator have successfully reformed the banking sector in Pakistan during the last several years and this model should be replicated elsewhere in the economy. It is not ideology but pragmatism and learning from the past mistakes that should drive our economic policies and strategies. Growth takes place only when productivity from the existing resources keeps on rising. The global experience shows that by and large, productivity actually declines or remains stagnant when the businesses are managed and operated by the government thus slowing down or hurting the pace of growth. I will now turn to the economic rationale of privatization that is not fully understood by many. In particular, there is a popular view that it is okay to sell the loss making enterprises but retain the profit making entities such as PTCL and PSO in the public sector. It is true that the budgetary stress and commercial bank borrowing factors are not valid in such cases but there is a larger economic case for the divestiture of even such profit making enterprises. The main logic behind this divestiture is that it will promote efficient allocation of scarce resources, optimal utilization of resources, making sound, timely and market responsive investment choices, winning and retaining customer’s loyalty through better service standards and lower product prices or user charges and contributing to the expansion of the economy through taxes, dividends etc. I would take the most debated example – that of the PTCL – as an illustration of the general point I am making about the economic rationale for privatizing profit making public sector enterprises. The most oft pronounced arguments against privatization of profit making enterprises are (a) why fix it when it ain’t broke? (b) Protection of workers (c) a better and more professional management can bring about the same results as under privatization. The basic reason for privatizing these enterprises is that the government should not be in the business of running businesses but regulating businesses. The role of the government should be that of a neutral umpire, who lays down the ground rules for businesses to operate and compete, to monitor and enforce these rules, to penalize those found guilty of contraventions and to adjudicate disputes between the competing business firms. If the government owned firm itself is one of the players in the market, there is a strong conflict of interest and the other market players lose confidence in the neutrality of the umpire. Under these circumstances, the market becomes chaotic, disorderly and unruly as there is no neutral ‘person’ to monitor and enforce the rules. The economy thus pays a heavy price for this loss of the market mechanism in the production, sale and distribution of goods and services. The present controversy between the PIA and private airlines is a manifestation of this tendency. If the ‘umpire’ favours its owned enterprise i.e. PIA and discriminates against the rival private airlines, the ultimate result would be the winding up of these airlines. The growth of aviation industry would suffer as the present competition is cutting down the prices and stimulating demand for air travel in the country. In absence of such competition, the PIA would have the sole monopoly and the planes would fly with empty seats as the ticket prices would not be market based but arbitrarily high. The consumers of airline industry – existing and potential – will be the loser in this bargain. The same argument can be applied in case of PTCL. If the Government had continued to own and manage PTCL, the private sector competing firms would have felt that they would always remain at a disadvantage in relation to the PTCL. The constant fear that the government’s coercive powers and full force of policy making ability would always be used to safeguard and enhance the interests of PTCL. This would have kept the private firms away from investment in the fixed telephone or wireless loop segments. If this may not be true under one particular set of rulers, the apprehension that such an eventuality may happen at some time in the future keeps prospective investors away from that field of business. The growth of a dynamic private sector in the economy is thus stifled. The PTCL would under that scenario preserve its monopoly, pass on its inefficiencies to the customers, charge exorbitant prices and resort to seeking concessions of various kinds from the government. The result would be stagnation in the growth of fixed telephony in the country and poor service to the customer. So while the PTCL is not broke and is indeed profitable it needs to be privatized to provide a level playing field for fostering competition, stimulating demand, expanding telecom customer base, improving service delivery and contribute to rapid economic growth. None of this will happen if the PTCL remains a public owned and managed firm. A lot is being made of the fact that the PTCL was making huge profits for the exchequer and these profits will now be diverted to the private owner. The facts are quite contrary to this assertion. The Government of Pakistan will still retain 62 percent of the shares while the private operator will have only 26 percent. Thus out of each billion rupees of profits earned by PTCL, the GoP will receive Rs. 620 million while the private operator only Rs. 260 million. In addition, the PTCL will continue to pay the corporate tax on its income. The burning desire to transfer the management to a private investor was that the profits earned by the PTCL were largely derived not from its own efficient operations but from its monopoly status as the sole provider of fixed telephony in the country. In the coming years, the PTCL will have to compete for its market share as it has lost its monopoly and it was quite likely that the public sector ownership will act as a serious constraint and the level of profits will be eroded over time. Since the private sector competitors of PTCL will have more flexibility, agility and capacity to respond and seize the opportunities for expansion and improved customer service, they will give a hard time to rule bound, inflexible and slow moving public sector owned PTCL. However, competent and able top managers and the Board of Directors may be, they have to follow set procedures, prior clearances and approvals by multiple ministerial bodies before they can make any operational decisions of significance. U-Fone lost 18 months’ valuable time facing various inquiries into its procurement while its competitors were enhancing their market share at its cost. Such a scenario is likely to recur once a government owned PTCL is pitted against several private competitors. The fears about employment losses in the industry as a result of privatization are also, by and large, unfounded. The example of the banking industry privatization controverts those who claim that privatization means jobs are lost. In 1997 when the restructuring, down-sizing and privatization of the nationalized commercial banks picked up speed there were 105,000 employees working in the financial sector. After privatization was completed, the banking industry has expanded and the work force has expanded to 114,000. It is true that the pattern of employment has changed and more productive and skilled workers have been taken in at the expense of low skilled or unskilled. There is no doubt that the PTCL will also expand under its new owners and employ more people but in the skilled category. This upgradation of skills will raise productivity of the firm as well as of the industry. The skill mix of the staff employed by the PTCL and its numbers at present are inappropriate to meet the new challenges of providing high standards of value added services and new product development. One of the difficulties faced by the public sector businesses is that they cannot pay market based remunerations to their executives or highly technical manpower. If the PTCL is not allowed to pay more than MP1 scale to its Chief Executive i.e. Rs. 200,000 per month which is a fraction of what senior executives in the rival private firms get, should we expect the PTCL to attract, retain or motivate high performing manpower. The field gets tilted against a public sector company as it has skill gaps and redundancies and is unable to provide value added services of the same quality as provided by the private sector rivals. The process of hiring and firing of employees in a public sector company such a PTCL is highly convoluted, complex and cumbersome. Those found guilty of infractions or negligence of duties or even corruption can only be dispensed with after a protracted process of disciplinary proceedings that sometimes take several years to complete. In the meanwhile, the employee continues to stay put in service and receives all the emoluments and perks. In a rare case, a departmental inquiry comes up with a guilty verdict, the employee can appeal to the Federal Services Tribunal and if he is unsuccessful, then all the way to the Supreme Court. Why will any right minded boss choose to go through such an ordeal? The alarm of employment losses after privatization is also unjustified for another reason. Telecom sector has already generated, after deregulation, hundreds of thousands of new jobs through public call offices, calling cards and pre-paid card companies, Internet Service Providers, mobile phone companies, broad band services, and other value added services under the private sector. As the penetration ratios in Pakistan are still quite low, there is going to be a large expansion in the telecom sector. The losses of redundant jobs in PTCL, if any, will be more than offset by new productive jobs in the Local Loop, Wireless Loop and LDI companies being set up in the private sector. Industry estimates that 100,000 new jobs will be added during next 3 – 5 years. The substitution of unskilled jobs in the PTCL by the skilled jobs in the telecom industry as a whole will raise the productivity of the sector as well as that of the user companies and institutions. Those among the unskilled who can be retrained or redeployed could be retained minimizing the overall loss of jobs within the PTCL itself. If the PTCL itself is able to expand its services and operations, the manpower that is surplus to its present requirements can be productively employed. Thus the fears of 8 workers losing protection under a privatized entity appear to be misplaced. After all, the PTCL is the only telecom company that has been in the business for the last 58 years. The oversight, monitoring and guidance capabilities of public enterprises are ridden with the aggravated problems of principal – agent relationship. As the Board Members, however able and honest they may be, have no direct personal stakes in the well-functioning of a public enterprise, they cannot be expected to devote as much time or energy to the Board’s affairs as the private strategic investors would. Thus, the PTCL’s governance structure would always remain second best to its private sector competitors and put it at a comparative disadvantage. If a more callous Minister is unfortunately appointed to chair the Board, the appointments, award of contracts and transfers and postings will do further damage to the performance of the PTCL. The temptation by the elected political leaders or other rulers to interfere in the affairs of the public sector companies is not only high but natural. They are constantly accosted by their constituents for jobs, contracts, postings and transfers and it is not possible for them to keep on saying no to everyone all the time. In some cases, they have to yield to pressures. It is, therefore, necessary to sever the connection between the government and the business. How can a public sector company then be expected to show same results as its private sector competitors whose compensation structure is driven by performance, whose managers enjoy full powers of hiring and firing without any restraint, their Boards have direct stakes in ensuring good governance and the political interference is almost non existent? The legacy of PTCL inherited from the culture of the Post and Telegraph Department cannot therefore be washed away if it operates under these constraints. This culture can only be replaced by a dynamic competition-oriented culture under the leadership of a private sector operator. As a government entity, PTCL is considered a rich cash cow to meet the fiscal needs rather than a business enterprise that requires funds for its own maintenance and operations and more important for its investment needs. The compulsions of extracting as much profits and cash for meeting fiscal deficit will always predominate and the imperatives of expanding the network, infrastructure and services through retained earnings will be neglected. Even assuming that a perceptive government does allow PTCL the funds to make investment, it is not obvious if these will be used in an efficient and costeffective manner. The World Bank has recently blacklisted 200 firms for padding contracts and bribing officials in public sector procurement awards in a number of developing countries. It must once again be stressed that private sector ownership and efficient functioning of market mechanism require certain legal and regulatory institutions. In absence of these institutions, private monopolies or oligopolies can surface, market distortions can accentuate and markets can be rigged for the benefit of few. Strong legal and regulatory institutions would be able to counter these evils forcefully and provide a level playing field for all market participants. We have to strengthen these legal and regulatory institutions in the country. Public policy should also be geared at removing preferential treatment or granting of concessions or privileges to a particular segment of the population. During the last five years, the Government has endeavoured to move in this direction and act in an even handed manner. No firm specific SROs have been issued to favour a particular enterprise at the expense of others. Under these circumstances, private sector will earn true ‘profits’ through competition and not ‘rents’ and the justified grudge against the private sector will be minimized. Conclusion Privatization contributes to economic growth through productivity gains, efficient utilization of resources, better governance and expansion in output and employment. Profit making enterprises under the public sector may be making profits due to the unique market structure such as monopoly or other privileges or concessions conferred upon them by the government but it does so at the expense of the consumer who has to pay higher than market price for the product or the services. The ordinary consumer gets a benefit only through competition among private sector firms in form of lower prices and better services as has been demonstrated in the cases of banking, telecommunications and, more recently, air travel. In a deregulated market environment, public ownership becomes a serious constraint as the rule – bound procedures and the rigidity in the structure do not allow public sector companies the flexibility to respond promptly to dynamic market conditions. Furthermore, the government’s role as a regulator and neutral umpire becomes questionable once it is itself a participant in the game through its own company. This stifles competition and subverts expansion and growth by the private sector companies. | state bank of pakistan | 2,005 | 8 |
Keynote speech by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Pakistani Professionals Forum, Toronto, Canada, 1 October 2005. | Ishrat Husain: Pakistan’s development challenges for the coming decade: how can overseas Pakistanis help? Keynote speech by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Pakistani Professionals Forum, Toronto, Canada, 1 October 2005. * * * Let me thank the Pakistani Professionals Forum of Canada for inviting me to address this august gathering. It is indeed a privilege and honour to be present here this evening and interact with such a istinguished audience. The topic which I would like to address today s: How the overseas Pakistanis can help Pakistan’s development challenges in the coming decade. Pakistan has been able to turn around its economy during the last six years from a situation of imminent default in the late 1990s to the current status of a dynamic, vibrant emerging economy - one of the fastest growing in Asia. Pakistan has successfully re-established its access to international capital markets and its sovereign bond is trading at a price that is not enjoyed even by investment grade countries. We have voluntarily said good-bye to the International Monetary Fund as the country has regained its economic sovereignty. Unlike the popular notion that the September 11 has benefited the economy, the fact is that dependence on foreign assistance has been reduced to the extent that it is now less than 10 percent of the entire foreign exchange earnings. The external debt ratio – one of the main indicators of the country’s dependence on the others – has sharply declined from over 50 percent to 30 percent of GDP. More importantly, despite all the various shocks, such as the recent oil price shock, the economy has remained resilient and has withstood these difficult times without any serious disruption to the market stability. The abolition of quotas on textile exports under the WTO regime and the withdrawal of preferential tariff arrangements by the European Union have not adversely affected our textile industry. Pakistan’s share in the highly competitive world export market has in fact risen during the last few years. In a survey of doing business in 150 countries around the world carried out by the World Bank this year, Pakistan has clearly emerged as one of the top ten reformers in the world. Its ranking in order of an enabling business environment was 60 compared to 116 for India. This shows that we have come a long way from a highly bureaucratic, controlled and regulated economy to a market and business friendly, liberal and deregulated private sector oriented economy. But having made these impressive achievements, the road ahead of us is still arduous and torturous. The imperatives of globalized economy demand that we should remain agile, dynamic and capable of competing with the rest of the world while taking care that one third of Pakistan’s population living below the poverty line is uplifted. The difficulty is that our labor force is poorly trained and our social indicators are so weak that we stand at number 137th in the country rankings of the Human Development Index. One half of our population is still illiterate, the access to healthcare is limited, mortality rates of infants and women are relatively high, the enrollment and retention ratios among our school-going population are low, and the number of students and the quality of our science and technical expertise are way behind other Asian countries. In other words, we have many difficult challenges to tackle before we can compete with other countries in the global economy. The good news is that if we are able to do so successfully, the incidence of poverty will also fall. In my studies of China and India’s development in the recent decades, what struck me most was the important role played by the overseas Chinese and overseas Indians. We have an estimated 3 million overseas Pakistanis concentrated mainly in North America, Saudi Arabia and the Gulf and the United Kingdom. We are extremely grateful to them for their invaluable assistance in the country’s turnaround by sending their remittances officially through the banking channels. Had we not received this large flow of remittances every year in the past four years, it would have been difficult to accumulate the foreign exchange reserves to the level we have today. We could neither have reduced our dependence on foreign assistance nor have been in a position to finance our growing trade deficit. So I wish to publicly acknowledge the role of the overseas Pakistanis who have helped us by sending remittances to their families through the banking channels. I hope that this amount will continue to expand as more Pakistanis find jobs in countries such as Malaysia and Korea, their incomes rise in the Middle East in proportion to the rise in oil revenues and as remittances are diverted from informal to banking channels. 1/4 This is only one of the examples in which overseas Pakistanis have made a very important contribution. But as I address you – the Pakistani professionals settled in Canada -- I would like to take the opportunity of spelling out various ways in which you and other overseas Pakistanis can help the country in meeting the difficult challenges ahead of us. Most of the speeches delivered at gatherings such as this are normally at a highly abstract and generalized level appealing to your sense of patriotism and urging you to help the country in a vague manner. But I wish to deviate from this tradition as I would like to make ten specific and concrete proposals for your consideration and through this forum to the larger community of overseas Pakistanis all over the world. Each proposal is targeted at a different segment of this group and you can pick and choose according to your own personal preferences and interests. Some of these proposals are doable in the near future but others will take some time to crystallize. The purpose of presenting these proposals before you is to provoke some further thinking, debate and discussion. It will be quite understandable that some of these ideas are rejected after thoughtful evaluation but even if a couple of these ideas survive and are implemented, my purpose would have been achieved. First, the country is faced with a shortage of skilled manpower that is in high demand for sustaining the growing economy. While we have hundreds of thousands of educated unemployed, we have at the same time vacancies for hundreds of thousands of people in different skill categories. We would therefore like you to help fill in this gap by setting up institutions of learning for imparting vocational training and technical and science education ranging from universities, colleges, post-high school institutes to post-primary and secondary school apprentice workshops. The curriculum, content, the pedagogical tools and testing methods in these institutions should be designed and delivered in such a manner that the employers compete with each other to hire the products of these institutions. The Government is encouraging private-public partnership in this area and has a number of existing physical facilities that can be used for this purpose. The Federal Government has formed an independent authority for technical and vocational education and you should approach this body with your specific proposals. Second, groups of enlightened overseas Indians and Chinese have not only established institutions of higher learning in their countries of origin such as the Indian Business School at Hyderabad set up in collaboration with Kellog School at Northwestern University and Carnegie-Mellon but they are also helping the existing institutions of learning and healthcare. Some of you, I know, are helping Aga Khan University or Shaukat Khamam Hospital but we need more of such quality institutions dispersed all over the country. We need them not only in Karachi, Lahore and Islamabad but we need them in Peshawar, Quetta, Hyderabad, Sukkur, Bahawalpur, Multan, Sialkot, Faisalabad. Those of you who belong to these areas owe it to your hometowns to get together and help some of these educational and healthcare institutions at these places acquire eminence in the delivery of these services. Your involvement will also help improve the governance and management structures of these institutions which are badly in need of reform. Third, many among you are highly respected researchers and innovators who are at the cutting edge of their disciplines. We would like you to provide intellectual leadership in designing, organizing, collaborating in practical-oriented scientific research and applying the results of this research to enhance agriculture and industrial productivity. The link between academic research and the industry in Pakistan is quite weak and the billions of rupees being invested in research establishments are not producing the kind of benefits that are needed to boost the productivity and efficiency of our industry. Some of you can help in strengthening these linkages by applying the business models that have successfully worked elsewhere. Fourth, the outsourcing of services in China and India was initiated by a group of overseas nationals of these countries working in multinational firms. They acted as the conduit and honest brokers between the foreign firms and the host country firms because they had the intimate knowledge of the multinational firms’ requirements and the understanding, contacts and knowledge of the capabilities of the firms in their countries of origin. In many cases, they advised the recipient firms as to how to go about writing contracts, developing quality assurance methods, and the means for delivery on time, etc. I am sure we have a large reservoir of Pakistanis working in the multinationals and there are now well established firms in Pakistan who can cater to their outsourcing needs according to international standards. What is missing is the link between the two and I would encourage you to work on this missing link even on a fairly modest scale to begin with. 2/4 Fifth, as the cotton textile industry in North America and Europe is no longer competitive, there is a great scope for formation of joint ventures in which the local companies in Canada and the US provide design, technology, marketing, services while the actual production is carried out in the low cost factories of Pakistan and the final output is shipped to North America. This is a win-win situation for both parties as the dying textile firms in North America will be able to retain some jobs while Pakistan will enhance its labor intensive exports and provide employment to a large pool of unskilled labor force. The management consultancy firms and investment banks in which overseas Pakistanis are serving can help identify such opportunities. Sixth, the organizations of overseas Pakistanis can set up scholarship funds to enable some talented young Pakistanis, who cannot otherwise afford, to study for advanced degrees in Science, Engineering and technology at the top elite universities in North America. There is always an apprehension that these scholars, if they are good, will not return to Pakistan upon completion of their studies. But there is no harm if they acquire practical experience in their fields as today’s world is characterized by brain circulation rather than brain drain. The attractive prospects in Pakistan will sooner or later take them back and this investment in human development will never be wasted. I will very much hope that the organizations of overseas Pakistanis such as yours will give a serious consideration to this suggestion. Seventh, in this age and day, we have to play by the practices and rules of the countries we have chosen as our new home. As you know better than I do, think tanks play an important role in influencing public policy in Canada and the U.S. Some Pakistani businessmen have taken the lead in establishing Pakistan Fellowship Funds at the School of Advanced International Studies (SAIS), John Hopkins University and the Woodrow Wilson Center in Washington, D.C.. This initiative has proved successful as is evident from the number of seminars, conferences held and working papers, policy briefs, op-ed columns that have appeared on Pakistan’s development issues in the U.S. in the last two years. I suggest that similar ventures should be encouraged in other think tanks in the U.S. and Canada. These think tanks can be our powerful allies in influencing opinion makers in the media, parliaments, academia, governments, political parties in responding to their concerns about Pakistan and inprojecting a realistic image of our country. Eighth, those among you, who are medical professionals and are also enterprising and willing to take risks, should consider setting up in the private sector, modern hospitals of world standards in Pakistan. These hospitals can attract patients from the western countries and the Middle East for surgical procedures and other quality services at costs which are a fraction of those charged in developed countries. I emphasized the word ‘enterprising’ because these hospitals have to be run on a commercial basis offering five star hotel facilities, meet and receive facilities at the airports and cater to other needs of the patients and their families. Such hospitals are operating successfully in other developing countries and I do not see any reason as to why they cannot be replicated in Pakistan given the large pool of Pakistani medical practitioners. The banks and financial institutions are willing to provide debt finance for such ventures and equity finance can also be raised through public offerings. What is required is getting together top notch medical professionals working in concert with the top class business and finance managers and hospital administrators. Ninth, since the introduction of Oxley-Sarbanes legislation in the United States and similar stringent laws and regulations elsewhere, the profession of chartered accountancy has become extremely lucrative. There is an overall shortage of qualified accountants in all parts of the world. Those who have qualified from the Institute in Pakistan are in heavy demand in U.K. and the Midddle East as they have established a good track record. The limiting factor in producing more accountants as I understand from my interaction with the Institute of Chartered Accountants in Pakistan, is the shortage of qualified faculty. Some of you practicing or actively engaged in this field may consider the possibility of helping meet this shortage by offering your services to teach at the Institute for short periods of time. I am sure in this way, we will be able to produce a large pool of quality accountants whose services can be exported abroad or utilized at home. Tenth, the tourism industry has not taken off in Pakistan for a variety of reasons, including the negative perception that the country is a dangerous place to visit. On the other hand, we have the most beautiful places which would interest the eco-tourists as well as the heritage tourists. The Northern areas and the KaraKorum range offer the potential for those interested in eco-tourism. Mountaineering, tracking, etc. while Taxila, Harappa and Moenjodaro are the bright spots for the heritage tourists particularly those having a penchant for the Buddhist and ancient civilizations. For the Mughal monuments located in Lahore, the tour itinerary for India can be extended to include these 3/4 monuments. Those associated with the leisure and hospitality industry here can help in organizing group tours and also investing in the supporting infrastructure – tourist lodges, hotels, transport, etc. I have presented the above examples as simply illustrative of the many opportunities which exist for the overseas Pakistanis to explore and exploit. In my view, you are in a relatively better position to exploit some of these opportunities as compared with the foreigners because you have a better understanding of the cultural milieu in which we operate. You have a more realistic appreciation of the constraints which we face but at the same time you are in a better position to help in getting the problems resolved. I hope that some of you would give serious consideration to some of the proposals I have put forth this evening. On our part, we can assure you that the Government is willing to assist you in all ways possible to get these ideas implemented. 4/4 | state bank of pakistan | 2,005 | 10 |
Speech by Mr Ishrat Husain, Governor of the State Bank of Pakistan, public lecture at the Indian Business School, Hyderabad, 7 October 2005. | Ishrat Husain: Structural reforms in Pakistan’s economy Speech by Mr Ishrat Husain, Governor of the State Bank of Pakistan, public lecture at the Indian Business School, Hyderabad, 7 October 2005. * * * Pakistan is one of the few developing countries that was able to attain an impressive record of economic growth and poverty reduction in the first forty years of its existence. GDP growth rate until late 1980s averaged about 6 percent per annum and the incidence of poverty was lowered from 46 percent to 18 percent. Inflation remained low and despite high population growth per capita incomes had almost doubled. This favorable situation was reversed in the decade of the 1990s. Growth rates tumbled to an average 3 to 4 per cent and poverty resurged to 33 percent of the population. Inflation was in double digits, large current account and fiscal deficits escalated debt – GDP ratios to over 100 percent. The country’s foreign exchange reserves fell to less than $1 billion, exports were stagnant, tax collection efforts were lackluster. The country was almost on the verge of a default crisis on its external payments in October 1999 when President Musharraf took over the reigns of the Government. He assembled an economic team of technocrats under the leadership of Shaukat Aziz to formulate and implement a strategy that prevented not only the payments crisis but also led to the revival of the economy. The team was given full support and a free hand in its work. I do not wish to dwell on the actual course of events but suffice to say that the outcome of the implementation of this strategy during the last six years is quite remarkable. GDP growth in 2004-05 reached 8.4 percent after recording upward moving growth rates in the preceding three years; inflation during the first five years of the present regime was lower than 4 percent, only in 2004-05 it exceeded 9 percent; manufacturing sector output growth was over 15 percent, exports have doubled in US dollar terms in these five years, tax revenues have risen by 14 percent a year although Tax-GDP ratio is still low. Consolidated Fiscal deficit is down to 3.3 percent of GDP. Current account was in surplus for three consecutive years turning to a modest deficit of 1.5 percent of GDP in last fiscal year due to oil price shock. Workers’ remittance flows have multiplied four-fold to over $4 billion annually and Foreign Direct Investment has witnessed a sharp escalation to $1.5 billion, about 1.5 percent of GDP. Public sector enterprise losses have been curtailed substantially. Foreign exchange reserves are twelve times their level of 1999 at over $12 billion and cover nine months of imports. Debt- GDP ratio has declined to 56 percent and the savings on debt servicing have allowed the Government to triple its public sector development program from almost $1.7 billion to $5 billion investing in infrastructure and human sector development. Pakistan has successfully entered international capital markets and raised over $1 billion at extremely fine pricing that was better than the investment grade sovereigns. Both sovereign bond issues were subscribed four times and are at present trading at much tighter spreads than the EMBI average. The most recent survey of doing business in the world conducted by the World Bank and IFC has placed Pakistan as one of the ten top reformers and Pakistan ranked 60 in the case of doing business – quite a high position among the developing countries surveyed. How was this turnaround achieved in such a short period of time? Our strategy was to launch a multifaceted attack that combined macroeconomic stabilization, reduction in debt burden, fundamental structural reforms and improved governance. We felt that pursuing simply stabilization was not enough as it would have turned out to be a short term palliative and the risks and vulnerabilities of relapse into crisis situations would have remained elevated. What were the ingredients of this strategy and what was the sequencing and phasing of the various policy actions taken to implement this strategy? The first and foremost measure was to find a durable solution to the external debt problem as it was the major cause of stress to the economy. Bulk of the debt was owed to multilateral institutions and the bilateral official creditors. The former was unassailable and thus the focus was centered on the bilateral debt reprofiling. To make any headway on that front, the country had to come to terms with the IMF. The problem here was that in the decade of the 1990s, Pakistan had entered into successive agreements with the Fund but never implemented any one of them beyond the first or second tranche release. This had created a credibility gap for Pakistan among the international financial institutions. To resume any meaningful relations with the IMF, we had to establish a track record of performance before they could agree to debt restructuring. In 2000, Pakistan entered into a nine-month stand-by 1/3 arrangement which involved a large number of prior policy actions, performance criteria and structural conditions. Only after the stand-by program was completed well before September 11, 2001 to the full satisfaction of the IMF authorities that Pakistan was able to secure a long-term restructuring of its Paris Club debt. The popular notion that the Sept. 11 events helped Pakistan obtain favorable terms on its Paris Club debt is contrary to the facts. We had already reached an agreement well before Sept. 11 with the Fund on a three-year Poverty Reduction and Growth Facility (PRGF) of which the debt restructuring was an integral part. The success on the external debt front was absolutely essential for macroeconomic stability and we worked assiduously for almost a year prior to the approval of PRGF to fulfill all the conditions pre-requisite for obtaining debt reprofiling on a long term basis. The short term consolidation of debt was rejected as an alternate and therefore the country had to suffer the harsh and onerous conditions specified by the IMF under its stand-by program. Concurrently with the debt restructuring, the country embarked on the fiscal policy reforms and consolidation by raising tax revenues, reducing expenditures, cutting down subsidies of all kinds and containing the losses of public enterprises. Tax reforms were undertaken to widen tax base, remove direct contact between tax payers and tax collectors, introduce value-added tax as the major source of revenue, simplify tax administration and strengthen the capacity of the Central Board of Revenue. Although these reforms are still underway, the adoption of universal self assessment followed by random audit of selected tax returns, automation and reorganization of the tax machinery have begun to help improve tax collection although tax-GDP ratio has not yet improved. The next major thrust of the reform program was privatization of state-owned enterprises. Fortunately, the privatization process was initiated in 1991 under the Nawaz Sharif Government, continued under the Benazir Government, and further intensified under the Musharraf Government. Thus, there is a wide political consensus and support for privatization because of an underlying belief that the Government should not be in the business of running businesses but regulating the markets and laying down policies. Pakistan’s record on privatization has been impressive and this has helped in stopping the hemorrhaging of public finances and easing the pressures on fiscal deficit. Financial sector reforms in Pakistan were also initiated early in the 1990s when private domestic banks were allowed to set up their shops along with the nationalized commercial banks. Although these reforms were implemented with fits and start, they were accelerated in 1997 when the Nawaz Sharif Government brought in professional managers and boards of directors consisting of reputable persons from the private sector to manage and oversee the nationalized commercial banks. The Central Bank was granted autonomy and the control of the Ministry of Finance over banking institutions was diluted. Excess labor was shed off through voluntary golden hand shake schemes and unprofitable branches were closed down. Further reforms were undertaken since 1999 when the non-performing loans were tackled in a decisive manner, minimum Capital requirements were raised, the quality of new loans was improved, mergers and consolidations of financial institutions took place and the range of products and services offered by the banks was widened. But the most crucial policy action taken by the Government, in my view, was the privatization of Habib Bank, United Bank, and Allied Bank – three large nationalized commercial banks of the country. As a result of these reforms, the share of the private sector ownership of the banking assets has risen to 80 percent. The banks are highly profitable and the average lending rates declined to as low as 5 percent as automation, on-line banking and multiple channels of delivery have improved the efficiency of services and a healthy competitive environment has set in. Agriculture credit, SME financing, consumer loans and microcredit have become mainstream products of the banking industry and diversified their risks. The middle and lower middle class which had been completely shut off from access to banking services are now enjoying car loans, mortgages, credit cards, consumer durables. Small farmers have found themselves using chemical fertilizers, certified seeds, insecticides and weedicides, small implements and hiring tractor services. Small and medium entrepreneurs are expanding their fabrication and manufacturing capacities and upgrading technology. Landless labor and poor women in the rural areas are receiving loans for poultry, small livestock, sewing machines, etc. The main beneficiaries of these reforms, in my opinion, are the customers of financial services although it must be recognized that market determined deposit rates have also declined significantly. But as the lending rates are surging upwards, deposit rates are also going to depict an upward movement. Trade liberalization has been undertaken in Pakistan for the last 15 years and the maximum tariff rate which was as high as 250-300 percent has been brought down to 25 percent while the average tariff rate is about 9 percent. Non-tariff barriers and para tariffs have been eliminated and the culture of providing selective concessions, exemptions and privileges to individual firms has given way to an across-the-board uniform rules and regulations. Protection to domestic industry is no longer a policy 2/3 objective as in the globalized world efficiency can improve only under a competitive environment. The breaking down of these artificial barriers has led to significant productivity gains and manufactured exports now account for 90 percent of the total exports. Imports of all kinds of goods – capital, consumer, raw materials – are freely allowed into the country at negligible import duty rates. Foreign investment regime in Pakistan is also highly open and liberal. There are no restrictions or ceilings or prior approvals required for foreign investors to set up their business in Pakistan for any sector of the economy – agriculture, real estate, retail trade, manufacturing, services, banking, insurance and other financial services. As long as they bring in their initial foreign investment and register it with the Central Bank, the foreign investors are free to repatriate their profits, dividends, royalties, technical fees, debt servicing, etc. through their bankers without any prior approval. Foreign companies are allowed to raise funds from domestic sources, including bank loans, without any restrictions. They are treated equally with national firms in all respect and can bring in and out expatriate staff to run their businesses. Deregulation of oil and gas telecommunication and civil aviation sectors have also brought about significant positive results. Oil and gas exploration activity has stepped up in recent years and constant discovery and production from new gas fields operated by private sector companies have added new capacity to meet the growing energy needs of the country. Independent power producers – both domestic and foreign private companies – have played a critical role in filling in electricity generation requirements of Pakistan. Telecommunication has witnessed a boom since the private sector companies were allowed licenses to operate cellular phones. One million new cellular phone connections are being added every month and the number of phones has already reached about 15 million. Long distance international and local loop monopoly of Pakistan Telecommunications Corporation has been broken and new licenses including for wireless local loop have been issued. The customers are reaping rich dividends as the prices of phone calls – local, long distance, international – are currently only a fraction of the previous rates. Since the government recently announced the policy of allowing the private operators to fly on international routes, there has been a big uptake in the aviation business. Domestic airfares have been cut by PIA which had almost a monopoly and seat load factor has reached an all time high. PIA and the private airlines are all scrambling for new planes to meet the pent up demand for air travel. Despite these reforms, Pakistan is facing many difficult challenges. One third of the population still lives below the poverty line. Human Development Indicators remain low as almost half of the population is illiterate, infant and maternal mortality rates are high, access to quality education and health care particularly by the poor is limited, income and regional inequalities are widespread, infrastructure shortages and deficiencies persist, skill shortages are taking a toll in the economy’s productivity while at the same time, there is high unemployment and underemployment. Most worrying to me is that Pakistan’s image abroad is quite negative. Foreigners are reluctant to visit Pakistan as they perceive the country to be a dangerous place. The worldwide preoccupation with the large economies of China and India and the ever-increasing quest to enter these markets is also working to the disadvantage of countries such as Pakistan. But the lesson we have learned is that there is no point in complaining and whining about this but to get on with the job, to work even harder, to overcome these deficiencies and constraints and to hope for the best. Thank you. 3/3 | state bank of pakistan | 2,005 | 10 |
Chief guest address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Prize Distribution Ceremony of the Institute of Bankers, Karachi, 26 November 2005. | Ishrat Husain: The perils of higher skill shortages for Pakistan’s economy what can we do about it? Chief guest address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Prize Distribution Ceremony of the Institute of Bankers, Karachi, 26 November 2005. * * * It is highly paradoxical that in a developing country such as Pakistan, we are experiencing serious skill shortages and, at the same time, high rates of open and under employment. A lot has already been said about the causes of the mismatch between the skills required by the economy and the skills generated by the educational institutions. In this paper, I am also not going to focus on technical and vocational skills such as carpenters, masons, electricians, plumbers, automobile, air conditioning, refrigeration mechanics, medical technicians, nurses, foremen, etc. but mostly on higher skills such as needed by the I.T. and telecommunications industry, aviation industry, financial sector, accountancy, engineering goods industry, infrastructure industries, bio-medical sciences and bio-medical engineering, media industry, etc. A box, containing my assessment of where the shortages and surpluses are, is presented for provoking further refinement and discussions. (Box I). The basic thesis of this paper is that in absence of an integrated model of skill formation, upgradation and maintenance, the adhoc and piecemeal approaches will remain unproductive and inadequate. It is true that the start-up costs and time involved in getting this integrated model up and going are high but we have already wasted so much time and energy that we are lagging behind other countries. Moreover, this proposed model has been tested and applied in case of the State Bank of Pakistan (SBP). We should, therefore, adopt a bootstraps approach and lay solid foundations for reliable flows of high quality skilled manpower responsive to the changing needs of the economy. The pipeline we have constructed in the State Bank in the last six years has already produced 400 out of 800 professional staff easing the shortages of skills in the Central Banking segment. These young men and women, I am very proud to say, are in heavy demand both within and outside the country. From a situation that we were stuck with people who could not be used anywhere now there is a high degree of mobility and the SBP professionals recruited and trained in the recent years are commanding premiums in the market place. We have not adopted a myopic approach by preventing them from leaving the SBP as this will be highly counter-productive; on the other hand, we are enlarging the capacity of our pipeline by increasing the number of recruits and training and developing the staff inhouse and outside. We are keen to maintain the quality of intake as once the quality is compromised then the model which I am proposing will become dysfunctional. The structural reforms in the banking industry have brought about some unintended consequences that are creating serious pressures on the future growth of the industry. From a situation where the movement in and out of the banks was almost non-existent and life-time secure tenure was assured for all the insiders, the industry is going through a major upheaval in achieving stable and cost effective work force. During my recent farewell visits to more than 30 banks in the country, the common theme was the complaints about the widespread poaching of staff among the banks, the unwarranted escalation in compensation packages to attract and retain the staff and the consequent instability in the work force. In a way it is extremely satisfying to witness that the banking industry is going through the early pangs of professionalization where the market is able to discern and reward people on the basis of their output and performance and hunt for the talent. Another positive aspect is that this process gives signals to the rest of the employees and potential entrants that they should also acquire and master the skills that are in short supply if they have to advance their careers or earn more money. Overtime, the expansion in the supply brings back the equilibrium in the market and normalizes compensation packages. But in the transition period the pains are felt by everyone. In this transition phase, this instability gives rise to dangerous trends of out pricing of banking products with adverse impact on the consumers, the widening gaps between the marginal and average salary scales in the industry and thus the consequences for motivation of the majority staff and the perpetual struggle by the senior management to manage the scarcity and mobility of human resources. What can be done to smoothen this transition and enhance the requisite supply of skills? Let me first say that there is no short cut and it will take time, efforts, coordination among various players and agencies and continuous monitoring and follow-up. The business model for the skill formation, upgradation and maintenance process is presented graphically below. There are three distinct stages of this process with spheres of responsibilities and inputs. The starting stage is the quality and quantity of student intake into our universities, professional colleges and institutes, along with strong accreditation bodies. In Pakistan, we all have become familiar, with the passage of time, as to which institutions are the breeding grounds for quality raw materials of skills for various industries. The problem at this stage is that the numbers being produced from the quality institutions are totally inadequate in relation to the demand. For example, the banking industry is now moving to second tier educational institutions for sourcing their recruitment. This may give a false sense of complacency to these institutions that as their graduates are finding jobs in the market they have attained the required standards of acceptance. Nothing could be far from the truth. The banking institutions have no other alternative but to scrape at the bottom of the barrel to bring people on board to meet their rapidly growing demands. At this stage, the Universities should work closely with the Industry Associations such as Pakistan Banks Association to revise the curriculum, attract qualified faculty and instructional staff, and modify the testing and examination methodology to produce the required number and quality of graduates. There should be no compromises and short cuts by the universities to meet this upsurge in demand. Linkages should be established to train the trainers at world class institutes of learning. This will have a multiplier effect in producing both the numbers and quality. The Industry Associations or individual large firms can help upgrade the quality of our Universities and institutes by setting up endowed chairs and attracting world class scholars, establishing competitive research grants for exploring practical issues of interest to them, funding scholarships for the best and brightest, who cannot otherwise afford to study at the top private universities and provide travel grants to teachers to attend international conferences, symposia, etc. These initiatives will not cost very much in terms of actual outlays but produce highly desirable results in enhancing the quality of our educational institutions and promoting scientific and technological disciplines needed by the economy. The second stage is the recruitment process and post-induction period after the professionals have entered the industry. The recruitment should be based on merit through a highly competitive process. The written test should be more a test of applying knowledge and techniques to solving problems rather than reproduction of memorized material. The interviews should be structured to find out the interpersonal communication skills, suitability to work in a team environment and the values and attitudes. At this post induction stage, the responsibility shifts from individual company to the industry associations which should develop, certify and help maintain excellent centers for imparting standardized, uniform, theoretical, applied and hands-on training to the new recruits. In some cases, passing of professional examinations such as the Diploma in Banking may also be the pre-requisite for career progression. The experience of the State Bank of Pakistan in this regard may be illuminating. The recruitment practices initiated by SBP several years ago have been adapted by almost all the banks and are becoming industry-wide standard practices. Post-entry training is also catching on rapidly but the efforts of individual banks should be supplanted by a collective effort of Pakistan Banks Association (PBA) and the Institute of Bankers, Pakistan (IBP) to develop standardized curriculum, approved list of trainers, pedagogical tools, testing methodology, and minimum acceptable grading system. The training delivery can then be decentralized under these parameters and quality control and assurance can be centralized by the PBA and IBP. The process of value addition does not end simply with the post-entry training. We have found that the direct linkage of intermediate training courses and advanced training courses and passing of professional examinations linked with promotion plays a critical role in the continuous improvement and voluntary upgradation of skills. As there is overall shortage of trainers in these areas, the PBA and IBP should enter into strategic alliances or joint ventures with foreign and international banks or training institutions. This will minimize the costs to individual member banks and also relieve them of the search and organizational costs. Another clever way of skill upgradation is to send the rising stars in the industry or profession for attachments to foreign banks for short periods of time to acquire the state-of-art knowledge and practices. They should be expected, on their return, to disseminate and share their learning with their peers and colleagues and take the lead in applying those practices in their own institutions. The SBP has so far sent almost one half of their 800 professional staff for foreign training and attachments and the results are for everyone to see. Those Chief Executives, who only focus on the cost side of the equation and miss the benefit side, are indeed doing a great disservice to their own organizations as the competition will sooner or later beat them because of this inadequacy in the skill acquisition by their staff. The universities should organize Executive Development Programs such as being done by the business schools. The banks should also avail of these courses and work with the business schools to tailor them to their requirements. Institutions such as GIK, NED, UET, NUST, FAST, etc. should not only organize refresher technical courses for the executives working in engineering profession but also hold management courses for the middle level managers of various companies. There is an acute shortage of project management skills in this country. To begin with, our engineering universities can bring in foreign trainers or institutions as partners and then gradually build up their own capacity. Continuous collaboration with leading universities such as Caltech, Georgia Tech, etc. would be the best way to value addition of our engineering professionals. At the last stage, the finished product rising from within the organization or recruited from outside should remain engaged in learning and skill upgradation. At this stage, the job content emphasizes less of technical skills but more of leadership and managerial skills. We do not realize how much difference a good manager can make to the efficiency and productivity of an organization. But our senior managers feel they have reached the nirvana, they know everything and nobody can teach anything to them anymore. I believe they are sadly mistaken as they do not realize how much they are missing in terms of their own personal and professional growth. Management Development Programs both at our universities and institutes of higher learning and at foreign institutes should be encouraged and made an integral part of their career management. The model that I have laid out is nothing new or spectacular. The different elements of this model do exist in bits and pieces and have been applied in varying intensity across many companies in Pakistan. I have mostly relied upon the examples of banking industry as I am more familiar with the developments there. I do not know very much about the other sectors and I am sure a lot must be happening there. If it is not happening, then I will urge the universities, institutes, industry associations to work together and test this model, adapt it and apply it widely and in a systematic say. I am confident that the skill shortages, which we are observing today in Pakistan, will not only disappear domestically but we will become the conduit for supplying these skills to other countries and a magnet for outsourcing business. | state bank of pakistan | 2,005 | 12 |
Keynote address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the SBP Conference on Monetary-cum-Exchange Rate Regime, Karachi, 14 November 2005. | Ishrat Husain: What works best for emerging market economies? Keynote address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the SBP Conference on Monetary-cum-Exchange Rate Regime, Karachi, 14 November 2005. * * * Conduct of monetary policy in emerging market economies is certainly no less challenging than it is in advance economies; it may be argued that it is, in fact, more challenging because of different nature of economic, socio-political and institutional structure of emerging market economies. However, the experience of advance economies in formulating and implementing monetary policy combined with the broad principles of economics and their own experiences provides a natural starting point for the central banks of emerging economies to actively search for improving their monetary regimes. Last decade of twentieth century witnessed significant transformations in the institutional workings of central banks around the world starting with the landmark independence of Reserve Bank of New Zealand in 1989. Greater realization for the need to have independent central banks on the part of governments, and the need to enhance institutional competence on the part of central banks produced a wave of central banking reforms both in advance and emerging market economies. Pakistan had also immensely benefited from this evolution starting with the administrative and operational independence legislated first in 1994 and again in 1997 that completed its de jure independence. Before SBP’s independence, monetary and exchange rate regime had evolved from fixed peg up to early 1980s and managed float till 2000. From the onslaught of financial sector reforms in Pakistan, especially with reference to adoption of market-based or indirect instruments of monetary policy, SBP started to follow monetary aggregates targeting from early 1990s. With greater liberalization of interest rates and gradual strengthening of transmission mechanism of monetary policy, more attention was paid to management of shortterm interest rates, but within the framework of monetary aggregate targeting with inflation as the ultimate target, broad money as the intermediate target and base money as the operational target. Moreover, the focus of monetary regimes during 1993 to 2004 was on quantity variables like ceilings on SBP NDA and floors on SBP NFA, which is the hallmark of IMF monetary programs. Focus has since then shifted to base money rather than its subcomponents after the successful conclusion of Poverty Reduction Growth Facility (PRGF). Over the years, especially during the last couple of years, practice of monetary policy implementation was broadened to include important indicator variables like the yield curve in addition to several aggregates other than broad money. Furthermore, several steps were taken to make the monetary policy more transparent. Indicative monetary planning, rather than strict credit rationing that used to be practiced prior to 1992, is done under the aegis of National Credit Consultative Council, which still makes the Credit Plan. Intermediate monetary targets are set there consistent with ultimate goals of inflation and real GDP growth. Interest rates were increasingly given more importance because of their superiority in signaling of monetary policy stance, yet within the framework of monetary and reserve money program. Transparency was increased by issuing six-monthly statements on monetary policy. Candid analytical reviews in SBP Annual and Quarterly Reports, not only on the real economy, but SBP’s own monetary policy also added to increased transparency. Recent release of Monthly Inflation Monitor is also a step in this direction. At this juncture, when SBP has established itself as an independent central bank, with a sound banking sector, it needs to carefully review the international best practices of conducting monetary policy. In fact, many good practices are already in place; my predecessor Dr. Yaqub institutionalized internal monetary policy operational consultative process by constituting a committee that drew senior members from the relevant Departments under the Chairmanship of Deputy Governor that met regularly. I enlarged the scope of the committee to coordinate both money market and foreign exchange operations in 2001. Monetary and Exchange Rate Policy Committee meets bi-monthly, reviews the current economic situation together with emerging monetary and exchange rate trends, and forms a recommendation by majority and I then act by again taking views and evolving a consensus. The system is well structured, takes a lot of information systematically into account and can be termed as an eclectic approach to monetary policy implementation, which Mishkin has sarcastically described as ‘just do it strategy’. Nonetheless, system needs continued strengthening, especially when the fad of inflation targeting has spread quickly not only in advance countries, beginning with New Zealand in 1990 and several developed countries during early to mid 1990s, but to several emerging market economies as well, which are not very different from Pakistan in many of economic and social characteristics. Inflation targeting seems to offer a lot of advantages, especially in terms of increasing transparency and credibility of a central bank. However, the evidence of superiority of inflation targeting over other alternatives is, at best, partial. Cumulative experience of countries with inflation targeting is comparatively smaller than the historic experience of other regimes to conclude anything unambiguously. More importantly, monetary policy can not be formulated and implemented in isolation of government policies no matter how independent a central bank is whether of an advance or a developing country. This aspect is of utmost importance for developing countries that still have a relatively weak taxation regime, with lingering suspicion of fiscal dominance hovering most of the time. In Pakistan, the Government does not have a broad revenue base and the domestic financial markets do not have enough depth to absorb placements of public debt. So, although the precondition of Central Bank independence is met for pursuing inflation targeting the other conditions is missing. For example, selection of an appropriate price index itself to define the target is problematic in the choice of exchange rate regimes. As the role of market forces is expanding due to liberalization, deregulation and privatization of the financial sector there are changes taking place in the transmission mechanism of monetary policy also. The redefinition of the regulatory role of the SBP, the revision of the prudential norms, the revamping of the bank supervisory tools, the shift towards automation and electronic banking and financial innovations in products and services are contributing to the emergence of a different financial system. I now turn to the Exchange Rate Regime in Pakistan. Pakistan has adopted the floating inter-bank exchange rate as the preferred option since 2001. SBP has attempted to maintain real effective exchange rate at a level that keeps the competitiveness of Pakistani exports intact. But, like other Central Banks, it does intervene from time to time to keep stability in the market and smooth excessive fluctuations. The managed float has served us quite well as it has conferred a degree of certainty and predictability to the economic agents to make informed judgments about the relative movement of the exchange rate. The accumulation of reserves during the last four years has underscored the credibility of the exchange rate policy and minimized excessive speculative activity. At the same time and until mid 2004 – the exchange rate stability also helped contain inflationary expectations as unlike in the decade of the 1990s when the rupee was depreciating at an average of 120 per cent per year vis-à-vis the dollar, the rupee became strengthened. The current framework of monetary-cum-exchange rate policies and the underlying economic analysis in Pakistan can, thus, be broadly characterized as judgment and discretion based rather than model or rule based. The main justification for the current practice is that the economy is undergoing fundamental structural transformation and thus the behavioral relationships among the variables and the time lags influencing the behaviour are in a state of flux and transition. An added complicating factor is that measuring and predicting expectations about the possible effects of policy changes makes it difficult to model the monetary and financial behaviour in a robust way. Furthermore, the Central Bank’s own credibility is an endogenous variable that affects the outcomes and expectations. A model or rule based framework may, therefore, be inadequate at present to guide the SBP in meeting unanticipated exogenous shocks and managing unforeseen crisis or crisis like situations as our understanding of the empirical links between instruments and targets of monetary policy is incomplete and rudimentary. We must all remember that the recent episodes of financial crisis in the 1990s occurred in countries where inflation was low, fiscal deficits were small or even absent and the public debt burden was at tolerable levels. Models based on the past data missed these episodes as they would have emanated danger signals only if the countries had high current account deficit, unsustainable external debt burden and serious fiscal imbalances or a combination of these. In hindsight, a better way to detect the signs of danger would have been to complement the sound monetary and fiscal policies with flexible exchange rate, better regulations and supervision of the financial sector, greater disclosure, transparency and communication. This could have been possible if the policy makers did not concentrate on mechanistic tools but took a more holistic and broad-based view of the economic variables, their movements and assessed their relative impact on the macroeconomic outcomes. In this perspective, I hope that the present conference will provide a stimulating intellectual impetus to SBP research and policy staff to chart out alternative courses of monetary strategies for the future. It has already been envisaged in the 5-year Strategic Plan of SBP that the current internal Monetary and Exchange Rate Policy Committee will be transformed into a conventional Monetary Policy Committee with decision making powers about altering the monetary policy stance in a transparent manner in future. I am also sure that the papers presented today and tomorrow will also give ample food for thought to journalists and academicians alike who will be listening carefully to form their own views and expectations about future strategy of SBP that is best for enhancing the economic welfare of Pakistan. | state bank of pakistan | 2,005 | 12 |
Keynote address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Islamic Financial Services Forum organised by the Islamic Financial Services Board and the Central Bank of Luxembourg, Luxembourg, 8 November 2005. | Ishrat Husain: Islamic financial services industry - the European challenges Keynote address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Islamic Financial Services Forum organised by the Islamic Financial Services Board and the Central Bank of Luxembourg, Luxembourg, 8 November 2005. * * * Ladies and Gentlemen, First and foremost, I wish to commend the Islamic Financial Services Board and the Central Bank of Luxembourg for organizing this Forum and providing me with this opportunity to share my thoughts and experience with this august gathering. In view of the growing interest in Islamic Finance, it is incumbent upon us to outline the distinguishing features and delineate the unique characteristics that make it attractive to a segment of the consumers and investors all over the world. What is Islamic Finance? There are at least three characteristics which makes it different from the conventional debt finance. First, it prohibits riba or interest, or in other words a fixed and predetermined rate of return to be paid on the deposits or to be received from the borrowers. The rate of return is variable and determined by the profit and loss that the bank makes during a given period and the returns on assets depend on the particular mode and purpose of financing, i.e. Murabaha (trade finance), Mudaraba (profit sharing), Musharaka (partnership), Ijara (leasing), etc. Second, Islamic Finance does not allow undertaking or financing the antisocial and unethical businesses such as gambling, prostitution, alcoholic liquor, nightclubs and narcotics. These are the main channels used for money laundering, terrorism financing and organized crimes, etc. Islamic banks are prohibited from opening accounts or provide financing to persons or institutions involved in such activities. In this respect, it is clearly ahead of the recent surge in ethical finance and socially responsible finance that are becoming quite popular in the Western world. Islamic financial institutions, because of their active involvement and knowledge of the nature of businesses of their clients, are in a better position to detect and prevent the channeling of depositors’ money for financing highly risky but equally remunerative anti-social activities. The financing it provides is mostly asset-based, whereby the Islamic bank knows the actual utilization of its funds. Third, Islamic Finance has to be compliant with the basic percepts of Shari’ah, the legal code of Islam which is based on the principles of justice, fair dealings and harmony through equitable distribution of wealth. Islam is deadly opposed to exploitation of an individual or institution by the other for selfaggrandizement. Riba or usury is considered exploitative by its construct and is therefore prohibited. The equitable distribution dimension of Islamic Finance is therefore an add-on that is clearly absent from the conventional modes of financing. If we examine these properties of Islamic Finance, it becomes apparent that these will appeal to a large number of individuals and institutions whose set of beliefs and faith conform to these principles. It is not necessary that only the Muslims can subscribe to this particular mode of financing but the fact that it is being widely accepted and adopted in different parts of the world including Europe attests to its intrinsic value and strength. Ladies and Gentlemen, The Islamic financial services industry is the fastest growing component of the financial services industry, with an annual rate of growth ranging between 15 to 20 per cent. At least 70 countries all over the world have some or other form of Islamic financial services available in their territorial jurisdictions. It is instructive to note that almost all major multinational banks such as Citigroup, HSBC, BNP Paribas, UBS, Credit Agricole, Standard Chartered, etc. are offering these services. Why are these services spreading so fast? I can think of several possible reasons. First, there are around 15 million Muslims residing in non-Islamic countries in Europe, mostly in France, Germany and the UK. Islamic Finance is effectively contributing towards penetration of financial services and inclusion of this particular target group which previously avoided using existing banking facilities due to their faith. The members of the Islamic community in Europe that was not benefiting from the conventional banking on religious grounds are now participating through this particular mode in conformity with their beliefs. This group naturally provides the scale for the financial services industry to build upon. Second, there are investors who in their quest for diversifying their portfolios are looking for new asset classes, new instruments and new products with low correlation with the existing asset classes or products. Islamic financial products cater to this particular need and have, therefore, become attractive to that investors group. Third, there is a growing trend, particularly among the younger population to show unethical or socially irresponsible investment funds and businesses. Many funds have emerged that are exclusively devoted to meet the specifications of investments in ethical products or socially responsible services. Islamic Finance conveniently fits into this food chain because of its natural affinity and congruence with its end-use restrictions. Fourth, in this world where we have all become increasingly cautious and careful about possible risks arising from money-laundering and terroristfinancing, Islamic financial institutions enjoy a head start in mitigating these risks. Unlike conventional banks which rely on documentary evidence and usually have impersonal, arms-length, passive relationships with the majority of their clients, Islamic banks have more stringent Know-Your-Customer requirements. The reason for this difference is quite commonsensical. Conventional banks rely on a fixed pre-determined return framework and are, therefore less concerned about the character and credibility of their clients. They are often, more preoccupied with the underlying securities and assets. On the other hand, Islamic banks are engaged in a quasi-partnership profit-loss sharing framework and therefore have to know their clients, their businesses, as well as, their sources and uses of funding in order to satisfy themselves about the authenticity and legitimacy of their counterparties. Thus, they would be in a much better position to detect, prevent and disengage quickly from suspicious transactions compared to conventional banks. In addition to normal audits, Islamic banks have to conduct Shari’ah review of their transactions for ensuring Shari’ah compliance. This review will catch any funds mobilized or used for haram (prohibited) activities. This unique feature of Islamic Finance as possible prevention of money – laundering has not yet been widely disseminated and its potential not fully recognized. The Financial Services Authority of the UK, whom I consider an extremely conservative and competent regulatory agency, after considering all the pros and cons, has finally embraced Islamic banking and issued the first ever licence to the Islamic Bank of Britain which is now operational. Further, they have authorized Islamic investment funds which are a welcome move. In Germany, one of the State Governments has raised funds by issuing an Islamic suck. In the UAE, a number of long term infrastructure projects were financed by Islamic financial institutions as the relative advantages of Islamic modes of finance outweighed the costs in comparison to the conventional modes. Naturally, if there is so much rapid growth, a question that should arise in everybody’s mind is: what is happening on the legal, regulatory, accounting and auditing and governance fronts of Islamic Finance? Are these keeping pace with this growth and are we making sure that the supporting infrastructure are in place to avoid any pitfalls or hazards in the future? This is quite a legitimate concern and I would like to share with you as to what is actually happening on these fronts. Ladies and Gentlemen, Several of us – the Governors of the Central Banks of Islamic countries – worked closely with the International Monetary Fund (IMF) for many years and ultimately formed the Islamic Financial Services Board (IFSB) whose headquarters is in Kuala Lumpur, Malaysia. This Body is working on the development of prudent and transparent standards and codes by introducing new or adapting existing international standards consistent with Shari’ah principles. I am sure the Secretary-General of the IFSB would be in a better position to inform you more about the activities of this Body. However, I am satisfied that the work it has initiated through various working groups on Risk management, Capital Adequacy, Corporate Governance, Transparency and Market Discipline, as well as Supervisory Review Process, is proceeding well and we expect the end products to be rigorous and of high quality. This institution, in our view, will economize on scarce expert resources, come up with a consensus view after rigorous debate and research and create uniformity and standardization of Islamic products and services across countries. The second important body which I have also been associated with is the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), which has so far issued over 50 accounting, auditing, governance and Shari’ah standards for Islamic financial institutions. Islamic banking practices are becoming an integral part of the leading accountancy firms of the world – the Big Four – and many other countries and are, thus, being disseminated through their national affiliates and consultancy services. In the last few years, a number of other bodies dealing with different components of the Islamic financial infrastructure have been formed and are beginning to take shape. They are, of course, at different stages of evolution but together they form the necessary complements. The Islamic Development Bank (IDB) must be given credit for taking the lead in establishing the International Islamic Financial Market (IIFM) which is working on the development of liquidity management instruments and markets for Islamic financial institutions and more recently, the International Islamic Rating Agency (IIRA) which will provide credit rating, Shari’ah rating and Corporate Governance Rating to Islamic financial institutions. Ladies and Gentlemen, I now turn to the example of Pakistan where we have vigorously introduced Islamic Banking in its true letter and spirit. We considered it totally imprudent to dislocate the entire financial system by directing substitution of the on-going banking by Islamic banking in one-go by a certain given deadline. Instead, we decided that we should provide a level playing field and afford opportunity for Islamic banking to co-exist with conventional banking. We believed that the choice should be left to the individual consumer whether they would like to switch over to Islamic banking or stick with their existing banks. The endeavor of the government and the Central Bank was to ensure that there was no discrimination, preference – overt or convert – policy biases in favour of one system or the other. If, over time, the majority of the consumers decide to opt for Islamic banking, the whole system will naturally be transformed and the end point will be reached. In our view, it is not the responsibility of the Government or the Central bank to impose their will or dictate choices to the people. We have, therefore, opened up the banking system by allowing: (a) establishment of stand-alone Islamic banks; (b) setting up of subsidiaries of banks for Islamic banking; or (c) setting up of full-fledged Islamic Banking branches of the banks. The initial response has been overwhelming and hundreds of thousands of Pakistanis who had never done any banking in their lives are now asking for more Islamic banks or branches in their areas. In the very first year, Islamic banking segments have captured 1.6% of the total assets of the banking system and the rate of growth is extremely fast. In the basis of the current trends, we project that the Islamic banks will attain about 10% of the market share in the next few years. The State bank of Pakistan has developed a market-based regulatory framework including a high-powered Shari’ah Board to provide guidance on the Shari’ah compliance aspects of the business and regulations. The Institute of Chartered Accountants of Pakistan (ICAP) has prepared accounting standards for Islamic modes of finance which are being implemented. These standards are based on the AAOIFI Standards and are compatible with the International Accounting Standards. We have developed innovative products such as Islamic Export Refinance Scheme in consultation with the Islamic banking industry for it to remain competitive with other banks. Despite these positive developments which I have sketched above, I will be remiss in my duties if I do not put forth the enormous challenges in Islamic Finance and let me tell you there are many. (a) Fund Mobilization: The ways in which Islamic banks can and do mobilize funds are all non-conventional and, in some ways, new to the regulators. Several issues and questions arise in the minds of regulators confronted with the task of supervising and regulating Islamic banks. Some methods for mobilizing funds, for example, would require asset-management instead of the conventional concept of fund management. This is an area where the Central Banks do not have either adequate expertise or much knowledge. (b) Nature of Contracts: The use of non-conventional contracts to offer products for financial services can create a whole range of issues concerning corporate governance standards, sources of new risks and how to manage them, as well as how to make Islamic banks conform to the market discipline already created for conventional banks. For example Risk profiles of some financial products may be quite distinct and do not seem to have been addressed by Basel II. The new dimensions of risk emerge on both assets as well as liabilities sides of Islamic banks’ balance sheet. On the asset side, Islamic banks will use contracts such as Ijarah, Murabaha, Istisna’a and Salam which have more complex implications towards risk management than that of products on the asset side of the conventional banks’ balance sheet. On the liabilities side, Islamic banks will be offering profit-sharing investment accounts to the depositors. These depositors are assumed to share the profits and losses of the bank, but neither fall into the category of the capital of the bank nor can be regarded as liabilities of the bank, in the accounting sense of the term. This raises complications for the formula for capital adequacy and for other indicators and measures. How to make the accounts of Islamic banks to conform to the banking laws of Europe without violating Shari’ah provisions will be a challenge for the lawyers of Islamic banks intending to provide financial services in Europe as well as a challenge to the regulators who will be evaluating the proposals for establishing such banks in Europe. This question is already being examined by lawyers of Islamic banks and regulators in Europe as exemplified by the U.K. The outcome will benefit the rest of Europe. (c) Regulatory Challenges: The regulatory challenges have three main dimensions, as highlighted by the Managing Director of the Financial Services Authority of the US when he spoke at a recent conference in the Middle East: (i) protection of consumers of Islamic Banks; (ii) Transparency (including issues relating to corporate governance); and (iii) Professional competition (in different and distinctive aspects of Islamic banking, in addition to competence in the conventional aspects of banking. Regulators will need to look at profit-sharing investment accounts from the investors’ protection point of view and not merely from the depositors’ protection point of view, as in the case of commercial banking. The application of Islamic modes of financing require Islamic banks to assume at some stage of the ownership of the underlying asset, though in some cases it may be made effective only for an extremely short period (such as in the case of Murabaha-based financing). The ownership of the asset, for whatever period it is assumed, involves bearing the risks associated with the ownership. These risks, of course, can be insured but that will involve additional costs. (The insurance of third party risks could be quite expensive). Firstly, this is an issue of efficiency in providing an alternative product. Secondly, this is also a question of who will pay for this additional cost. If the depositors have to pay for it, it will have implications on the rate of return of their deposits. There will, therefore, be an issue of transparency about all costs and their implication on return for the depositors of the bank and costs to the clients seeking finances from the bank. To conclude, let me say that we have made a modest beginning in several Islamic countries for Islamic Finance to take off. The response so far has been positive and the spill-over effects are being felt in other parts of the world such as in Europe. This gathering is an ample testimony to the interest that is being demonstrated in the Western world. Nevertheless, we should be cognizant of the enormous challenges which we face. However, I am sure that the institutional framework that is being put into place would adequately prepare the growing Islamic financial services industry in meeting these challenges in the future. Thank you. | state bank of pakistan | 2,005 | 12 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual Global Transaction Banking Seminar, organised by Deutsche Bank, Karachi, 3 May 2006. | Shamshad Akhtar: Global transaction banking Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual Global Transaction Banking Seminar, organised by Deutsche Bank, Karachi, 3 May 2006. * * * Let me first welcome the Deutsche Bank global team to Pakistan. Deutsche Bank has been an age-old partner in the development of Pakistan’s banking industry and we look forward to the advice of their global team, and their contribution to supporting the enhancement of global transactions in Pakistan’s banking industry. Today, Pakistan offers a promising ground for financial experimentation and innovation. Pakistan’s banking industry has seen brisk growth in banking assets which today stand at over $60 billion. Bank’s profitability is at an all time high and unprecedented, reaching close to Rs 95 billion by end 2005. Aside from higher efficiency gains in the industry attributable to benefits arising from significant banking sector restructuring and reforms, high profitability of banks has been achieved because of high interest margins. In the period ahead, the financial industry however has to be positioned for a more competitive environment and has to cater for more diverse and complex requirements of Pakistan’s consumers and infrastructure. Pakistan, like the rest of Asia, is growing fast and the rise in per capita income, emergence of the middle income group and relative wealth increases altogether bring with them new demands for the retail banking industry. Among others, both investors and industry are seeking better investments and financing alternatives and solutions, with demand for private debt, asset based and mortgage based securities, credit derivatives and hedge products etc. now emerging from different segments of the economy and population. Beside these real sector developments and requirements, financial industry of Pakistan has to catch up fast with the global developments and achieve better financial diversification and strengthen its risk management systems. In Pakistan’s context, it has to be recognized that while large banks will continue to thrive on volumes of business which they have traditionally captured given their reach across the country, it is the foreign banks with their competitive edge in global transaction banking that can offer unique and new financial solutions and lead the way for the rest of the banking industry to provide to customers an integrated solution that caters for emerging consumer and industry requirements. Global changes in the financial industry Compulsions to go this route are mounting. World-wide, the financial landscape has changed driven by: • Changing macroeconomic factors such as economic growth and demography and institutional development as capital markets have matured and population demands for retirement funding and insurance has grown • The phenomenal growth in financial markets and cross border flows • The ability of the financial industry to take advantage of the opportunities provided by the lending and mortgage markets, and development of credit risk transfer instruments which involve structuring and trading of credit derivatives and asset backed securities that allows risk inherent in a loan to be repackaged into two or three tradable components to offer optimal allocation of risks– this is particularly relevant in the context of developing financial markets where the risk profiles of banks are still dominated by credit risk predominantly of the issuance of loans even though there are moves towards corporate bonds or transactions in over-thecounter markets, which involve the risk of a counterparty defaulting. • Adoption and adaptation of technological advancements in communication and information technology that has seen the explosion of financial innovation with service providers now offering multiple and diverse solutions that enhance efficiency and reach of products across boundaries and across national jurisdictions. • Need to globally integrate financial systems and encourage end-to-end straight through processing capabilities and development of payment, clearing and settlement systems to overcome time zone and currency constraints. • With globalization of markets & businesses, there is greater need for global transaction solutions for effective cash management, trade finance, trust & securities services, and continuous linked settlement. • Finally, there are now mounting regulatory pressures to seeking greater IT solutions to tracking money laundering as well as adopting the new risk management framework including Basle II. Role of the central bank Recognizing that Pakistan’s banking industry subsequent to its restructuring is now positioned to move to the next level of development, SBP has been focusing on promoting gradual migration from a predominantly cash and paper-based system to electronic payments. This has involved on one hand development of the Real Time Gross Settlement (RTGS) system, awareness creation and information dissemination about the role, importance and issues of payment systems and protection of consumer interests. On the other hand, it has involved encouraging banks to invest in technology and improve their payment and settlement system infrastructure, internal controls and move to e-banking. Clearing and settlement systems in Pakistan As a custodian of the Payment System of the country, SBP has nurtured and supervised the operation of the clearing house for the member banks operating within its jurisdiction. Automated Clearing services are now provided by National Institutional Facilitation Technologies (NIFT) under the supervision of SBP in nine major cities of Pakistan. A complete range of conventional clearing services including overnight clearing, same day high value clearing, intercity clearing etc are provided by NIFT. In rest of the business centres the process is manual but would eventually need to be automated. The Local US dollar clearing system provides a low cost and efficient clearing system for US dollar denominated local instruments. The new system has reduced the clearing time of US dollar cheques from three weeks to only four days and has reduced the cost to the account holders. Banks and their branches in eleven cities are fully utilizing this facility. Real Time Gross Settlement Pakistan’s Real time Inter bank Settlement Mechanism (PRISM) is at an advanced stage of installation and is expected to be live by the 3rd quarter of 2006. It will automate the current inter-bank settlement systems for large value payments at SBP and will minimize risks like credit, liquidity and settlement risks inherent in the end of the day settlement system. Its implementation will make the payments system much more efficient and resilient, offering transactional features which are hard to achieve under the current settlement systems. The RTGS system is based on the Society for Worldwide Interbank Financial Telecommunication topology and includes the functionalities of Queue management, Grid Lock Resolution and interfacing with Globus. PRISM will not only automate the Inter Bank funds transfer but will also facilitate the settlement of government securities transactions in Primary and Secondary Markets. After the implementation of PRISM, settlement of securities between the participants will be on Delivery vs. Payment basis thus reducing the risk in securities trading by minimizing the settlement lag. SBP will also be able to settle the open market operation transaction through PRISM. PRISM will also bring more efficiency in intercity and intra-city clearing between the banks as NIFT will handle clearing on multilateral basis and these clearing results will be settled on a real time basis in PRISM. PRISM will also facilitate the commercial banks in making time critical third party funds transfers on behalf of its customers. Payments System and Electronic Funds Transfers Act 2005 To facilitate nation-wide RTGS and electronic funds transfer, Pakistan has now drafted the “Payments System and Electronic Funds Transfers Act 2005” that ensures conformance with industry demands and the Bank for International Settlements Core Principals for Systemically Important Payment Systems. The proposed Act addresses issues like operation of payment systems, including the clearing and settlement obligations of the parties involved, supervisory role of SBP, documentation requirements by the participants, liabilities of parties in payment systems and legal proceedings in case of any conflict, finality and irrevocability of settled transactions etc. The Act also gives necessary legal coverage to PRISM. SBP is also framing the requisite rules and regulations for the smooth operations and participation in PRISM. Progress in electronic payment systems There has been substantial improvement in the payment system infrastructure and consumers’ payment patterns over the last few years, particularly in urban areas, which is evident from the exponential growth in Automated Teller Machines (ATM) Cards, Debit & Credit Cards, ATM outlets, Points of Sales (POS) accepting payments through cards and number of online branches of commercial banks providing SWIFT intra bank account to account funds transfer facilities and the interconnectivity of the two ATM switches viz. the MNet and 1-Link. With the strategic focus of SBP to develop a well functioning and efficient payment system in the country coupled with rapid technological changes, the pace of growth in payment system infrastructure will further accelerate in the medium term and its outreach will extend to even smaller towns. This will enable a larger number of consumers to use the enhanced and extended payment system infrastructure, and will bring greater efficiency and cost effectiveness in the system.Figure 5.1: Growth Online branches network The online branch network is also expanding at a fast pace and reached to 3,265 at the end of Dec 2005 from 2,475 at the end of the preceding year, indicating an impressive increase of 32 percent or 790 branches. The addition of 315 branches into the online network in the fourth quarter is signalling further acceleration in the pace of growth of the online branches. The coverage of online branches as a percentage of total branches (7,245 branches) has now reached 45 percent. At this pace, the whole branches network of the banking system will be online in the very near future, which will substantially improve efficiency of the payment system. Point of sale transactions Usage of cards at POS is expanding with the passage of time. This channel recorded remarkable growth of 62 percent in number of transactions, to 13 million transactions in FY05 from 8 million in the previous year. Value of transactions grew by 56 percent to Rs 42.8 billion in FY05 from Rs27.4 billion in FY04.Figure 5.3: Number of Cardholders Conclusion The GTB concept though newer to Pakistani banks, will help service the ever growing need for Pakistan’s trade & finance and facilitate investors’ awareness to the growing Pakistani economy & markets. We see inter-exchanges like this to further strengthen the transaction banking business in Pakistan. SBP is conscious of the need to further strengthen the payments & settlement systems in Pakistan to reduce inherent settlement risks and bringing efficiency to the financial system. We look forward to global entities, like Deutsche Bank, in performing their due role to facilitate providing awareness & expertise to further strengthen the financial system. GTB will help in providing fully integrated risk mitigation, settlement, financing and information solutions, which help unlock working capital trapped in inefficient order-to-cash and purchase-to-pay cycles. It will also assist businesses to achieve greater integration of the supply chain, which facilitates greater efficiencies and streamlined workflows, whilst reducing operating costs and accelerating payment cycles. More efficient trade processes also mitigate risk exposure and help the businesses optimise returns from trade assets. | state bank of pakistan | 2,006 | 5 |
Inaugural address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Dawn Asia Finance Conference - Asian Banking: A Paradigm Shift, Karachi, 13 May 2006. | Shamshad Akhtar: Financial sector of Pakistan – the roadmap Inaugural address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Dawn Asia Finance Conference - Asian Banking: A Paradigm Shift, Karachi, 13 May 2006. * * * The financial system in Pakistan has grown substantially, benefiting from multi-pronged financial reforms. These reforms have been pursued persistently and vigorously over a decade or so and have supported economic growth. The inefficiencies and weaknesses, which were typical of banks’ operations in the pre-reforms era, have been reduced radically. We have now started to realize the dividends of reforms in the form of a healthier, sounder and stronger banking system. Liberalization and deregulation, core pillars of the reform measures, have served to enhance the size of the banking system both in terms of the number of banks and growth in credit, besides instilling a degree of competition in the banking industry. However, the task of financial sector reforms is far from accomplished. Given the changing dynamics of the economy and its growing complexities and accompanying associated risks, the financial industry has to remain responsive and supportive of the broader economic ambitions and agenda. The country can neither afford slippages nor can we visualize the future dispensation of the banking system of Pakistan. All the major players and stakeholders in the banking system will have to strive for continuity, broadening and deepening of reforms, build and sustain the already implemented reforms and fill the remaining fissures. The growing competition along with increasingly diversified services, both across the regions and sectors, and improved access to customer-base on the back of progressive reliance on technology, are the harbingers of the changing and efficient intermediation role of banks in the days ahead. In order to develop the future outlook, I will now examine both the emerging domestic and external trends, which potentially impact the future financial sector architecture: its structure, texture and the operations of financial institutions. In this respect, eight factors are generally believed to have been the major drivers of change in the financial industry the world over. They include: 1) Macroeconomic performance and priorities 2) Deregulation and market forces 3) Product innovation 4) Globalization 5) Technological advancements 6) Universal banking 7) Risk Management and Mitigation 8) Changing Role of and demands on the Regulator These forces, to a varying degree, will play a more dominant role in shaping the future complexion of the financial sector and its institutions and entail far reaching implications in terms of stimulating increased competition, greater consolidation, increased diversification and enhanced dynamism in the financial players and markets. The central bank, along with major players in the market, will continue to develop and refine the mutual vision and plan for the financial system of Pakistan. All key players will have to correspondingly position themselves, change their attitudes, and be responsive to collectively transform the financial system of Pakistan into a dynamic and efficient arm of the economy. This can be attained if the financial system meets the divergent needs of all segments of the economy by providing a wide array of financial services based on the use of globally competitive technology, highly skilled human resources and harnessing global best practices. Equally critical for regulators, are the aspects of the stability and robustness of the financial system and as such there will have to be further refinements in the domestic regulatory and supervisory framework to align it more closely with international standards, while taking due notice of the attendant and emerging global and domestic challenge and risks. I will now elaborate on the forces and factors which might be directly or indirectly related to the future performance and standing of the financial system of Pakistan. Macroeconomic performance and priorities Financial system of any country has an intrinsic relationship and needs to be shaped in accordance with the broader economic needs, structure and policies. Considering this interdependence, it is imperative to assess the behavior and trends of the key macroeconomic indicators while drawing the emerging contours of the financial system. In this respect, the major indicators of the economy during the last few years have shown robust performance. GDP growth shot up to over 8 percent in FY05 and the current year also promises higher than 6 percent growth. Undoubtedly, consistent and stable economic policies provided the businesses with confidence. However, easy availability of funds on the back of historically low level of interest rates proved to be the real catalyst for the subsequent sharp growth in credit to the manufacturing sector and eventually proved to be the real determinant of high GDP growth. Strong credit demand of the manufacturing sector translated into a sharp increase in the interest income of the banking system, giving rise to unprecedented profits and healthier balance sheets during the last two years. Redeployment of these profits to augment financial services will help meet the growing economic requirements. The near term economic prospects are promising. The continued strong pace of economic activities, and plans to launch widespread infrastructure reforms offer strong business prospects for the financial sector. Real interest rates remain at tolerable limits. Notwithstanding, there will be demand pressures in particular if the trade deficit grows out of proportion and inflationary tendencies continue to persist. A consequent fall in demand for credit or a possible impairment of the debt repayment capacity of borrowers does carry the risk of reversing the current gains enjoyed by the banking system. But these risks are being well managed and if the economy continues the growth momentum for the next decade or so, the financial system of Pakistan is expected to reap benefits out of rising incomes, consumption and emerging investment demands. Traditionally, infrastructure projects fell in the public sector’s domain of activities. However, recent years have seen a paradigm shift in this area, with the growing interest of the private sector to undertake such projects. There exists immense potential for the financial institutions to finance such infrastructure projects built on public-private partnerships or even exclusively in the private sector. This will help diversify their activities as well as enhance their earnings. Similarly, financial institutions can take advantage of the changing demographic patterns, rising incomes and enhancement of policy priorities for various sectors. These trends are already visible as reflected by the increasing proportion of urban population, rising literacy rates, and the increasing share of the industrial and services sectors in GDP. The financing to SME, Agriculture, and Micro finance segments of the economy carries special importance with respect to future economic growth and diversification of banks’ loan portfolios. The State Bank will accord further priority to improving access of development finance to these segments and will work with the provincial and local governments to facilitate a conducive environment, and supportive financial and legal infrastructure to give impetus to economic growth and poverty alleviation. The banks will have to strengthen their systems to meet the challenges and opportunities arising out of their venture into these segments. Deregulation, market forces and consolidation The spate of liberalization and deregulation measures in recent years has unleashed strong forces of competition. These are fast defining the future course of Pakistan’s financial sector. Emerging role of the private sector has displaced the public sector from its dominant position, giving rise to aggressive competition across the market operators, and the market pressure by the stakeholders to perform is going to result in fiercer competition. This is expected to change the business landscape and chemistry of the competition as market players will have to use fresh thinking on financial products and the structure of the market, and focus on value creation to survive. The stiffening licensing policy and regulatory capital requirements are already posing a great challenge to the small banks, and with gradual enhancement of the minimum capital requirements in the coming years, they will have to either inject more capital to become compliant or amalgamate with other financial institutions, or as a last option, exit the market. The current trend depicts that new entrants, only allowed by way of strategic partnership in existing banks and/or new Islamic banks, are coming in with higher capital. More so, consolidation of financial institutions is well underway and is likely to lead to the emergence of fewer but stronger institutions to meet the challenges of the increasingly complicated financial environment of the future. The competitive environment might also force financial institutions to specialize in offering certain types of services based on their respective expertise and market niches. Product innovation In a sharp contrast to international trends, the financial system of Pakistan has been lacking in developing innovative products to meet the diversified needs of different customers. However, the emerging financial scenario characterized by intense competition leaves little room for complacency in developing new and attractive products on both the asset and liability sides. Product innovation and developing brand loyalty by creating specialized products will decide the volumes of business and market shares in the future. Presently, the absence of specialized liability products is most conspicuous. The growing awareness among investors and the expected development of other avenues of funds’ deployment e.g. the long term fixed income and mutual funds market provide attractive alternatives. Thus the financial institutions which take initiative of these kinds are likely to grab greater market share of funds in the future. Ideally, greater liberalization with ensuing competition should have led to a narrowing down of spreads. However, in case of Pakistan, there appears to exist a somewhat paradoxical situation, where banks are able to widen their spreads mainly because they enjoy comparative advantage in offering unique banking services, primarily because of the almost non-existent competition from nonbank finance companies and a dormant institutional finance industry as pension and insurance sector reforms have yet to catch up with other financial sector reforms. However, the future promises emergence of competitive non-bank companies which offer alternative sources of investments. And banks will need to generate fee-based income to fill the gap created by declining interest incomes. Pakistan’s market has a huge room for the development of derivatives and synthetic products. The growing financial engineering of services and products requires greater attention to the hedging of risks. Financial institutions need to increase their role as risk managers to corporate and other entities by offering a variety of derivative products. Financial institutions are also expected to employ processes and practices, which could help them to become more cost effective and efficient. Certain traditional services might also be outsourced to gain efficiency and focus on core areas as competition might not be the only rule of the game. The financial institutions might also cooperate in offering certain types of services. Presently, this is reflected in the networking of ATMs. This co-optation is expected to become the order of the day as banks seek to enlarge their customer base and at the same time realize cost reduction and greater efficiency. Globalization With the falling barriers to capital mobility and opening up of financial services in the wake of WTO, globalization of financial services is expected to accelerate in coming days. As the financial institutions gains size, competitive edge and develop their systems at par with the global practices, it would be profitable to seek greater opportunities offered by the large financial markets around the globe. Particularly, opportunities in emerging and regional future economic power hubs are bright. Moreover, higher trade activities are also likely to give boost to banks’ role in forex business and their support to corporate customers to expand their business across the borders. So far, Pakistani banks have performed fairly well against the foreign banks operating in the country. Lately, under the intense competition put up by the local banks due to significant improvement in their processes, foreign banks have been on the retreat even in the areas where they used to enjoy virtual monopoly. However, with the increasing trade volumes in relation to GDP and growing overseas business opportunities for Pakistani corporates, as well as increasing capital flows, the large foreign banks would find considerable scope to capitalize on their expertise due to their established global position and awareness of different markets around the world. Technology Technology helps to catalyze efficiency in the provision of financial services and ultimately in determining the winners in the intensely competitive financial markets of the future. Technological breakthroughs have forced fundamental changes in the financial industry: strategic business plans have taken into account new ways of doing businesses, launching e-banking, and using information and technology for developing better internal controls, more sophisticated risk management systems and better and convenient customer services. Hence it is critical that Pakistan’s financial industry adopts an appropriate organizational model that supports a customer-centric approach and reengineers business processes to exploit technology to derive economies of scale and create cost efficiencies. The use of ATMs and e-banking products is gaining currency and almost all banks have established networking of their ATMs with the interconnectivity of switches. Better outreach offered by ATMs will enhance the customer base and offer more alternatives and choices to customers. Further development on e-banking and internet banking will open up new avenues like on-line banking. Among others, the relatively smaller size banks will be able to compete with the large banks and retain their market presence by using technology more effectively. Technology tends to have a high degree of obsolescence. Thus, the financial institutions will have to invest heavily in the development of their IT systems, which might initially burden their resources. For this purpose, the financial industry will have to optimize its resources for technology applications. The immediate solution might lie in sharing of facilities. Banks in Pakistan are already cooperating extensively in using ATMs services. The future areas of cooperation might involve payment and settlement, back-office processing, data warehousing etc. At the same time, financial institutions will also have to raise adequate safeguards to deal with the associated operational risks. This would invite special focus of their management in the future. Universal banking Universal banking has gained sharp acceptance as traditional boundaries of financial service provision have become blurred. In addition to their conventional commercial banking services, banks have withdrawn from specialization to offering a broad menu of services. This presents the banks with opportunities as well as challenges and requires constant development of their expertise in the new areas of their operations. The idea of universal banking, which is still evolving in Pakistan, is likely to galvanize the non-banking financial sector in developing competitive products and use modern technology to secure themselves against banks making inroads into their traditional areas of operations. This is likely to give further impetus to competition in the financial sector for the provision of quality financial services. At the same time this might catalyze mergers among banks and non-bank financial institutions for their mutual survival. This trend may lead logically to promoting the concept of a financial super market chain, making available all types of credit and non-fund facilities under one roof or in terms of specialized subsidiaries under one over-arching organization. Consolidated accounting and supervisory techniques would have to evolve and appropriate firewalls built to address the risks underlying such large organizations and banking conglomerates. Risk management The above-mentioned forces of change have significantly increased the importance of strengthening the risk-management practices of the financial system. With the proliferation of new techniques and financial institutions venturing into new areas, a whole range of market related risks have surfaced. This will render the traditional risk-management techniques obsolete as new derivative products and off-balance sheet operations become more common. The hitherto neglected area of operational risk management has also come to assume greater importance and the pervasive use of technology has multiplied the importance of managing this risk in tomorrow’s more volatile banking environment. The financial institutions now have to have enough paraphernalia to tackle these risks in line with the international best practices. In this respect, risk-management tools built upon the latest technology would provide the financial institutions to manage the host of new risks in a more efficient manner. This will enable them to deploy resources more effectively. The importance of sophisticated risk-management practices will become even more pronounced as the banks strive to implement the Basel II accord. The smooth switch over to Basel II will be a challenging task before the banks, and this has far-reaching implications for the future structure of the banking system. Basel II would require a heavy investment in technology and development of MIS tools to incorporate the internal risk-based approach. The risk-based approach to capital allocation will be the inherent theme, as each asset will be allocated a rating both externally and internally. This will ultimately influence the capital charge for each asset and would thus help minimize the reckless risktaking by banks on account of the heavy capital charge. As financial innovation becomes ubiquitous and new technology and standards evolve to make financial transactions more complex and volatile, the role of the regulators is going to become tougher in the days ahead. This brings me to the concluding, but not the least important section, i.e. the changing role of and expectations and demands for regulators. Changing role of regulator The central bank has been transformed substantially. It is today a very user friendly institution, based on feedback of the industry. It is candid in putting forth its views, and over the years has withstood a number of political challenges. Over the next few years, we plan to : First, with the support of the Government, launch adequate initiatives to strengthen the governance of the central bank. In this context, SBP is in the process of benchmarking itself with the other central banks that have attained good governance standards. The evaluation of central banks’ governance practices is judged on the basis of the roles and responsibilities of the Management and the Board of Directors, and the appropriate interaction and interface between the central bank and the government. In deciding an appropriate balance in these roles and responsibilities, it is critical that central bank’s independence is not compromised in terms of the conduct of monetary policy as well as the oversight of the financial sector. In all contexts, it has to be recognized that independence has to be accompanied by effective accountability of the central bank. The institution has to be accountable to the Parliament and the Senate, and work in conformity with the Federal Government’s goals, as the central bank, among other functions, also serves as an advisor to the Government. Second, SBP needs to examine where there is further need for internal strengthening. Few areas where SBP will gear itself further would be in terms of increased responsive to industry changes in order to align prudential regulations accordingly. Among others, SBP needs to be equipped to assess banks when they adopt higher standards of risk management which will be promoted when Basel II is introduced. Another area would be for the central bank to strengthen its oversight and supervision, with particular emphasis on closer supervision of the emerging conglomerate structures in the banking industry as some of the commercial banks are now owned by industrial groups and brokers. Third, in conclusion, the central bank should energize itself to finance the under-served areas, regions and segments. And, the central bank would like to promote the Islamic Banking Industry, as it has the potential to introduce innovations in the market. As part of the reorganization of the central bank, which is currently in process, we plan to set-up a separate department for development finance, which will push for this objective. Having assumed office in January, I am in the midst of developing a strategy for the next ten years of the financial sector, and my talk today presents some ideological thoughts on the long-term vision paper for the central bank, which will be developed in consultation with the stakeholders. We then need to set up an implementation task force, which will be a combined effort of the banking industry and the central bank to take forward these reforms. There has been tremendous change in the banking industry in the last few years and we need to fine-tune our strategic direction as we go forward. | state bank of pakistan | 2,006 | 5 |
Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, as chief guest at the Woodrow Wilson Centre, Washington DC, 24 April 2006. | Shamshad Akhtar: Perspectives on Pakistan’s monetary policy developments Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, as chief guest at the Woodrow Wilson Centre, Washington DC, 24 April 2006. The references for the speech can be found on the State Bank of Pakistan’s website. * I. * * Introduction In line with trends world-wide, Pakistan adopted liberal and market-oriented monetary policies and procedures in the 1990s. This involved a move to indirect tools of monetary policy management and a major departure from the age-old practice of relying on direct interventions, such as liquidity reserve ratios and credit ceilings and controls. Accompanying this policy change were gradual changes to the legal and institutional framework of monetary policy formulation, its targeting and operating procedures as well as development of infrastructure for treasury operation to allow for effective open market operations. These changes have had a subtle but profound impact on monetary management which in turn has impacted economic management of Pakistan. Like in several other places, there however remains a level of ignorance regarding the virtues and technicalities of monetary policy management and there is a debate on some key issues. Academics often question the relevance of policy goals and tools because of their different ideological stances and positioning. Structuralists doubt whether monetary policy has any significant impact, in particular on price stability. Frustrations are also evident among different economic players who are forced to change their behaviors and expectations in line with tighter monetary discipline and interest rate adjustments. There is less understanding and patience for the lagged effects of monetary policy to defuse the inflationary pressures or to ease the liquidity conditions. Recognizing the concerns and debate, Pakistan’s central bank regularly reviews the monetary policy in line with the evolving changes in the structure and workings of financial markets as well as in the broader economic and political environment. Since the mid-1990s, State bank has further strengthened the market-orientation of policy implementation, cut reserve requirements, developed open market operations, increased the flexibility of liquidity management, sharpened the focus on interest rates while maintaining reserve money as the operating target, improved the transparency of policy signals and shortened the maturity of interest rates serving as the fulcrum of policy. I propose to initially provide few perspectives on the evolution of monetary policy, its challenges and practical difficulties in its implementation and then share with you the monetary policy outlook for 2006 and finally lead into a discussion of some of the complications and challenges in the conduct of monetary policy. II. Policy, legal and institutional improvements in monetary management Monetary policy of Pakistan now for some years has been largely supportive of the dual objective of promoting economic growth and price stability. It achieves this goal by targeting monetary aggregates (broad money supply growth as an intermediate target and reserve money as an operational target) in accordance with real GDP growth and inflation targets set by the Government. Qualitatively monetary policy formulation and its implementation has improved substantially, benefiting from the following actions. • First, legislative changes to the State Bank of Pakistan Act has empowered the SBP and SBP Central Board to formulate, conduct and implement its monetary policy • Second, a Monetary and Fiscal Board has been set up to ensure formal monetary and fiscal policy coordination and this Board is currently chaired by the Prime Minister in his capacity as Finance Minister with representation from economic ministries. • Third, the Fiscal Responsibility and Debt Limitation Act 2005 mandates a steady reduction in revenue deficit to zero by 30th June 2008 and maintaining it thereafter, and reducing total public debt to sixty percent of GDP by 2013 and below that limit thereafter. These two principal steps lay the foundation for reducing fiscal subservience of monetary policy that for years served to complicate monetary management and allowed the Government unlimited recourse to low and fixed interest rate financing. • Fourth, SBP continues to refine the institutional mechanism for monetary policy formulation and its regular review. For instance, SBP has replaced the Open Market Policy and Review Committee by the Monetary and Exchange Rate Policy Committee. This Committee meets bimonthly to establish parameters of broad monetary policy and reviews monetary and economic conditions on a regular basis and recommends changes in monetary policy instruments. • Fifth, SBP Treasury's capacity has been strengthened to manage financial markets and related activities more effectively. Proactive conduct of monetary operations and management of market volatility has helped improve market flows. The Open Market Operation (OMO) process has been institutionalized with better flexibility vis-à-vis tenors and frequency. From 1995 - 2005, SBP's monetary operations were focused on T-Bill Auctions and predetermined schedule of weekly OMOs of fixed tenors with no forecasting capability of market liquidity. This resulted in a high degree of volatility in Overnight (O/N) & Shortterm Money Market rates. During 2005, SBP Treasury introduced the Money Market Computerized Reporting System (MM-CRS) for banks which helped in not only assessing the market liquidity, but to improving the grip on market gaps and interbank activity, thus strengthening the market management capability and SBP's forecasting capacity. Between Apr-Dec 2005, not only OMOs have been conducted both ways, but with a greater flexibility of tenors and frequency. Additionally, being active in the Swap Market has helped SBP Treasury to mop-up/inject USD/Rupee liquidity in the money market, as and when required, thus complementing the monetary management. This has resulted in managing excessive market volatility, providing effective signals/direction to the market and to set benchmarks for the rupee inter-bank market in line with the monetary policy stance. Consequently, O/N Rates now move within a 100bp – 150bp range compared to previous trends when it fluctuated between zero to 9.0%. III. Monetary outlook for 2006 and associated challenges. Current fiscal year is an important departure from the preceding few years’ monetary stance and trends observed. After 3-4 years of lax monetary policy, Pakistan faced significant monetary overhang since the growth in broad money supply every year exceeded the growth in nominal GDP. Since the second quarter of 2005 monetary policy was tightened as the headline inflation, measured by Consumer Price Index (CPI), reached close to 11.1 in April 2005 - edging beyond the yearly target of 8% with Wholesale Price Index (WPI) pointing to the risk of moving to double digits. It has to be further recognized that given structural issues, the inflation threshold for developing countries is high inflation in excess of 8- 12% is found to hurt economic growth. 1 To start off, SBP raised discount rate to 9% in April 2005 which generated an uptrend in interest rates on T-bills auctioned and sharpened its yield curve: 3 months Tbill rate rose from 4.3 % Jan 05 to 8.1% by mid April 2006, 6 months 4.3% to 8.3% and one year from 5% in early 05 to 8.8%. Has this monetary tightening achieved the desired results i.e. of curbing inflationary pressures? Latest trends of CPI are comforting but reveal different levels of deceleration across CPI categories and point to lingering concerns whether the deceleration will continue and/or if the decline in CPI and its components is there to stay. Some numbers are illustrative of this concern. • While CPI had dropped to 6.9% YOY by March 2006 (compared to 10.2% recorded in the same month last year) with food inflation falling to 5.4% (compared to 13.3% in March 2005), the level of decline in nonfood inflation has been modest at 8.0% (compared to 8.2% in March 2005). Khan, S. Mohsin and Abdelhak, S. Senhadji: Threshold Effects in the Relationship Between Inflation and Growth. IMF Staff Papers, Volume 48, Number 1, June 2001. • While month to month comparison point to sharper decline in inflation rate, the period average CPI and 12 month moving average CPI are still at 8.2% and 8.6%, respectively which is above the target inflation rate of 8%. • The core inflation (measuring the non-volatile components) however confirms the deceleration in inflationary pressure as core CPI was down to 6.7% in March 2006 relative to 7.6% in March FY05 and the decline is 6.1% (compared to 8.0% in March 2005), if 20% trimmed mean is calculated. IV. Realities and complications facing monetary policy In evaluating the effectiveness of the monetary stance on inflation there is need to recognize some economic realities and complications which eventually help in developing an appropriate policy response. growth and financial development Nexus: MOHSIN S. KHAN AND AXEL SCHIMMELPFENNIG (2005) 2 conclude an inverse relationship between inflation and real per capita Inflation, GDP: when inflation was 8 percent on average during 1978-1991, per capita growth averaged 3 percent but when inflation rose to 11% during 1992 and 1997 real per capita growth averaged only 1 percent and it further recovered as inflation fell to 5 percent. Further this study concludes that “the direct inflation-growth nexus suggests a threshold in the range of 4 to 9 percent, while the inflation-financial development nexus suggests a lower threshold of 3– 6 percent….. Based on this, it is further recommended that SBP adopts an inflation target of 5 percent.” This evidence has been arrived at based on empirical evidence of a number of studies: For instance: • In a panel of 140 countries, Khan and Senhadji (2001) estimate inflation threshold to be 1–3 percent for industrial countries and 7–11 percent in developing countries. • Focusing on Middle East and Central Asian countries including Pakistan, Khan estimates the optimum inflation rate to be 3 percent and argues that policy-makers should keep inflation below 6 percent to avoid a negative impact on growth. • Mubarik (2005) using time-series data for Pakistan from 1973 to 2000 3 finds that inflation in excess of 9 percent harms short-run growth in Pakistan. • Hussain (2005) estimates thresholds of 4–6 percent beyond which inflation adversely affect growth. Furthermore, inflation hurts growth by making financial intermediation costly as high interest rates raise costs and lower long-run real returns for the corporate sector, while introducing adverse selection and moral hazard problems. Lags in transmission mechanism. Empirical evidence indicates that there is a 6-24 months time lag in developing economies in the transmission of monetary policy impact on aggregate demand. In Pakistan, studies point that this lag is in the range of 12-18 months. It is because of this that the tolerance level of the economy for the fairly accommodative and easy monetary policy adopted over FY00-04 was remarkable as inflation remained low over this period with an average level of 3.9%. Admittedly, fiscal borrowing pressures during this period being low also provided scope for private sector credit growth. However, monetary overhang of few years of accommodative monetary policy finally generated inflationary pressures which remained entrenched for some period. Consequent monetary tightening, now in place for over one year, is eventually showing signs of transmission channels working as evident from CPI deceleration. Mohsin S. Khan and Axel Schimmelpfennig: Inflation in Pakistan: Money or Wheat? Paper presented in SBP conference, November 2005. The authors use the Hodrick-Prescott filter to reduce volatility in the data which potentially removes relevant information. Furthermore, in a single country case, the threshold will be restricted to be within the range of inflation experienced by that country. An SBP Working Paper on the transmission mechanism of monetary policy 4 studies the relative importance of four channels through which monetary policy shocks are transmitted in Pakistan. While other transmission channels have yet to fully manifest themselves, banks have been observed to play a major role in the transmission mechanism with private sector credit as the leading indicator. But monetary policy transmission mechanism of this channel is weak because of the low impact of the interest rate channel, and also because the transmission mechanism cannot be developed on the basis of the short end of the yield curve, it needs a spectrum of rates in order to develop further, and the government has kept closed the long-term rate structure by holding off PIB auctions. Going forward, we need to work on strengthening the transmission mechanism by (a) further strengthening the banking sector, and (b) developing the market and the long-term yield curve. Is inflation a structural supply side or monetary phenomena? While supply side factors do play a role in short term, inflation is always a long-term monetary phenomenon driven by demand pressures. Inflation trends follow broad money growth and private sector credit growth closely with a lag of about 12 months and above. Given these factors, (i) SBP monitors CPI food and non-food inflation and (ii) two core inflation indictors that (a) excludes all volatile components and constitutes principally of a non-food and non-energy index and (b) another is derived as 20% weighted trimmed mean. 5 While (i) reflects overall price trends, the main driver for monetary policy is the core inflation. On the supply side, price behavior is impacted by structural impediments facing the agriculture and industry sector which ranges from year to year fluctuations in crops and industrial capacity, distributional problems and sometimes hoarding practices. In Pakistan, supply factors influence 55% of CPI which accounts for three commodity groups (i.e. food and beverages, fuel and lightening and transport and communication) and food alone accounts for 40.3% of CPI and wheat (and wheat flour) has a weightage of 5.7%. Is inflation a fiscal phenomenon. Studies for Pakistan have confirmed that excessive government’s recourse to the central bank for financing fiscal deficit is inflationary in the long-run and complicates monetary management and its implementation. Fiscal deficit has a direct impact on inflation as government expenditure constitutes a large part of aggregate expenditure that might lead to demand pull inflation, and an indirect impact as the fiscal deficit is financed partly through central banks. With the reduction in fiscal deficit in recent years, both the direct and indirect impacts of deficit have been low and headline inflation remained low. Exception to this is FY06 when fiscal pressures have been stronger partly because of the unanticipated earthquake spending but more significant because of the inherent weaknesses in the structure of taxes as the tax/GDP ratio has been low. These trends have interrupted compliance with the Fiscal Responsibility Act. The Act underscores a zero primary balance and a steady reduction in the overall fiscal balance with the objective of reducing Pakistan’s debt/GDP ratio to sustainable levels. Fiscal dominance of monetary policy would remain until the taxation structure is overhauled and there are explicit legal provisions which limit government’s recourse to central bank financing that in turn will induce further fiscal discipline while encouraging mobilizing funding requirements from the market. Legally, SBP has recourse to section 9(A) of the SBP Act which allows the SBP to take a decision, in consultation with the board, on the total government borrowing as specified below: “the Governor may ….. determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the Bank to the Federal Government, Provincial Governments and other agencies …..” Aside from the need for better understanding in this area, issuance of debt securities has the additional benefit of diversifying debt financing sources by encouraging development of the long term debt market in Pakistan. Ahmed, Noor & Hastam, Shah & Agha, Asif Idrees and Mubarik, Yasir Ali (2005), “Transmission Mechanism of Monetary Policy in Pakistan”, SBP Working Paper Series. All CPI items are arranged according to their YOY changes in a given month, 20% items showing extreme changes are excluded with 10% of the items at the top of the list and 10% of the items at the bottom of the list. The weighted mean of the price changes of the rest of the items is core inflation. The impact of monetary tightening on inflation would have been more visible if the government had kept its recourse to central bank financing at manageable levels. Over the last few months, there were concerns that the drift in fiscal management would persist and derail low and stable inflationary trend. 6 The stock of Marketable Treasury Bills held by SBP did rise to over Rs 540 billion but this was brought down to Rs 400 billion as the Government retired a part of its obligations with PTCL proceeds. Minimizing fiscal dominance is a key pre-condition for an efficient conduct of monetary policy and for enhancing central bank independence. 7 V. Medium term outlook In reviewing the monetary policy stance at this juncture, SBP recognizes the potential downside risks to the medium term macroeconomic outlook: • First, international crude prices remain a potent threat to overall price stability. While the pass-through of international crude prices has been managed well so far, further escalations could immediately endanger the fragile balance that currently prevails between the budget management, oil companies and consumers. • Second, portfolio switches and liquidity mismatches that have emerged have produced sizeable volatility in reserve money with an upward pressure on money supply, combined with a shortening of maturity of deposits in the banking system. Demand deposits have grown faster than time deposits and certificate of deposits have become an important source of funding for certain banks. These developments warrant continuous and careful monitoring so as to be on guard against the incipient build-up of potential demand pressures. • Third, continued vigilance is required to examine possible strains on credit quality especially to ensure financial stability and thereby derive synergies with macroeconomic and price stability. • Fourth, the surge in imports has produced a sizeable expansion in the current account deficit in the first half of FY06 despite a significant of growth of exports. Higher oil prices accounted for 28% of the increase in oil bill and 47% of the increase in external current account deficit. Concurrently, there has been high demand for capital goods, raw material and intermediate goods (including fertilizer, non-ferrous metals and iron and steel) and some of this is expected to help in enhancing industrial capacity utilization. Management of external current account deficit pressures and their non-debt financing would be critical for the next few years. Recognizing this, the foreign exchange reserves would be kept at prudent levels to provide cover for six months of imports. • Finally, in view of the upward pressures on aggregate demand including pick up in investment activity, a reduction in the revenue deficit and further improvement in the fiscal deficit will add comfort to macroeconomic management. VI. Inflation targeting Recently, there has been a proactive debate in Pakistan on alternative monetary policy frameworks monetary targeting and nominal income targeting versus inflation targeting. Former is questioned because of an unpredictable relationship between money and nominal income and instability in the demand for money. Advocates of inflation targeting have pointed out to the substantive success across industrialized and emerging market economies of achieving a high degree of price stability. At the same time it is recognized that preconditions for adopting inflation targeting are now evolving in Pakistan, for instance there: Draft Paper on “Is Inflation a Fiscal Phenomenon”, Economic Policy Department, SBP. Akbari, Ather H. and Randukwa, Wimal, “Inflation Targeting in a Small Emerging Market Economy: The Case of Pakistan” and Khalid, Ahmed M., “Is Inflation Targeting the Best Policy Choice for Emerging Economies ? A Survey of Emerging Market Experiences and Lessons for Pakistan.” (i) Exists Legal framework for central bank’s operational independence (ii) Exists Fiscal Responsibility Act which offers an opportunity to impose greater fiscal discipline (iii) Financial sector is growing and has benefited from privatization of banking system (iv) Pakistan is now exploiting domestic and international capital markets Some studies have further recommended that exchange rate would have to be factored in the inflation targeting framework not only to the extent that the inflation forecast is affected by the exchange rate, but also insofar as the SBP may need to adjust the monetary policy instruments to limit the impact of exchange rate changes on other objectives, say, external competitiveness. 8 There are however concerns that preconditions for Pakistan switching to inflation targeting do not exist and that commodity and import prices are a major determinant of inflation in Pakistan, rather than monetary policy. As has been discussed earlier, there is sufficient evidence and grounds that inflation is a monetary phenomenon too and this will continue to prevail more visibly as the economy further matures. Given the risks and vulnerabilities associated with emerging markets which have good growth prospects but remain prone to a series of shocks (oil prices, export prices, droughts, floods, and so on) a move towards adoption of suitably modified inflation targeting would be in order to prevent the drift in headline inflation rate, as well as their potential reverberations. It is this consideration, which is motivating SBP to launch development of appropriate data and models to assess the determinants of inflation and to be able to forecast inflation. Conclusion In the short-term, while pursuing monetary aggregate, SBP will need to maintain its monetary tightening stance and enhance its communication to influence inflation expectations, and counter concerns about the adverse effects of higher interest rates on competitiveness and/or growth. However it is important to note that monetary policy alone will not be able to contain all the rise in inflationary pressures. In particular, there is an urgent need for the government to supplement its administrative supply-side measures with policies to address market structure problems. Inflationary pressures arising from supply side factors respond more to legal and administrative measures, and are less sensitive to monetary tightening. Going forward, SBP will be launching preparatory work on inflation targeting. Among others, it will be important for SBP to explore what is an appropriate index to target, whether some components of the CPI should be systematically excluded from or added to the CPI index, what new statistics and refinements in data (including information on stock market indicators and real estate prices) might be needed for developing model and analytical framework for inflation forecasting. There will be need for introducing supportive legal and regulatory framework which allow for targeting inflation and allow greater operational independence to the central bank, while ensuring that SBP has the desired transparency and communication strategy critical for transition to an eventual adoption of inflation targeting. As discussed in Zaidi (2005). | state bank of pakistan | 2,006 | 6 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Seminar on "Beyond Charity : Commercial Opportunities in Micro and Small Lending", jointly organized by USAID and Shore Bank International, Islamabad, 6 June 2006. | Shamshad Akhtar: Development of microfinance Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Seminar on “Beyond Charity : Commercial Opportunities in Micro and Small Lending”, jointly organized by USAID and Shore Bank International, Islamabad, 6 June 2006. * * * Ladies and Gentlemen, let me welcome you all to the one-day international seminar on “Commercial Opportunities in Micro and Small Business Lending”, jointly organized by USAID and Shore Bank International. The seminar comes at the heels of a ‘pro-poor, pro-employment’ budget 2006/07, which has a special allocation of Rs. 10 billion for the Khushhal Pakistan Fund, in addition to employment generation schemes. Pakistan has enormous potential for the development and exploitation of the microfinance industry. At the onset, the concept of Microfinance as a tool and mechanism for poverty alleviation needs to be well understood. It refers to the provision of a whole range of financial services to lower-income people, especially the poor, who can use the funding to finance their businesses, acquire household assets, improve consumption, invest in health and education and fund emergencies and social obligations. Its definition has to be broad based to include micro-credit 1 for tiny informal businesses and micro-entrepreneurs who are provided loans and a range of savings products and transfer services. 2 A range of options exist to intermediate microfinance which goes beyond NGOs, and includes commercial banks, state-owned development banks, financial cooperatives, and a variety of other licensed and unlicensed non-bank financial institutions. Setting aside the broader framework for microfinance, it is important to recognize that Pakistan is a late starter in developing the microfinance industry. There is a lot of work ahead to promote and systematically develop this sector. At the same time, it is important to note that Pakistan’s microfinance industry has followed a conventional route and has taken some significant initiatives to set on course the development agenda for microfinance. Moving away from the traditional reliance on nationalized banks to finance small farmers (which were seen as the primary universe in terms of being eligible for micro-credit) and the few NGOs which provided a range of special rural support or special urban slum targeted programs, Pakistan has now entered a new phase of microfinance development. The country has witnessed a wave of experimental programs. Sequentially, some sponsors promoted a number of foundations e.g. the Kashf Foundation program modeled along the Grameen Bank of Bangladesh, the Taraqi Foundation and the Damen Foundation. Other major initiatives include setting up of donor led apex arrangements such as the Pakistan Poverty Alleviation Fund (PPAF) and the Microfinance Sector Development Program (MSDP) which promotes the development of the microfinance policy framework while funding select institutions through foreign exchange credit lines. Subsequently, State Bank of Pakistan took a more holistic approach towards the development of the microfinance industry by developing the (i) policy, legal and regulatory framework of the microfinance industry, and (ii) promoting diversity and sustainability in the microfinance business. All such businesses are licensed and supervised by the State Bank of Pakistan and have to comply with Prudential Regulations for Microfinance Banks (MFBs). Today, along with the traditional NGO based programs, Pakistan has about six MFBs of which 2 have been in operation for around 4-5 years whereas four have been recently licensed with one MFB having been licensed a week or two back. In tandem, there is a formally recognized Pakistan Microfinance Network (PMN), which is self regulated. PMN members are a mix of the banks, leasing companies and focused financial services agencies along with the conventional NGOs that offer services to special segments of the society and community. Average microcredit loan balances tend be below per-capita national income. Insurance is an important financial service that is often unavailable to lower-income clients and can therefore also be considered to be a component of ‘microfinance.’ However, insurance involves different regulatory issues that are beyond the scope of this paper. It is estimated that all told, 40 Microfinance Institutions (MFIs) operate in Pakistan out of which 19 institutions are members of PMN which capture almost 99% of the MFIs market. Today, this network offers over 400 outlets of which 308 are branches of PMN members, besides which there are 92 MFIs with 145 service centres. Cumulatively the outstanding loans of these institutions are no more that Rs 3 billion and deposits of Rs 6.6 billion of which the bulk is so far intermediated through PMN members. Unlike some countries, Pakistan has lifted prohibitions and limitations on the participation of foreign equity holders (or founders / members in case of NGOs), borrowing from foreign sources, and employment of non-citizens in management or technical positions. This should go a long way to help set up businesses on modern lines and will also bring with it the necessary experience and technological support for this industry. While development is underway, it is important to recognize the challenges we are beset with. Of principal concern is the low coverage of Microfinance services. The Microfinance institutional framework currently supports barely 600,000 active borrowers. Existing coverage of the formal microfinance sector is only 10% of the estimated 6 million households in need of Microfinance. The requirements clearly are above these norms as currently one fourth of the population of Pakistan is below the poverty line. Another feature is the high concentration across institutions, in lending and among clients. Khushhali Bank and PMN provide the bulk of the services given their edge in starting business early on. But these institutions have only provided lending facilities without adequately tapping the deposit base of their clients. Also, their lending profiles reflect a degree of concentration in select regions and sectors. As of March 2006, 41% of loans distributed by the MFBs are for agri-inputs, 24% for livestock, 26% for small enterprises and 9% for other purposes. This is because Khushhali Bank which accounts for the bulk of this business is rural focused. An analysis of gender-wise loans granted reveals that 84% of borrowers are male. Average loan size of MFBs is Rs 9,300. The microfinance business further faces difficulty in accessing alternative sources of investment particularly equity investment - which is a world wide problem. Knowing how to conduct micro-businesses is an additional challenge in Pakistan given its low financial and accounting literacy. The newly licensed institutions will not only help in diversifying the institutional risk and provide better coverage, but also introduce the much needed competition in this area. SBP has further developed the legal framework for microfinance institutions. MFIs are governed and regulated by the MFIs Ordinance, 2001, the promulgation of which resulted in a paradigm shift in the microfinance industry, and has laid the foundation for the systematic growth of the sector. Microfinance is now seen as a major tool for eradicating poverty. MFIs’ paid up capital requirements are lower than commercial banks at Rs 250 million, 3 and to promote flexibility and innovation, SBP has adopted international standards in establishing requirements for capital adequacy, maximum loan size, credit and operational risks, KYC norms etc. The Finance Bill for 2006 now includes the long awaited amendments and refinements in the MFI Ordinance of 2001. Among others, the amendments; (i) empower SBP to introduce flexibility and broadening of Microfinance Institutions to include Microfinance Banks, (ii) give SBP flexibility in the determination of CRR and SLR with a flexible monitoring system, (iii) provide SBP the option of determining the definition/threshold income level of the poor, (iv) strengthen provisions to introduce explicit clauses regarding licensing of new MFIs, separate licensing requirements for existing NGO-MFIs, new start-up MFBs as well as improving provisions related to suspension of licenses, (v) bring in line with SECP guidelines on corporate governance, the terms of external auditors and extending period of submission of accounts, and (vi) strengthen regulatory powers of SBP. These amendments are quite far reaching, are in line with the stakeholder’s demands and hold the promise of providing the desired level of flexibility both at the regulatory cum supervisory level, while For provincial level MFB. The minimum requirements are Rs 100 million for district level, 500 million for national level. easing constraints of the industry. Microfinance Institutions will now be able to tailor their products to meet the needs of their customers as they move along the prosperity continuum. The amendments have also made it possible to increase the business viability and diversity of institutions by the emergence of Regional Microfinance Banks that might obtain license for five adjacent districts with the prescribed minimum capital requirements. 4 The enhanced regulatory powers of SBP are aimed to ensure proper regulatory and supervisory oversight of the licensed MFBs. The amendments would also help improve the corporate governance of microfinance banks to become socially responsible and financially sustainable institutions. As an additional feature, mobile banking guidelines have been designed to facilitate MFBs to penetrate their target market. SBP has issued NGOs/Rural Support Programs/Cooperative Transformation guidelines. Fit and proper criteria has been laid down for CEOs and Management of MFBs. Guidelines have also been issued for commercial banks interested in engaging in microfinance business. Some unfounded myths often complicate the development and understandings of microfinance. Recognizing this, in Pakistan we need to encourage a paradigm shift in the rapidly evolving operating environment for the microfinance sector. ¾ First, there is a need to move away from subsidization of microfinance services to commercialization of such financial services. This, among others, involves looking beyond the government or donor subsidized credit delivery systems to self sufficient institutions providing commercial finance. Bank Rakyat Indonesia (BRI) and Bolivia's fini institutions BancoSol, both leaders in the microfinance revolution, are good examples among others to study what it means to be a financially self-sufficient microfinance institution. Both banks provide wide outreach to low-income clients, encourage commercialization, and both have been profitable. BRI finances its loan portfolio with locally mobilized savings; and BancoSol finances its loans with savings, commercial debt, and for-profit investment. In both institutions, the relationship between sustainability and outreach is emphasized. ¾ Move from single to multiple products is key to financial and social sustainability of microfinance industry. There are three basic microfinance products: loans, savings and insurance; Loans • Mostly short term working capital • Larger loans for fixed assets • Housing Savings • Mostly compulsory savings used a loan guarantee as protection to the lender. Most microcredit operations and MFIs cannot mobilize deposits without a license from the Central Bank. Member societies can mobilize savings from their members. • Savings are often a more appropriate financial product for the very poor than credit. This implies working with formal financial sector institutions, ROSCAS 5 and member societies. Insurance • Loan insurance is most common. • Common ways of providing loan insurance are: • purchased by the borrower when taking a loan as a percentage of the loan; Rs. 150 million. Rotating Savings and Credit Associations • establishing an emergency fund in village banks, community loan associations and other groups; and • compulsory savings. ¾ Third, financially sustainability of microfinance is contingent on recognizing that the credit has to be priced effectively. The administrative cost of delivery, disbursing and collecting a micro or tiny loan portfolio is much higher in comparison with conventional loan portfolios. So the borrowers end up paying interest rates that are substantially higher than the rates banks charge to their traditional borrowers. According to a recent ADB study, the nominal interest rate charged by MFIs in the Asia region ranges between 30-70% (on reducing balance) which is excessively high given that the inflationary trends are relatively low. The key to reducing costs is to introduce market competition, innovation and efficiency. Further, MFIs should disclose their effective interest rates to loan applicants on standard guidelines. The mandated discipline of disclosing effective interest rates may help micro lenders in focusing on steps they can take to increase their efficiency and thus lower their rates. ¾ Fourth, options to enhance the access to credit for the lower income group can be augmented by the combination of credit bureaus and statistical risk-scoring techniques. In the context of Pakistan, simpler solutions involve verification based on the national identity card (NIC) or new technology popularly adopted by NADRA i.e. thumbprint readers and retinal scanners. When MFIs begin to compete with each other for customers, overindebtedness and default will rise sharply unless they have access to a database that captures relevant aspects of their clients’ borrowing behavior. ¾ Fifth, Know Your Customer, Educate and Give Voice to Clients. MFBs/MFIs need to know their customer, know their market and design products to fit the financial requirements of the people they serve. The design of products is based on the financial requirements of the household and the economic activities the household supports. Successful MFIs are responsive to the market. They listen to their customers. To conclude, it is important to recognize that recent initiatives and developments in Pakistan’s microfinance sector are impressive and there is enormous potential for the industry to expand and for the population to exploit these financial services to their benefit. The outreach of these institutions has grown recently, albeit at a slow rate, and the numbers and beneficiaries remain much below our requirements as well as the standards prevailing in other developing countries. | state bank of pakistan | 2,006 | 6 |
Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the US Chamber of Commerce, Washington DC, 20 April 2006. | Shamshad Akhtar: Economic transformation of Pakistan Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the US Chamber of Commerce, Washington DC, 20 April 2006. * * * Abstracting from year to year changes, structural changes in Pakistan’s economy have been significant and across the board. What is impressive is that these structural changes have been achieved despite the complications generated by shocks such as rising international oil prices. Pakistan is heavily import dependent and higher prices of oil alone accounted for 28% of the increase of import bill for and 47% of the increase in the current account deficit during July-Feb FY06. The structural reforms are already showing visible results and have set in motion an economic transformation in different segments. In my talk today I propose to: I. • First highlight some of the key structural changes, which I believe would be key drivers of change and hold promise for future economic prospects. • Second, I would like to share some perspectives on monetary policy and financial sector reforms, which have played their role in rejuvenating the economy. • Finally, I would be highlighting some emerging issues and challenges that the Pakistani economy faces which we propose to tackle to ensure the sustainability of economic growth and reforms. Structural changes: production, trade and markets First, in the agriculture sector it is encouraging that producers have responded positively to the increased access to market credit, and reforms encouraging private sector participation have led to pricing advantages in major crops, and contributed to growth in the non-farm sector (e.g. livestock and dairy). As a result, the growth of both farm and non-farm activities has gathered pace. Second, growing demand, led by improving credit access and export supportive polices, has enabled industry to achieve full or higher level of capacity utilization in a number of critical sectors – e.g. textiles, cement, steel, automobile, paper and paper board, etc. New capacity will soon be on-stream in a number of areas. Third, the services sector is emerging as a vibrant industry, which is not only contributing directly to real GDP growth, but is also supporting the productive sectors’ performance. Fourth, Pakistan’s trade openness, as measured by the trade/GDP ratio – an indicator of global integration – has risen from 25.8% in FY00 to 31.7% in FY05. More significantly, Pakistan, while maintaining its edge in textiles has managed to diversify its export structure with the non-textile share in exports having grown from 35% in FY00 to 41% by FY05 reflecting a shift from agriculture and primary commodity exports to labor intensive, higher value added manufacturing exports. Within the textile sector, share of the medium to high value-added products (knitwear, bedwear, ready made garments, towels and synthetic textiles etc.) has improved. Pakistan has stood to benefit from the post MFA regime. Sale of a number of strategic industries, with management control, will over the next few years help improve efficiency of critical public services. In the short term, resources mobilized through the sale of these assets have helped augment foreign reserves, while reducing government debt obligations both have positive consequences. Stock market of Pakistan has outperformed expectations in terms of growth in the KSE index and equity prices are at an all time high. Besides speculative trading, this significantly manifests growing corporate and banking sector profitability and restoration of investor confidence. Non-debt flows, close to $7.6 billion, have now emerged to be a sizeable source of funding; these include remittances of $4.2 billion, privatization proceeds of $1.6 billion, and foreign portfolio investments of $1.8 billion. Debt dynamics are favorable and foreign exchange reserves adequate. Exchange rate has been stable but allowed to free float to correct for appreciation as and when it emerges because of movements in relative prices and currency movements of Pakistan’s trading partners. II. Development of monetary policy formulation and its implementation Economic performance has benefited from a highly supportive and accommodative monetary policy. Aside from continued financing of the budget, the low interest rate environment over the last four years helped facilitate a sharp growth in private sector credit from Rs. 18.3 billion in FY00 to Rs. 438 billion by end FY05, providing higher level of financing to the manufacturing and agriculture sector, while catering for consumer and personal loans, and trade and commerce financing. Consequently, broad money growth exceeded nominal GDP growth and fuelled aggregate demand pressures that translated and manifested itself in a sharp rise in inflation, which reached 11.1% by April 2005. Anticipating continued and further build up of these pressures, the central bank raised the discount rate in April 2005. Continued monetary tightening over the past 12 months coupled with the decline in net foreign assets (triggered by a rise in trade deficit) would result in the containment of monetary expansion relative to FY05. Notwithstanding the 1.5% rise in discount rate in April 2005, domestic demand pressures remained high as both private sector credit and government borrowings remained strong. SBP’s continued monetary tightening and government’s supply side interventions to curb shortages of key products has together helped weaken inflationary pressures (built up since late 2004) with headline CPI declining from 9.3% on YOY end June 2005 to 6.9% in March 2006, and core CPI coming down from the range of 7.0-8.0% during Jun FY04-Oct-05 to 6.7% by end March 2006. It is expected that the CPI inflation rate would be in the range of 7.7-8.3 percent in FY06. Underlying these trends is the expectation that (i) monetary policy will remain tight, (ii) domestic fuel prices will not rise further in the remaining months of the fiscal year, and (iii) supply of essential products would be managed effectively. Monetary policy, its conduct and transmission mechanism has also benefited from the structural transformation of the economy and the banking system, which forms a significant component of the financial system. What is appropriate to acknowledge is that the central bank’s independence in monetary management has been respected despite the resistance to interest rate hikes. And that the dividends of interest rate adjustments are visible since inflationary trends have shown a persistent downtrend since the beginning of January 2006. Most encouraging is the fact that interest rate adjustment and its transmission mechanism has started to work. SBP has increased its interventions to ensure that the short term inter-bank market rates remain close to the discount rate. The higher inter-bank market rate, tight liquidity conditions and demand for credit have increased the weighted average lending rate by close to 200 bps over July-February FY06. While private sector credit remained robust, it rose by 18% relative to over 25% in the preceding year. Overall impact of this would be more visible but for high recourse of the government to SBP financing. Fiscal dependence on SBP generates inflationary pressures and deters growth of the long-term government securities market priced in line with the prevailing yield curve. III. Transformation of the banking system Process of modernization of the banking system is well underway as there is no scope for complacency in Pakistan after the tremors and economic losses caused by the Asian financial crises in 1997/98. It has to be recognized that Pakistan’s banking system has witnessed a sea change: (i) In terms of size, structure and ownership, the banking assets doubled over CY00-05 reaching Rs 3,649 billion (over $62 billon) by end-CY05. Around two thirds of the banking system is with local private banks and 9% with foreign banks, while the share of public banks has been scaled down to approximately 20% by end CY05, relative to 50% at end CY00. Interestingly, while foreign banks have a low deposit base, foreign shareholding of banks is quite significant, spread across 8 banks that account for 42% of the deposit base. Large foreign presence would facilitate adoption of international norms and practices and expose Pakistan’s banking industry to e-banking etc. (ii) Banks declared unprecedented profits in CY05 close to Rs 95 billion before tax and Rs 64 billion after tax, relative to losses of Rs 4.5 billion (after taxes) in CY00. Aside from the gains of a relatively high interest environment, banks benefited from an increase in the volume of business (especially increase in lending activities which are well supported by fee-earning activities), improvements in operational efficiency and better risk management (that helped contain administrative costs and loan infection). (iii) Banks have managed to contain their credit risk at prudent levels, with the Net NPLs to Net Loans ratio at 2.4%, and gross NPLs to advances ratio at 9.0% for the overall banking sector. Among the various categories of banks, foreign banks have the lowest levels of NPLs and domestic private banks are second in ranking. (iv) Concentration in size and ownership structure is prominent. 5 Large banks account for over half of the deposits and assets and remaining is held with smaller banks. The consolidation of the banking system generates efficiency and economies of scale as long as high system risks are well managed. (v) Cross shareholding among banks and other financial institutions and the ownership of banks by big business houses and other segments of financial industry pose regulatory challenges for banking supervision where individual and group risk exposures in family owned banks need closer monitoring. From a development perspective the key factor that the Pakistani banking industry has to work towards is enhancing access and improving financial intermediation, stimulating domestic savings, and broader financial innovation in services and products. Undoubtedly, banks have realized high profits by maintaining sizeable spreads and keeping deposit rates low, while charging higher interest on lending. There is no doubt that the spreads of the banking system have been high, but with the growing demand for credit and liquidity constraints on the margins, banks are having to pay higher deposits rates. With growing competition, it is expected that banks will need to tighten their spreads and offer better returns to depositors, while launching efforts to reduce the administrative costs to maintain their profitability. IV. Conclusion Effective economic management and liberalization together have helped Pakistan achieve a fair degree of economic stability, while setting the stage for economic restructuring and industrial development. However, preliminary results for FY06 outcome do highlight some short-term risks and vulnerabilities. The fiscal deficit is expected to exceed target in FY06, because of the unanticipated earthquake spending and continued stagnating of the tax/GDP ratio, despite enhanced tax collection. Simultaneously, the external current account deficit will be over 4.0% of GDP as the trade deficit is likely to reach $6.8 billion with import growth outpacing the rise in exports (even though exports will reach new record levels). While about one-fourth of the trade deficit stems from the rise in oil prices, the broad based growth in imports of machinery, capital goods and raw material augurs well for fresh investments and enhancement of industrial capacities. Import dependence seems inevitable as Pakistan needs to raise its investment levels and expand and diversify its industrial base and capacities. Going forward Pakistan plans to raise its investment in infrastructure and human resources, as shortcomings in these areas are now hurting Pakistan’s industrial and export competitiveness. | state bank of pakistan | 2,006 | 7 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Adam Smith Institute, Thun, Switzerland, 27 June 2006. | Shamshad Akhtar: Pakistan – economic outlook and prospects Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Adam Smith Institute, Thun, Switzerland, 27 June 2006. * * * Economic turnaround of Pakistan has been remarkable and impressive. This is more obvious if one keeps in perspective (i) the context of the pre-2000 scenario when un-sustainability of macroeconomic imbalances and debt threatened medium term economic prospects; (ii) the fact that achievements and gains have been realized in the midst of economic complications caused by high oil prices, growing global and regional competition both for investment and trade and the fiscal consequences of the earthquake that rocked north-Pakistan in 2005; and (iii) that Pakistan opted to graduate from IMF’s structural adjustment program and has since designed its own economic policies, steered their implementation and addressed effectively emerging challenges. Aside from reducing and restructuring its external debt in a short period, the Government’s resolve to unleash Pakistan’s real economic potential has, within a period of 4-5 years, strengthened the country’s fundamentals and has improved its medium term economic outlook and prospects. Sequentially, I propose to discuss: (i) key features of this success story (ii) structural reforms that have helped this turnaround (iii) medium term economic prospects and challenges Economic turnaround – its key features and structural shifts FY05 was a record year for Pakistan. Its economic growth at 8.6% surpassed the average economic growth of 8.2% recorded for emerging Asia. Backed by significant across the board growth in all productive sectors, this growth has been primarily consumption led. Aggregate demand pressures were at an all time high as the per capita income grew and public had easy access to low interest credit for almost 4 years in a row. Four fold increase in remittances inflow since FY01 also contributed to strong demand. Pakistan’s growth has trickled down as the poverty head count ratio declined to 25.4% relative to 32.1% in 2001 and the unemployment rate also declined to 6.2%. The macroeconomic imbalances remained at manageable levels despite fiscal pressures, and the external current account registered a deficit relative to surpluses achieved in the preceding year. The higher aggregate demand manifested itself in the build up of inflationary pressures and CPI rose to 9.3% in FY05 – more than double the average inflation rate recorded in the preceding 4 years. Prudent economic management has helped change the dynamics of external debt since FY00. Pakistan’s external debt and liabilities fell by $ 1.3 billion – down from $37.9 billion in FY00 to $ 35.8 billion by end-FY05 as it prepaid expensive debt and a part of debt was written off. The combined effect of this debt reduction and greater prudence in fresh borrowing coupled with GDP growth, helped reduce the external debt and liabilities/GDP ratio to 32.5% by end-FY05 relative to 51.6% in FY00, and external debt and liabilities as a %age of foreign exchange earnings declined to 134% relative to almost 300% in FY00. Aside from the decline in external debt, the external debt burden also fell as a consequence of the real cost of borrowing. With the pace of foreign exchange earnings gaining momentum, the country’s debt carrying capacity grew. At the centre of all these developments was the pursuance of prudent monetary, fiscal and exchange rate policies. Against this background, S&P has revised its outlook on Pakistan: B+/Positive/B to B+/Stable/B for foreign currency, while keeping BB/Stable/B rating for local currency. Pakistan returned once again to the international capital markets earlier this year and the sovereign bond issue was oversubscribed. This reflected investor appetite for long term sovereign paper which was tightly priced relative to the earlier two issues: a $500 million 5-year Eurobond in February 2004 which was priced @6.75% implying 370 bps spread over US Treasuries and a Sukuk for $ 600 million issued in January 2005 carrying a yield of 220 bps over the six-month LlBOR. The benchmark set for Pakistan sovereign paper is expected to help Pakistan’s firms with stronger balance sheets to turn to the international capital markets for raising their financing requirements. This has already been contemplated as the Oil and Gas Development Corporation plans to float a Global Deposit Receipt soon. Enabling policies Fiscal responsibility: To promote fiscal stability and sustainability, the Government promulgated the Fiscal Responsibility and Debt Limitation Act 2005 in June 2005 which encourages a steady reduction in revenue deficit to nil by 30th June 2008 and maintaining it thereafter and reducing the total public debt to sixty % of GDP by 2013 and below that limit thereafter. Sound fiscal management helped Pakistan reduce its overall fiscal deficit, from an average of 7% of GDP in the 1990s to around 4% in recent years. Although the deficit levels are higher than what is desirable this reflects the strains of (i) the recent loss to the budget of the Petroleum Development Levy (PDL) as the oil price increase has not been passed to the domestic consumers, (ii) the low tax/GDP ratio, even though tax collections in nominal terms have been higher, and are expected to support a modest increase of 0.4% in the tax/GDP ratio for FY07, (iii) higher transfer to provincial governments, (iv) unforeseen spending on earthquake, and (v) determination of the Government to raise both infrastructure and social expenditures which for some time were not raised in real terms. Despite these fiscal strains, key structural changes are notable. Aside from near elimination of the revenue deficit, prudent fiscal management has helped reduce the share of interest payments in the total outlay from 33% in FY02 to 17.6% in FY05 – a 15 percentage points decline in just four years. This in turn helped achieve primary surplus. In wake of these developments the public debt burden continued to decline to 62.5% of GDP from 84% in FY00. Over the medium term, greater fiscal sustainability can only be achieved if there are more substantive tax reforms which extend the tax base beyond the corporate and professional tax payers. It is with this intention that the Government has now started to tax the financial services industry, though the agriculture sector and other services remain outside the ambit of the tax regime. Monetary policy now for some years has been largely supportive of the dual objective of promoting economic growth and price stability. It achieves this goal by targeting monetary aggregates (broad money supply growth as intermediate target and reserve money as operational target) in accordance with real GDP growth and inflation targets. The fiscal responsibility legislation and central bank’s mandate to formulate, conduct and implement its monetary policy combined to somewhat help reduce the fiscal subservience of monetary policy. With the rising inflationary pressure in FY05, the central bank raised its discount rate by 1.5% to 9% in April 2005 and maintained its tight monetary stance by conducting frequent Open Market Operations (OMO) to manage liquidity, while minimizing the volatility in overnight rates. The policy stance has yielded results as headline CPI has reduced by 1.4% to 7.9% in FY06, in line with the annual target of 8%. Like other developing countries where transmission mechanisms are not immediately obvious or efficient, it takes well over a year or more for high interest rates to curb the credit growth. Thus far while credit growth has decelerated, it remains fairly robust as demand pressures from both public and private sector remained high during the course of the year. Consequently, it is no surprise that while food CPI decelerated as the Government eased constraints by allowing imports of essential products (sugar, cement and selected pulses) and enhanced its distribution mechanism, the core inflation (excluding volatile components of CPI i.e. food and energy) is 7.1% for FY06. Although the rate of passthrough from the higher prices of energy and other commodities to core consumer price inflation appears to have remained relatively low, the cumulative increases in energy and commodity prices have been large enough to account for the recent inflationary pressures in core CPI. Anecdotal reports suggest that the labor market in Pakistan is tight. While labor productivity remains low, the wage increases will generate additional pressures. Over the medium term, managing inflationary expectations and perceptions and designing an appropriate monetary stance, which aligns economic activity with the economy’s productive capacity, will remain a challenge. Financial sector reforms: Consistent with trends observed in growing Asia, structural changes in financial markets have been remarkable and significant. First, a word on the financial sector’s scope and scale: - Financial assets grew by 70% over the past five years and in CY05 reached Rs 5.1 trillion ($ 85 billion), equivalent to 80% of GDP; - The banking sector grew at a faster pace relative to non-bank sectors and accounts for 71% of the financial industry assets; - Market capitalization of the stock exchange grew steadily and recently peaked at 44% of GDP relative to 10.3% in June FY00 Latest Financial Sector Assessment for Pakistan and the Banking Sector Review 2005 1 , which will be released by July 2006, together lend comfort that: (i) Banking sector profitability (after tax), at over $1 billion, is at an all time high and the return on assets (after tax) increased to 1.9 % in CY05 2 from 1.2 % in CY04; surpassing the relevant international benchmark. The rapid growth in profits also resulted in considerably higher return on equity (after tax), which improved to 25.8 % 3 from 20.3% in CY04. (ii) Falling NPLs to loans and net NPLs to net loans ratios improved to 8% 4 and 2.1% 5 in CY05 respectively. (iii) With strong profits, declining NPLs and fresh capital injections, the solvency position of the banking system strengthened further. Capital adequacy ratio (CAR) increased to 11.3 % 6 from 10.5 % in CY04. (iv) Despite losing some momentum in FY06, the overall performance of the corporate sector, which is the major user of banks’ funds, remained satisfactory. While the banking system has grown significantly in strength, credit growth in a high inflation and a rising interest rate environment could pose a potential risk if the debt burden on banks’ borrowers exceeds their capacities and potentially erodes their repayment capacity. So far, the exposure and default rates on advances to the consumer, SME and agriculture sector has been manageable as the risk management systems within banks have improved significantly. Greater disclosure requirements, strengthened corporate governance structure and Credit Information Bureau, which now provides access to the credit reports of all borrowers, irrespective of the loan amount, are all effective risk mitigants. Pakistan is now embarking on the next phase of financial sector reforms which would focus on: (i) Further consolidation and restructuring of the banking sector; (ii) Strengthened risk management; (iii) Developing capacities to cater for unmet requirements of special segments of the economy and diverse needs; (iv) Diversification of the financial sector by further development of the securities and debt markets, which while fairly vibrant, need to play a more significant role in meeting the country’s financing requirements; and (v) Promoting financial product innovation. Trade liberalization has been underway steadily. With lifting of quotas and abolishment of several special and industry specific regulations, all goods are today freely importable and protection granted in the past to the domestic industry has been lifted. Maximum tariff rate has been reduced from 120% Annual publications of State Bank of Pakistan 1.7% for Q1-CY06 21.5% for Q1-CY06 8.1% for Q1-CY06 1.9% for Q1-CY06 11.6% for Q1-CY06 in 1985 to 25% since FY01 and tariff bands have been reduced from 42 to 4. Almost half of the imports enjoy zero to 5% tariff and the simple average tariff is now only 8.5% on dutiable & exempt imports taken together and the SRO regime has been reduced to a bare minimum. The trade policy aims to promote exports, which despite reaching $16.5 billion in FY06 relative to averages of $7-8 billion over early FY00, have to make more inroads to raise their share in world markets. Pakistan is launching a stronger drive to revive its exports which can only grow on a sustainable basis if there is (i) sufficient surplus to export, (ii) if there is product, sector and geographical diversification combined with value addition through capacity building and enhancement, (iii) textile industry which contributes close to 60% of export earnings positions, repositions itself to withstand new competitive forces emerging in the post quota regime, and (iv) the cost of infrastructure, which is still suffering from bottlenecks, is improved. Medium term economic prospects and challenges High growth rates can be sustained. Pakistan being at the crossroads of one of the ancient trade routes of the world and being richly endowed with natural resources has enormous potential and has shown increased resilience to withstand economic shocks both domestic and external. The economy is set to grow at around 7% in FY07. In FY06, despite set backs to agriculture and the industrial sector, the buoyancy in the services sector helped real GDP to grow by 6.6%. Structural changes underlying the real sectors, albeit slow, are emerging. In agriculture, it is worth mentioning that Pakistan attained self sufficiency in major crops a long time back. Notwithstanding, disruptions in production are inevitable given the uncertain weather conditions as well as low yields which require far reaching efforts in research and extension and appropriate use of inputs that have benefited from the rise in agriculture credit and fertilizer input use. More exploitation of water resources is critical to ensure timely supplies of water. In agriculture, significance of livestock, poultry and dairy products is visible and encouraging. The former accounts for 46.8 % (FY05) of agricultural value added and about 10.7 % of the GDP, while providing livelihood to one third of the population, and the latter produces 28 billion liters of milk a year, whose value is more than that of the combined value of wheat and cotton. Although the manufacturing sector grew at 18% and 15% respectively in the preceding two years, decline in its growth rate is notable. The performance of this sector is impacted by some of the structural issues typical of Pakistan’s manufacturing sector. Manufacturing sector is now beginning to slowly diversify and modernize itself. Presently, almost three-fourths of the production stems from the large-scale manufacturing sector. The key contributor is the textile and apparel group, though chemicals, petroleum, engineering, tyres and tubes, fertilizers, cement, and automobile and durable white goods are adding capacities and are likely to boost industrial production. SME Policy and enhanced flow of credit for this segment would eventually enhance the linkages of this sector. Macroeconomic sustainability: After a consistent reduction in macroeconomic imbalances over FY00-04, the fiscal and external current account deficits have been above targeted levels for FY06 and are likely to be in that range in FY07. Most notable is the concern regarding trade deficit that is to range around $8.2 billion in FY06. 7 Almost 45% of the increase in trade deficit for FY06 stemmed from the rise in import bill for crude oil and petroleum products. Demand pressures are likely to grow further as the Government accelerates social and infrastructure programs, and segments of population and businesses benefit from the FY07 fiscal package. Infrastructure sector programs, while ambitious, are absolutely needed as businesses are set to grow, capacities are being enhanced, new industries and sectors are being opened up and development of industrial parks and additional EPZs are in the offing. After a span of price stability, Pakistan continues to face inflationary pressures that emerged in late 2004 in response to an accommodative monetary policy. Thus far effective monetary management and administrative measures to ease product supplies have controlled inflation which is now well within single digits. With demand pressures expected to grow, SBP will continue to pursue monetary tightening but there will be need to strike an appropriate balance between promoting economic growth As reported by Statistics Department, State Bank of Pakistan and price stability. Over the medium term, Pakistan is well positioned to deal with these emerging trends effectively. While the consumption demand would remain high, there are strong indications that investment has picked up – though perhaps not fully captured by national accounts statistics. Rising investment demand is confirmed by: First, the rise in gross fixed capital formation over the last two years by 29.6% in nominal terms and by about 9.8% in real terms. This has raised investment levels to Rs 1.42 trillion, equivalent to 20% of GDP and is likely to result in a reversal of the declining trend observed in the preceding years. Private investment accounts for two thirds of the gross fixed capital formation. Second, the rise in imports, which, excluding crude and POL products, grew by 35%. Third, the rise in private sector credit which, while decelerating, still grew by 19% in FY06 despite rising interest rates. Fourth, foreign direct investment flows, excluding privatization proceeds, also contributed to the rise in investment. Finally, high corporate profits have largely been reinvested in industry and there is a high degree of self financing taking place. Furthermore, the Government is confident that all spade work undertaken in the last few years will now pay off as approved or lined up industrial and infrastructure investments take off. The Medium Term Development Framework (MTDF) anticipates a rise in the investment/GDP ratio of 20.7% by 2010. Early indications are that both domestic and foreign investors are upbeat about the future prospects, and there are already investment commitments lined up from Gulf states. During its economic transition, Pakistan will have to develop capacities to tolerate and finance the required level of trade deficit as fresh investments will bring in additional import demand. Over this period, leveraging non-debt foreign flows will be critical to finance and sustain the external current account deficit. Growth prospects for Pakistan are fairly promising. Sustainability of investment trends would, among others, depend on Pakistan’s success in improving the business climate by removing investment constraints, continuity in financial reforms coupled with strong vigilance of credit growth, and success in curbing inflationary pressures and tendencies within manageable levels. The World Bank report ‘Doing Business in 2006’ has placed Pakistan amongst the leading economic reformers of the world and the top one in South Asia. For foreign businesses, investing in Pakistan not only facilitates production but also provides opportunities to export to the Middle East, and Central and South Asian markets. To attract investment, Pakistan has fully liberalized its incentives framework. All economic sectors are open to foreign investment, foreign investors are allowed to hold 100% foreign equity in all economic sectors, barring very few exceptions, and there is equal treatment given to local and foreign investors with flexibility to easily remit Royalty, Technical & Franchise Fee, Capital, Profits, Dividends etc. No Government sanction is required for setting up any industry, in terms of field of activity, location, and size. Tourism, housing and construction sector, computer software and information technology (IT) have been declared as industries and provided a set of tax incentives. | state bank of pakistan | 2,006 | 8 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Society Dinner, London, 21 June 2006. | Shamshad Akhtar: Pakistan’s financial services sector – a future perspective Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Society Dinner, London, 21 June 2006. * * * Poised to continue on its high-growth trajectory, Pakistan has now joined the league of emerging economies. The economic turnaround owes its origin to two principal factors: (i) persistent political and macroeconomic stability which has helped restore investor confidence and attracted domestic and foreign capital; and (ii) the ongoing financial sector development and transformation which has helped meet the growing financing requirements of the productive sectors, while generating consumption demand that turned out to be the main driver of economic growth. Consistent with trends observed in growing Asia, structural changes in financial markets have been remarkable and significant. First, a word on Pakistan’s financial sector’s scope and scale: - Financial assets grew by 70% over the past five years and by end-CY05 reached Rs 5.1 trillion, equivalent to 80% of GDP. - Banking sector grew at a faster pace relative to non-bank sectors and currently accounts for 71% of the financial industry assets. - Market capitalization of the stock exchange has grown steadily and recently peaked at 44% of GDP relative to 10.3 percent in June FY00. Second, a word on the qualitative change and improvements in the financial sector. The liberalization and deregulation of the financial sector has helped transfer the banking sector’s majority ownership to the private sector. This has helped to reorient the sector, which is continuously changing and restructuring itself in the wake of enhanced domestic and external competition as Pakistan’s economy is rapidly integrating itself with global and regional markets. There has been exceptional growth in the profitability and efficiency of the financial services industry. This, among others, has induced a degree of institutional diversification as evident from: (i) the growth of equity markets that, given their high returns, has attracted foreign portfolio flows; and (ii) proliferation of a wide array of non-bank financial institutions which provide a range of financial services such as leasing, investment banking and fund management, and offer Islamic instruments such as modarabas and musharikas. The changing characteristics and complexion of the financial sector, its dynamism and growing strength has catalyzed economic transformation. In FY05, real GDP growth rose to 8.6% supported by double digit growth in large-scale industry which has met domestic requirements and has generated an exportable surplus which facilitated almost doubling of the exports to $16.5 billion in FY06 relative to $7-8 billion in the preceding decade. Normally real sector development precedes the development of the financial sector, but strong credit growth in the wake of a low interest rate environment in the last few years helped Pakistan stimulate economic activity. Consistent and stable economic policies enhanced business confidence. In the absence of alternative sources of funding, businesses relied heavily on banks to finance their needs. Growth in advances coupled with gradually rising interest rates has provided a unique opportunity for banks to generate unprecedented profits and redeployment of these funds in the banking and economic system has helped strengthen banks’ balance sheets and continue to meet the growing economic requirements, respectively. After having achieved high economic growth, the key question posed to the Pakistani economic-policy makers is how sustainable is this high economic growth path? Some even contest that the economy is showing signs of overheating. This debate is triggered by few emerging trends which are typically observed when economies are set to achieve new heights of growth. Economic sustainability is being questioned on the grounds that: (i) Pakistan’s growth has been primarily driven by growth in real consumption expenditure – this is partly true but is also a manifestation of rising per capita income that in FY06 is around $850, and higher remittances inflows that have now reached close to $4.1 billion. (ii) After a consistent reduction in macroeconomic imbalances over FY00-04, the fiscal and external current account deficits have been above the targeted levels for FY06 and are likely to remain in that range in FY07. Most notable is the concern regarding trade deficit which is around $8.2 billion in FY06. 1 Around 45% of the increase in trade deficit for July-May FY06 over the comparable period in the preceding year is on account of the rise in import bill for crude oil and petroleum products, 39% due to higher imports of machinery, 11% because of iron and steel and 14.3% for food and fertilizers. (iii) Government is offering a renewed and aggressive fiscal stimulus in FY07, but as is well known, Pakistan has no choice but to accelerate social and infrastructure development and offer relief to certain segments of population and businesses to sustain its economic achievements. Infrastructure sector programs while ambitious are absolutely needed to meet the growing demands in the economy as capacities are being enhanced, new industries and sectors are being opened up and development of industrial parks and additional EPZs are in the offing etc. (iv) After a span of price stability, Pakistan continues to face inflationary pressures that emerged in late 2004 as a by-product of an accommodative monetary policy. Thus far effective monetary management and administrative measures to ease product supplies have controlled inflation which is now well within single digits. With demand pressures expected to grow, SBP will continue to pursue monetary tightening but there is need to strike an appropriate balance between promoting economic growth and price stability. Over the medium term, Pakistan is well positioned to deal with these emerging trends effectively. While consumption demand would remain high, there are clear indications that investment has picked up – though perhaps not fully captured by national accounts statistics. Rising investment demand is confirmed by: First, the rise in gross fixed capital formation over the last two years by 29.6% in nominal terms and by about 9.8% in real terms. This has raised investment levels to Rs 1.42 trillion, equivalent to 20% of GDP and is likely to result in a reversal of the declining trend observed in the preceding years. Private investment accounts for two thirds of the gross fixed capital formation. Second, the rise in imports which, excluding crude and POL products, grew by 33%. Third, the rise in private sector credit which, while decelerating, still grew by 23% in FY06 despite rising interest rates. Fourth, foreign direct investment flows, excluding privatization proceeds, also contributed to the rise in investments. Finally, high corporate profits have largely been reinvested in industry and there is a high degree of self financing taking place. Furthermore, the Government is confident that all spade work undertaken in the last few years will now pay off as the approved or lined up industrial and infrastructure investments take off. The Medium Term Development (MTDF) anticipates a rise in the investment/GDP ratio of 20.7% of GDP by FY10. Early indications are that both the domestic and foreign investors are upbeat about the future prospects and there are some investment commitments lined up from the Gulf states. During its economic transition, Pakistan will have to develop the capacities to tolerate and finance the required level of trade deficit as fresh investments will bring in additional import demand. Over this period, leveraging non-debt foreign flows will be critical to finance and sustain the external current account deficit. Sustainability of investment trends would, among others, depend on Pakistan’s success in improving the business climate by removing investment constraints, continuity in financial reforms coupled with strong vigilance of credit growth, and success in curbing inflationary pressures and tendencies within manageable levels. The latest Financial Sector Assessment for Pakistan and the Banking Sector Review, 2 which will be released by July 2006, together lend comfort that: (i) Banking sector profitability, at over $1 billion, is at an all time high and is generated by the enhanced business volume, the rising share of high-yield assets and widening spreads, on the back of the lagged impact of rising interest rates on deposits. Non-core activities also made valuable contribution. Resultantly, the return on assets (after tax) increased to 1.9% from 1.2% in CY04; easily surpassing the relevant international benchmark. The rapid Provisional figure, Statistics Department, State Bank of Pakistan. Annual publications of State Bank of Pakistan growth in profits also resulted in considerably higher return on equity (after tax), which improved to 25.8% from 20.3% in CY04. (ii) Falling NPLs to loans and net NPLs to net loans ratios improved to 8 percent and 2.1 percent respectively. (iii) With strong profits, declining overhang of NPLs and fresh capital injections, the solvency position of the banking system strengthened further. Capital adequacy ratio (CAR) increased to 11.3% from 10.5% in CY04. The core capital to risk weighted assets (RWAs) ratio also improved to 8.3% from 7.6% in CY04. Both these ratios comfortably satisfy the generally acceptable benchmarks for wellcapitalized banks. 3 (iv) Despite losing some momentum, the overall performance of the corporate sector, which is the major user of banks’ funds, remained satisfactory. (v) The exposure of banks to the households increased at a fast pace carrying it to more than 12% of total outstanding private sector credit. The low default rate remained the prominent feature of lending to households. While the banking system has grown significantly in strength, rapid expansion in loans during the past few years in the midst of high inflation and a rising interest rate environment could pose a risk, if the debt burden on banks’ borrowers exceed its limits and potentially erode their repayment capacity. So far the exposure and default rates on advances to the consumer, SME and agriculture sector have been manageable but potential losses in view of high credit risk cannot be ruled out. In a stark contrast to past practices, the risk management systems within banks have improved significantly. The greater disclosure requirements, strengthened corporate governance structures and the enhanced capacity of SBP’s Credit Information Bureau, which will allow access to the credit reports of all borrowers, irrespective of the loan amount, all contribute as risk mitigants. Nevertheless, banks’ classification strategies of their liquid assets portfolio contributed to increasing the liquidity constraints. Loans to deposits ratio, an important liquidity indicator, also increased to 70.2% from 65.9% in CY04. Market risk, dominated mainly by interest rate risk, also depicted increasing concerns. While the upward movement of interest rates started to erode the value of banks’ investment portfolio, especially the proportion held in longer-term securities, investments in capital markets garnered precious capital gains due to the rise in the stock market index. The absence of any fresh issue of long-term paper gave rise to heightened uncertainty regarding the future movement of interest rates, and market displayed greater interest in short-term paper leading to a significant rise in the banks’ holding of MTBs. Despite these positive results, Pakistan can ill-afford to be complacent. With an average credit growth of 30% over the last three years, and the rapid diversification of banks’ loan portfolios, there is need for vigilance in the future. Recognizing this, Pakistan is embarking on the next phase of financial sector reforms. Broadly, this would involve reforms that would focus on: (i) Further consolidation and restructuring of the banking sector; (ii) Strengthened risk management (iii) Developing capacities to cater to unmet requirements of special segments of the economy and catering to diverse needs; (iv) Diversification of the financial sector by further development of the equity and debt markets which, while fairly vibrant, need to play a more significant role in meeting the country’s financing requirements. (v) Promoting financial product innovation Furthering consolidation and restructuring of the banking sector Following the privatization of banks, today almost two-thirds of the banking sector consists of local private banks and 9 percent is owned by foreign banks; consequently the share of the public sector For a well-capitalized bank the capital adequacy ratio should be above 10%, tier 1 to capital to RWA ratio and capital to total assets ratios should be above 5%. banks has been scaled down to around 20 percent, from 50 percent in CY00. The net effect of the liberal licensing policy and consolidation is that today Pakistan has 39 banks (down from 46 in 1997). Excluding the five large banks, of which the largest bank is government owned, there are around 20 banks among the remaining 35 banks, which together hold a mere 9 percent share in the banking system. While large banks are improving their performance and converging on bottom-line performance indicators under increased competition, small banks are gradually losing ground because of the lack of scale and operational efficiency. Enhanced competition and the need to substantially grow the lending portfolio to remain commercially viable would eventually pose problems of existence for small banks. Recognizing the system risk, SBP has stiffened its licensing policy and regulatory capital requirements and has increased the paid up capital requirements for banks to $100 million. 4 Positioning themselves accordingly, a few banks have injected fresh capital or amalgamated with other financial institutions to meet these requirements. A wave of mergers and amalgamation has become a business reality in Pakistan and over the last five years, 21 financial institutions have been merged / acquired. This has involved a buy-in of foreign banks by the local banks, merger of smaller banks and DFIs, merger of investment banks with commercial banks and so on and so forth. In order to eventually have a stronger banking system, Pakistan is striving for further consolidation of the banking sector and it is with this in mind that the SBP has approved in principle additional five strategic mergers: 1. Standard Chartered Bank (SCB) is acquiring Union Bank which had sometime back acquired Bank of America and Emirates International Bank. Following this SCB will emerge as a local subsidiary 2. Merger of Rupali Bank Pakistan operations with and into Arif Habib Rupali Bank 3. Merger of Atlas Investment Bank with and into Atlas Bank Limited after its acquisition of Dawood Bank Ltd. 4. Merger of Habib Bank AG Zurich Pakistan operations with and into Metropolitan Bank 5. Merger of PICIC and PICIC Commercial Bank Going forward, SBP’s strategy is to allow new entrants by way of strategic partnerships with licensed banks and to encourage additional mergers and acquisitions. This will help evolve a stronger and robust banking system to meet the challenges of the increasingly complicated financial environment. The competitive environment might also force financial institutions to specialize in offering certain types of services based on their respective expertise and market niches. Government shareholding is still significant in about 11 financial institutions including 4 larger banks, few joint ventures, and DFls. Barring joint ventures, the Government is in the process of offloading its shareholding in larger banks through the stock market. Aside from restructuring and selling of the Industrial Development Bank (IDBP), SBP is working with specialized financial institutions and the provincial government to also reduce their shareholding in provincial banks. Developing capacities to meet requirements of the underserved markets SBP has been quite proactive in developing the prudential regulatory framework for the SME and microfinance sectors. Even though access to credit has improved, there are still outstanding issues of inequitable distribution of credit to the sectors and segments which remain underserved. With rapid economic growth in the country, there are plenty of opportunities available for these sectors to grow, the key issue is to provide an enabling policy environment, improve delivery and outreach of banking services to far flung area, and resolve collateral issues. In order to improve the access of financial services to these sectors, the State Bank is in the process of setting up a Development Finance division dedicated to serve as an interface with the industry and improve access of credit to various districts and provinces. SBP has also been instrumental in the amendment of the legal framework for microfinance. These amendments are quite far reaching, are in line with the stakeholders’ demands and hold the promise of providing the desired level of flexibility Under the regulations, Banks were required to increase their capital base to Rs2.0 billion by end-CY05, and further to Rs6.0 billion in a phased manner by end-CY09. both at the regulatory cum supervisory level, while easing constraints of the industry. Microfinance Institutions will now be able to tailor their products to meet the needs of their customers as they move along the prosperity continuum. Going forward, development finance is a high priority area for the central bank. Strengthening risk management SBP has instituted an all-embracing framework viz. the Institutional Risk Assessment Framework (IRAF) to further strengthen the existing supervisory mechanism and to mitigate the variety of risks banks are exposed to. The framework envisages a collaborative and seamless supervisory focus amongst various supervisory departments within SBP to ensure cohesive and proactive monitoring of risks within banks and DFIs. The framework, being highly technology driven, provides for the timely flow of information and enables SBP to institute more efficient and effective banking supervision and continuous monitoring both on the part of SBP and the financial institution themselves, integrating off-site surveillance, on-site examination and current market information. Further, considering the importance of a forward looking approach to risk management, SBP has instituted a framework of stress testing. The framework is based on single factor sensitivity and regression based analysis. Under the single factor sensitivity analysis, exposures of all banks towards five major risks i.e. interest rate risk, credit risk, real estate price risk, equity price risk and exchange rate risk is assessed after subjecting the underlying risk factors to unusual but plausible shocks. These exercises have helped considerably to assess overall risk exposures as well as structural vulnerabilities in banks that could trigger potential externalities and market failures. Besides, in order to inculcate sound risk management practices among the banks and DFIs and to make the stress testing exercise more effective, consistent and focused, SBP has issued guidelines on stress testing. These guidelines contain a framework for regular stress testing, the technique and scope of stress testing along with methodologies and calibration of shocks. Encouraging greater depth and breadth in equity markets Pakistan’s Stock market has been the best performing market in the region. The Karachi Stock Exchange (KSE) share index – that stood at 1,507 points at the end of the year 2000 – reached record levels by 17 April 2006 at 12,274 points with market capitalization being close to $57 billion, or equivalent to 44% of GDP. In recent weeks, the stock market has experienced substantial volatility and has declined to under 10,000 points. In a vein similar to global and regional exchanges, there are different interpretations and conflicting stories regarding the current volatility in equity markets. Aside from rising global interest rates and uncertainties regarding US economic data, the fall in share prices in the regional markets is being attributed by some to “overdue correction” and by others to rising domestic inflationary pressures or other macroeconomic concerns. In case of Pakistan, there is no one explanation for the oscillation in share prices which after a decline seem to be re-bounding – with almost 1,174 points being added on one day in one go. Besides the standard pre-budget euphoria and reaction to a modest increase in the turnover tax on shares and the perceptions relating to the removal of capital gains tax scheduled to be phased out by 2007, there is a view that this volatility is a manifestation of structural weakness in the front line regulator i.e. the stock exchange, overleveraging of the market, and margin calls which triggered heavy selling, uneasiness with delays in the settlement of the continuous funding system (CFS) which is expected to be modified and eventually be replaced by margin financing to do away fully with badla – a form of short selling – tightening of some regulations, introduction of universal identification number for brokers etc. SECP has launched a probe of short and blank selling and has proposed measures to boost investor confidence by tightening the risk management practices at the stock exchanges, addressing issues of netting of open market positions across three markets, mark to market profit/loss, etc. Barring these aberrations, the stock market has been exceptionally buoyant benefiting from the (i) increased investor confidence in economic policies and high corporate profitability, (ii) increased supply of scrips augmented by privatization of large government owned companies such as the recent additions to the market of issues of the Pakistan Telecommunication Corporation (PTC), Muslim Commercial Bank (MCB), and the large issue of a power project, namely the Hub Power Company (HUBCO), which has been actively traded (iii) renewed interest of a large number of buyers of shares, (iv) bright prospect of reaping dividends and capital gains, (v) foreign portfolio investments and (vi) continuous efforts to strengthen the legal and regulatory framework of the ,securities markets. The events in equity markets not only provide an opportunity for self correction of overvaluation but also will help strengthen the governance of the exchanges. The stock market is expected to further receive a boost from the continued implementation of the privatization program, issuance of GDRs by OGDC – a large utility company – and as the banking sector offloads more of their shareholding to markets, and companies initiate IPOs to meet their financing requirements. To restore investor confidence, the regulator is encouraging systematically the strengthening of the governance of exchanges by restructuring of Boards and appointment of independent management, encouraging the demutualization of exchanges, while strengthening risk management systems that have involved the introduction of T+3 settlement and circuit breaker limits, proper capital adequacy for brokers etc. Investor confidence will be further enhanced as the Code of Corporate Governance has been incorporated into the listing regulations of stock exchanges, there is enhanced vigilance to check undisclosed trading and front running, and effective enforcement mechanisms are implemented. Efforts are underway to achieve market development through the introduction of stock futures, over-the-counter market and online access for Internet trading and over the period phasing out of badla with CFS and eventually margin financing to provide funding to leveraged investors. Pakistan has set up its first fully automated National Commodity Exchange which plans to introduce trading in derivatives, mainly futures contracts in commodities starting with gold contracts and later to expand to agro-commodity contracts such as cotton, rice, and wheat. Riding on the strength of the stock market boom and in response to the rising demand for investment avenues among retail investors, mutual funds in Pakistan have more than tripled in the last few years. The industry’s combined net asset value stands at Rs125 billion as of end-June FY05. In parallel, there is need to launch pension and insurance reforms which would eventually help impart long term liquidity to equity markets. As a beginning, the Government is encouraging the Voluntary Pension Schemes and allowing Asset Management Companies and Life Insurance Companies, meeting the fit and proper criteria, to be licensed to act as Pension Fund Managers. Life insurance companies would be authorized to offer Annuity Plans at the retirement age of the participants. For insurance businesses, stringent solvency standards have been introduced and minimum capital requirements have been enhanced. Insurance companies have also been directed to obtain reinsurance treaties from the international “A” class re-insurers. Takaful rules have been issued to allow for Islamic insurance products. Promoting product innovation In Pakistan, though derivatives have been a relatively new concept until recently, the derivative volume has increased manifold amidst the changing market and regulatory environment. In response to the evolving market dynamics and in order to develop an Over the Counter (OTC) financial derivatives market in the country, SBP issued Financial Derivatives Business Regulations in November 2004. Prior to this, banks were allowed to undertake the business of financial derivatives after getting specific approvals from SBP. However, with the issuance of these guidelines, the banks/ DFIs, besides meeting the eligibility criteria specified therein, also obtain Authorized Derivatives Dealer (ADD) or Non Market Maker Institution (NMI) status from SBP; have been allowed to undertake derivatives business. The grant of such status is based on the capacity of the applicant to undertake derivatives transactions based on both onsite and offsite analysis. At present, three banks have been granted the status of Authorized Derivatives Dealer. The regulations allow three types of transactions viz. Interest Rate Swaps (IRS), Forward Rate Agreements (FRAs) and FX options. During the last one year, derivative transactions have grown substantially owing to the growing interest of the market players. Resultantly, the derivatives players in OTC derivatives market reported outstanding derivatives contracts with a notional value of Rs 115.5 billion as of March FY06, a measure that has grown manifold compared to Rs14.5 billion in March FY05. Most of these derivative transactions were under the IRS category. So far, foreign banks have been quite active in carrying out derivative transactions as the major chunk of these transactions lies with such banks. As for the FX options, around Rs 18 billion have been booked with major currency being the Euro against the US Dollar. Most of the IRS have been undertaken by the foreign banks with both their corporate and financial sector clients. Since FRAs are essentially short term in nature, outstanding FRAs stand as nil. Whilst the banks can undertake derivative transactions both for hedging and market making, most of such transactions were assumed for hedging purposes up till now. However, with greater sophistication of the market, the transactions for the latter are also expected to grow in future. | state bank of pakistan | 2,006 | 8 |
Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the International Conference of Young Presidents Organization, Lahore, 4 November 2006. | Shamshad Akhtar: Pakistan – changing economic and social paradigm Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the International Conference of Young Presidents Organization, Lahore, 4 November 2006. * * * Pakistan’s economic diversity and potential, its geography and strategic location and rich cultural heritage together offer this country a unique positioning. A confluence of international and domestic political events, however, has often been highly disruptive on a short term basis. Rather than dwell upon history, I will focus on what lends us confidence today that Pakistan is set to reach new economic heights and frontiers. Pakistan has on all fronts achieved development paradigm shifts – impact of some of it is distinctly visible and more is yet to unfold. On ideological front, leadership has been infusing high degree of moderation, nationhood and tolerance. On economic front, aside from changes in numerology by way of rise in GDP prompted by growth in industry and services sector supported by telecom growth, promising are the significant qualitative changes in macroeconomic management and sector level reforms. Political transformation is steadily emerging as democratic institutions and governance structures are asserting themselves. Pakistan is now in the league of emerging markets moving from low income to middle income state and on social side there is a growing awareness that we need to leverage younger population more effectively through social and human resource investment. Achievements and gains however cannot be a cause for complacency as Pakistan has a long road ahead to achieve economic, social and political sustainability. I firmly believe that the process of change and evolution does not end here as Benjamin Disraeli once famously said: “In a progressive country change is constant; change is inevitable” Exploiting further Pakistan’s economic potential promises to bring the remaining one fourth of population out of poverty and raising living standards as growing economy generate more jobs. Economic prospects depend crucially on Pakistan accelerating the pace and implementation across the board of economic reforms, and positioning itself to face growing global and regional competition. Infrastructure shortages which given domestic resource constraints can only be effectively addressed if foreign investors come forward more aggressively. Pakistan has most liberal economic environment and offers opportunities for exceptionally high returns be it banking, corporate, infrastructure or agriculture sectors. In my presentation, I propose to talk about what has finally triggered the development paradigm shifts and discuss major initiatives undertaken to bring about the economic, social and governance transformation in Pakistan. A qualitative change in economic management has induced a degree of macroeconomic stability providing opportunities for real structural changes. This has been recognized by the international raters and is also reflected in growing investor confidence as evident from the growing remittances, foreign investment and in the pricing of international sovereign bond issues. These issues were oversubscribed in the US, Europe and Far East financial markets that now have an appetite to take long term view and risks on Pakistan. Confidence in the economy was restored as the Government succeeded in reducing substantially its macroeconomic imbalances in FY2003-04 which had reached unsustainable levels in the late 1990s. Fiscal prudence and external debt restructuring together helped Pakistan reduce its debt/GDP which is currently down to 56% of GDP below the target of 60% to be reached in 2013 defined in the Fiscal Responsibility Act, 2005. Recent demand pressures stemming from a combination of factors (i) the hike in international oil prices, (ii) unanticipated costs of reconstruction of earthquake hit region, (iii) real increase in development spending of physical and social infrastructure that has been for years neglected and (iv) import requirements of fast expanding industry. These factors together strained the external and fiscal deficit that rose to 3.9% and 4% of GDP, respectively in FY06. While these deficits have been financed properly as Government’s realization of tax collection and external debt flows were supplemented by significant growth in non debt foreign inflows following the sale of state assets and FDI. Heightened business activity coupled with aggressive growth in financial industry prompted an unprecedented rise in private credit, stimulated not only by corporate sector but also by growth in agriculture, SME and consumer financing. The demand pressures from both public and private sector manifested themselves in rising inflationary pressures in the first half of 2005. Recognizing the lingering impact of past few years’ easy monetary policy and the emergent demand pressures, the central bank now for almost 18 months has adopted a tight monetary policy stance. Combination of rise in policy discount rate twice, rise in reserve ratios and proactive open market operations together have helped effective liquidity management. Inflationary pressures have come down significantly. Most distinct is the decline in core inflation though food prices have been volatile largely because of distributional disruptions. Maintenance of price stability calls for retaining tight monetary policy. The Government plans to finance its domestic and external current deficit from the non debt flows which have been buoyant given the strong international interest in Pakistan from all parts including oil exporting Gulf countries. Pakistan is keen to pursue its economic agenda while managing the attending challenges and risks. The Government is keenly pursuing foreign investment to finance its requirements and has enhanced vigilance on economy to ensure corrective actions are taken when warranted. Central Bank being independent has played its role to smooth short-term fluctuations and pressure of the aggregate demand therefore stabilizing the output close to its long-run path. Openness and market orientation Pakistan has for long nurtured openness and market orientation. Set of mutually reinforcing reforms today have made Pakistan a liberal and deregulated economy. A large segment of public assets have been privatized and incentive regime has been rationalized. Keeping aside ideological or philosophical consideration and Government’s fiscal compulsions, industrial, trade and price liberalization has infused high degree of competition which is auguring well for efficient allocation and use of resources. Private sector is allowed in all strategic sectors such as oil, gas, telecommunication and other services sector on a competitive basis which are supported by sound sector policies. Deregulation of civil aviation industry has given air travelers a choice and increased competition resulting in to better customer service and drop in fares. Domestic prices of major crops have been aligned to international prices, while eliminating distorting and untargeted subsidies. Sharp growth in private credit from virtually under Rs20 billion to Rs400 billion in FY06 (that has involved raising SME financing, doubling of agriculture credit, introducing consumer finance loans, etc.) has helped stimulate investments. Success of market mechanism however does not exclusively depend on price signals but it also requires right blend of host of non-price factors such as physical infrastructures (transport system, communications, telecommunications, etc.); institutional and organizational factors (credit facilities, marketing network and channels, training and educational facilities, information, R&D, technological and innovative facilities, predictable and stable ownership institutions); and, the organizational capacity of the government for administrative and fiscal purposes. Weaknesses in the non-price factors are common in Pakistan as in any emerging market economy and have required Government to play a coordinating role and lay down policies and procedures to address market failures. Notwithstanding these measures, reliance on allocative and creative functions of the market may not be optimal particularly with underdeveloped markets and institutions. Keeping these caveats in mind, Pakistan’s has launched wide ranging reforms which are yielding visible results. Liberal foreign investment regime Foreigners and overseas Pakistanis have been allowed 100% equity in all sectors (with no prior approval requirements) and foreign investment is treated at par with domestic investment. Foreign investors can repatriate capital, profits, dividends and fees etc. Special Rupee Convertible Account (SCRA) offers smooth avenue to bring in remittances and portfolio funds for purchase and trading of shares and exit freely from Pakistan. FDI flows have grown from under half a billion in FY 2002 to US$3.5 billion 1 in 2006 and it is not inconceivable that in next year or so we could double these levels. SBP Trade liberalization Moving from import substitution industrial strategy, Pakistan’s has adopted a conducive trade policies supported by tariff restructuring, rationalization and reduction; withdrawal of import quotas, import surcharges and the regulatory duties; and foreign exchange liberalization. Maximum tariff rate was reduced from 65% in FY97 to 45% and then again to 25% in FY03. Likewise, the tariff slabs were reduced from 14 to 4 in FY02. 2 Zero tariff slabs were replaced by 5% minimum tariff rate; and average tariff on agriculture inputs has been also reduced. Pakistan’s trade openness has steadily improved from 25.8% in FY00 to 34% in FY06. 3 Moreover other indices, such as the Overall Trade Restrictiveness Index (OTRI) and IMF’s computed trade restrictiveness index also indicate Pakistan’s improved trade openness – both reinforce that Pakistan has most competitive trade regime relative to its South Asian counterparts except Sri Lanka. 4 Privatization of state owned enterprises (SOEs) Reversing the 1970s nationalization of industry and banking system (when the Government took over 31 major manufacturing enterprises and all banks), Pakistan since 1990 has structured 161 private transactions which mobilized close to Rs378 billion ($6.2 billion @Rs60.5/dollar). Political commitment, build up of public acceptance, well conceived Privatization Law and guidelines and a fairly well equipped Privatization Commission of Pakistan (PC) (established on January 22, 1991) have together contributed to implementation of privatization program in a fairly transparent manner. Today most manufacturing sector and 80% of banking assets are in private hands. Strategic stakes have been sold in the Karachi Electric Supply Corporation (KESC), the Pakistan Telecommunication Company Limited (PTCL), Kot Adu Power Company, National Refinery, and has sold 5-15% shares in power, petroleum and gas companies etc. In the next phase, close to 26 large transactions 5 including the remaining gas, power and petroleum companies and financial institutions are slated to be sold off. These structural reforms have precipitated a steady economic transformation across the board. First, scene in services sector is changing led by hype in financial services, telecommunication, trade and wholesale all of which have been growing at a fast pace. In financial services, growth in banking sector assets and profitability along with privatization together have attracted cumulative FDI flow of $11 billion over past five years. The current wave of bank mergers is anticipated to and GDRs is further going to attract additional $1-1.5 billion including Standard Chartered Bank’s merger with the largest mid-size bank i.e. Union Bank. Telecommunication sector alone has attracted $2.6 billion and its expansion (with teledensity rate registering an increase from 3% to more than 10% in couple of years) is triggering telecom revolution with six mobile service provider entering in market in less than couple of years that have today about 40 million cellular phone subscriber. Exports of services sector have grown from negligible levels to over $300 million. This could be an underestimate as a study has pointed out that global IT exports from Pakistan could be $1 billion but a large chunk of export proceeds were retained in escrow accounts by several software houses. The prospects for this sector are bright and industry benefits from a combination of decade plus tax holidays, zero duties on computer inputs, incentives for venture capital, liberalization of wireless local loop and landline sectors etc. Second, long time back Pakistan achieved self sufficiency in wheat and other strategic products; it is the world’s fourth largest producer of cotton which caters for local textile and clothing industry, while Pakistan: Growth and Export Competitiveness, World Bank, 2006 Ministry of Finance: Economic Survey of Pakistan, various editions Trade Liberalization, Growth and Poverty, (SPDC) Annual Review 2005-06 Privatization Commission of Pakistan feeding China and other regional competitors with cotton yarn and grey cloth. Rice production of superior quality has boosted its exports that have crossed mark of $1 billion. Dedicated policies to nurture non-crop sector to offer nonfarm employment is showing visible results as it now contributes about 53% of agriculture value added relative to 43% in early 1990s. Pakistan is at present fifth largest producer of milk. These developments have helped raise rural incomes where almost 66% of population and agriculture offers employments to 45% of work force. Concrete efforts are underway to enhance complementarity and synergies between the agriculture and industry by exploiting backward and forward linkages. Third, Pakistan’s corporate sector has been quite vibrant and highly profitable which is driving slowly contribution of industry to value added – risen by over 3% between FY99-06. The private sector has been a key driver of this with the support of over 170 MNCs 6 that have had a long standing presence in Pakistan in financial services, chemicals, engineering and industrial products, pharmaceuticals and more recently in energy, shipping, trading and other services. Barring few exception, most industry sub-sectors have been operating at near or full capacity utilization which has triggered an interest in additional capacity enhancement. Consequently, gross fixed capital formation in the manufacturing sector has almost doubled in the past five years and 97% of this is private investment. Shifts in industrial production structure though slow are now emerging. While textile remains the major forte of industry, demand for consumer products catalyzed by rising income and accessibility to consumer finance has helped double the production of automobiles, white goods and electronics and construction demand has boosted cement production. Together, corporate sector profitability in 2005 reached record highs estimated to be ranging around 6% 7 (Net profit margin). Fourth, Pakistan’s engagement in world trade reached $42 billion reflecting the Pakistani companies’ integration with the global standards of quality, productivity and efficiency. Prospects for export that have reached $16.5 billion in FY06 (double the level of FY00) is to receive impetus as the Government concludes free trade agreements with United States, China, Malaysia, and Sri Lanka and hub’s like planned special economic zones and if joint ventures that would integrate Pakistan in the international production network become a reality. Pakistan has been able to somewhat diversify its exports: Share of textile has fallen from 65 to 59% over last few years and within this sector there has been growth in higher value addition products in particular in home textile where Pakistan has a leading edge. Concurrently, the share of manufactured goods has increased from 62 percent in FY96 and 72 percent in FY01 to 78 percent in FY06. Aggressive regional competition supported by subsidization is, however, hurting textile export prospects even though Pakistan private sector has well positioned itself by enhancing its capacities and upgrading its facilities and technology. To mitigate risks associated with high vulnerability to textile sector both at industry and export level, Pakistan is launching further efforts to encourage greater export diversification. Broadening and deepening of financial markets Pakistan banking industry is characterized as the most vibrant, healthy and well regulated. Dismantling all financially repressive policies and regulations, SBP has managed to discourage segmentation of credit markets, reduce high intermediation cost stemming from overstaffing, inefficiencies and accumulation of non performing loans. Financial system has now geared itself to better serve private sector and the populations credit requirements in particular of underprivileged sectors such as micro finance, small and medium enterprises (SMEs) and agriculture. Sequentially, in the financial sector following actions took place: • First, breakthrough in banking sector occurred when the Government amended SBP Act of 1956 in February 1994 and assigned SBP autonomy and providing powers to SBP Board of Directors for monetary and banking sector policies; • Second, the Government recapitalized banks (injecting close to Rs 46 billion in some of the public sector banks), laid off close to 35,000 employees in two phases 8 from public sector banks and closed over 2000 unbanked branches and eliminated credit controls; OICCI The State Bank of Pakistan: Banking Sector Review, 2005 In the first phase (1997) 24,000 employees were laid off and in the second phase around 11,700 employees were relieved • Third, privatized 4 major public sector banks 9 and supported a program of restructuring and improving asset quality which involved write off of loans (in the range of Rs 54 billion 10 ) and establishment of Committee for Revival of Sick Industrial Units (CRSIU), Corporate and Industrial Restructuring Corporation (CIRC) to acquire the NPLs of the public sector banks and creation of a National Accountability Bureau (NAB) Cell at SBP to expeditiously process the cases of willful defaulters. Moreover a special law, the Financial Institutions (Recovery of Finances) Ordinance, 2001 was enacted with a view to facilitate speedy recovery of loans; and • Fourth, introduced both financial innovation and diversification in banking sector by allowing entry of Islamic and microfinance industry, women’s banks and SME bank; • Fifth, SBP overhauled its prudential regulatory and supervisory framework setting in place international standards and new regulations for specific sectors such as SMEs, agriculture, and microfinance and steadily increased minimum capital requirements of the commercial banks to at least Rs 6 billion by the year 2009. SBP further issued risk management guidelines, e-banking and credit information system and has developed Institutional Risk Assessment Framework (IRAF) to enhance collaboration among the supervisory departments and efficient usage of all possible information available on banks and DFIs. • Finally, Pakistan launched fundamental reforms of stock market that have ranged from automation of stock market and change in their governance structure to the establishment of Securities Exchange Commission of Pakistan (SECP) to regulate the capital markets, NBFIs, insurance and corporate sectors. Impact of financial sector reforms has been far reaching. In general while real sector development is a prerequisite for growth of financial sector, in Pakistan context, our experience has shown that to some extent financial sector reforms have catalyzed and induced real sector development. Today, Pakistan has a sizeable banking industry with close to 55 Financial Institutions and asset size of $69 billion, deposit base of $52 billion and advances of $36.7 billion. Financial sector reforms have led to improvement in the following areas: • Financial depth has increased as Bank Assets to GDP ratio has improved from 49.1% in 1997 to 55.6% in 2005 whereas money supply (M2) to GDP ratio has also improved from 36% in FY 00 to 44% in FY 06. Private credit to GDP which reveals the extent to which the banking sector is efficiently allocating funds to the productive sector of the economy has increased from 18% in FY 2000 to 27.4% in FY 2006. However despite improvements Pakistan lags behind its regional peers. • Profitability as well as efficiency has increased in the banking sector. ROA has increased from negative 0.2 in CY 2000 to 2.1 by June 2006 whereas ROE has increased from negative 3.5% to 26.5% over the same period. Pakistan’s performance in these indicators is amongst the best in its regional peers. Intermediation cost and total expense/total income ratio have come down from 3.43% to 2.96% and from 97.4% to 67.6% respectively over the period CY 2000 to June 2006. However, the gains in institutional efficiency have not really translated into gains in allocative efficiency as spreads have also risen over the same period. • NPLs to total loans and net NPLs to net loans ratios have improved to 8 percent and 2.1 percent respectively over the period CY 2000 to June 2006. • All the capital adequacy ratios have shown improvement. Risk Weighted CAR has increased from 9.7% to 11.9%, Tier 1 Capital to Risk Weighted Assets from 8.3% to 8.9% and Capital to Total Assets from 4.5% to 8.1%. Presently 34 out of 40 banks are reporting above 10% capital adequacy. • Diversification of credit has taken place and previously underserved segments have better access to credit. The credit to agriculture sector has been mostly market driven and has almost doubled from Rs. 73.6 billion during FY04 to Rs. 137.5 billion during FY06. The share of commercial banks in credit to agriculture has risen from 49 percent to 61 percent mainly Two of these major banks (MCB and ABL) were privatized in early 1990’s while UBL and HBL were privatized These loans were written off under BPD circular 29 reflecting the strength of agriculture sector fundamentals and the success of the financial sector reforms. Moreover, SBP in its recent restructuring has created a new department for agriculture and rural finance with a strong reorientation towards development finance. Likewise, consumer credit has grown by more than 350% and SME financing by 66%. As on June 30th 2006, out of total credit, the shares of agriculture, SME, consumer credit were 6.2%, 16.4% and 14% respectively. • Micro finance banking sector which was initiated in 2001, now constitutes of 6 banks (with more than 110 branches) and an asset base of around Rs 9.7 billion as on 30th June 2006. Micro finance banking has a lot of scope in Pakistan as according to some independent estimates, it is potentially a Rs 300 billion size market which can generate revenues of around Rs. 90 billion per annum. • Likewise Islamic Banking constitutes 2.3% of the total assets of the banking sector with a branch network of more than 100 branches. In future according to estimates it will capture 10% of the total market in Pakistan by 2010. Moreover, growth in Islamic banking is also expected to increase the financial depth as it will bring a lot of people into the deposit net. • Realizing the importance of these sectors, SBP has further restructured itself in September 2006 and has launched efforts to enhance access to finance in these areas. • Pakistan’s financial sector after going through a process of privatization is already moving towards consolidation and mergers. This process spurred by SBP’s requirement of increasing MCR of banks, will weed out weak banks and will make the banking sector well capitalized and more resilient to shocks. Moreover, it will also ensure a smooth transition to Basel 2. • Due to stock market reforms and improvement in the stock market performance, equity market capitalization to GDP ratio has also increased from merely 16.8% to 31.4% in 2005 and in fact went as high as 44% in April 2006. However, equity markets are yet to fulfill their full potential as an alternative source of funds for the corporate sector. Moreover, bond market in Pakistan is fairly underdeveloped and is merely 5.5% of GDP. Strengthening of governance structure Political stability and good governance are essential pre-requisites for improvement in investment climate and sustainable growth. Following improvements have taken place in these areas: Political governance Pakistan despite all international and public perceptions, today is a functioning democracy and gradually there is a change in complexion and composition of legislatures with more educated people and women (27% of National Assembly and 17% of Senate) entering into politics as the law mandates for elected representative to have a minimum of bachelor degree to contest in an election. Aside from 100 members Senate and 342 members National Assembly with functioning Committees debating/approving budget, legislation and policies of the Government, Pakistan introduced a path breaking devolution process with the passage of the Local Government Ordinance in 2001 that has empowered locally elected representatives (more than one quarter of which are women councilors) to manage local government affairs and empowered communities to enhance government accountability. To enhance accountability and reduce corruption, the Government established in 1999 a National Accountability Bureau (NAB) which has its head office at Islamabad and five other regional offices in the provinces. Similarly, government has launched a major overhaul of civil/public services through civil services reform committee. Enhanced role and vigilance of regulators With private sector leading bulk of economic activity, Pakistan has now a web of regulatory framework for specialized businesses and products backed by strong regulators who operate on the basis of modern and transparent set of economic regulations consistent with international standards. On one hand, Pakistan’s regulator for telecommunications (Pakistan Telecommunication Authority (PTA)), Media (Pakistan Electronic Media Regulatory Authority (PEMRA)), Power Sector (National Electric Power Regulatory Authority (NEPRA)), and Oil and Gas Sector (Oil and Gas Regulatory Authority (OGRA)) etc. were established to unbundle Government’s role as producer of strategic goods and services and policy making from that of a body that licenses new entities, setting price mechanism and standard setting, ironing out and providing guidance on the issues arising out of market imperfections and checking compliance and monitoring etc. On the other hand, the financial regulatory authorities both for banking and nonbank financial sector have now been made independent. Social transformation Recent high growth trends coupled with enhanced spending on social and poverty programs 11 that rose from 3.8% of GDP in 2001/2002 to 5.05% by 2005/2006 has together begun to pay some dividends as evident from the reversal in poverty incidence trends and social indicators. • Per capita income has grown from $526 in FY 2000 to $847 in FY 2006. • The overall poverty has been reduced from 34.46% in 2001 to 23.90% in 2005. The percentage of population living below the poverty line in rural areas has declined from 39.26 percent to 28.10 percent while those in urban areas, has declined from 22.69 percent 14.9 percent. • Literacy rates of population 10 years and older have increased to 53% as compared to 45% in 2001/02. Both primary and secondary school enrolment have shown improvement in the recent years. However, while elementary education gross enrollment has increased from 41% in 2001/02 to 46% in 2004/05, it remains far below the targets. • Overall access to sanitation 12 has improved from 37% in 1990 to 59% in 2004 getting close to the sanitation levels achieved by lower middle income countries in 2004. • Improvements in immunization coverage of children and women from 53% in 2001/02 to 77% in 2004/05. Proportion of pregnant women attending antenatal care increased from 34% in 2001/02 to 50% in 2004/05. Future paradigm shift Given its recent track record, Pakistan economy is contemplated to grow at a rate of 7% per annum. This should help raise further its per capita income from US$847 per annum to US$ 1557 by 2015 which in turn will facilitate reduction in poverty. Economic prospects to realize these goals are good as ongoing structural reforms, monitoring of investment and pace of project implementation is being enhanced. Demand is expected to get stronger as the incomes rise further and assuming current population growth (1.8%) trends persist, Pakistan will be a market of 185 million – adding to this the relatively more affluent Gulf population and the Central Asian States population base Pakistan offers a large market. Connectivity and the modernization of existing two Ports and addition of Gawadar port will ease pressure. We do recognize that tackling the new challenges requires confidence from past achievements but not complacency about the magnitude of the challenges to be faced. "When it is obvious that the goals cannot be reached, don't adjust the goals, adjust the action steps." -- Confucius The key challenges going ahead are being addressed to sustain and build on the gains and achievements realized in recent years. Let me conclude by highlighting that most of these challenges require a further shift in development paradigm which will be pursued. First, Pakistan has to address low productivity and high sector and industry concentration which induce a degree of vulnerability. In agriculture, the Government is striving to develop mega water resources projects and launch further efforts to enhance crop yields key to enhance agriculture productivity of major crops stabilize performance. Concurrently, work is underway to mitigate excessive dependence on crop sector by nurturing non crop sector. There is strong potential in Economic Survey of Pakistan 2005-06 World Development Indicators 2006, Asian Development Bank livestock and dairy sector – in case of dairy only 2.5-3.0 percent of the production gets processed. Processing and packaging of these products and development of agro based industry would stimulate export of these products to the neighboring Middle East markets. Second, while export diversification is occurring, dependence on textile sector is critical to insulate from international fluctuations in textile demand. To achieve diversification, Pakistan has to make inroads into the medium and high-end technology spectrum of products which consists of products such as electronic goods, automobiles, engineering goods etc. and to look for newer markets. Third, while financial system’s depth and breadth has increased, there is continued excessive reliance on banking system; as such there is need for exploiting alternative sources of funds, particularly sources for meeting long term financing needs are yet to be developed. In this regard, Pakistan needs to develop long term bond market particularly corporate bond market and further strengthen its equity markets. Diversification will facilitate availability of funding for infrastructure development and help in structuring required risk mitigation approaches. Fourth, the country needs to expedite infrastructure development. Estimates indicate that there total infrastructure investment requirements exceed $40 billion over next five years. Mobilizing these investments and it implementation requires special initiatives. Fifth, the country needs to bring further improvement in governance and competitive investment climate making it more business friendly. Improvement in governance should include among others a strong commitment to rule of law, competent and efficient government sector, less cumbersome regulations and control of corruption. The strengthening of the competitive investment climate would require, further development of markets, efficient nonfinancial factor markets particularly labor markets and availability of skilled labor, improve the infrastructure services, and the existence of strong legal, regulatory and institutional framework. Sixth, it is critical that Pakistan shares its gains equitably across regions and metropolitan cities to satellite towns and to rural areas where there is need for further strengthening of incentive framework, enhanced availability of credit, and rising non-farm employment opportunities. Finally, the social transformation needs to occur side by side with the changes in the market place to further strengthen the demand for exiting and new products. People are better informed and have more choices in terms of goods and services. | state bank of pakistan | 2,007 | 1 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the FICCI-IBA Conference on 'Global Banking: Paradigm Shift', Mumbai, 26 September 2006. | Shamshad Akhtar: Demystifying Basel II Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the FICCI-IBA Conference on “Global Banking: Paradigm Shift”, Mumbai, 26 September 2006. * * * After years of research supported by several theoretical and empirical studies including rounds of country specific quantitative impact surveys and long drawn consultation with the industry, the Basle Committee on Banking Supervision (BCBS) issued an elaborate framework of International Convergence of Capital Measurement and Capital Standards – A Revised Framework (called Basel II Accord) in November 2005. Basel I served banking industry well since its introduction in 1988 but it lagged behind the financial market developments and innovation. It increasingly became outdated and flawed as it relies on a relatively crude method of assigning risk weights to assets, emphasized mostly balance sheet risks relative to multiple risks facing financial firms today. Furthermore, it offered a regulatory approach to capital determination and standard setting which did not capture fully the range of large and complex banking operations and the accompanying range of diverse set of economic risks. Addressing the perceived shortcomings and structural weaknesses of Basel I, the Basel II Accord – a landmark regulatory framework – offers a newer and comprehensive approach and methodology for financial sector regulatory capital calculation which recognizes well the advancements and innovations in banks’ businesses, policies and structures and the accompanying financial engineering and innovation. The relevance and significance of Basel II stems from its ability to recognize effectively the different types of risks facing industry and the new products as well as off balance sheet transactions. Some distinct characteristics of Basel II are noteworthy: • aligns capital of banks with their basic risk profiles, • it is elaborate and far superior in terms of its coverage and details, • it has the ability to exploit effectively new frontiers of risk management and gives impetus to the development of sound risk-management systems, which in turn are expected to promote efficiency and more prudent allocation of resources, • It is perceived to be the harbinger of the future disposition of bank supervision and the evolutionary path on which the banking industry would tread, and Finally, it is designed to promote financial stability by making the risk-management systems more robust and responsive to tackle the complexities arising out of a host of new risks. Given its complexities, Basel II has been subject of intense debate. The industry has been gripped with complexities of different dimensions of risk and capital calculation methods, data requirements, and costs related to upgrading IT systems and business processes. Meanwhile, regulators are forewarned to facilitate a proper and sequenced adoption of Basle II, while ensuring effective alignment of risk weights and capital requirements in line with Basel II Accord. The debate has brought to forefront some issues and inconsistencies which unless addressed would adversely impact the incentive framework. The final draft of the Basel II incorporated several of industry concerns. The paper aims to highlight the importance and challenges of introduction of Basel II. Basel II in itself has the ability to meaningfully capture and suggest probable solutions for virtually all dimensions and segments of banking risks. Diversity of approaches and methodology has brought with it criticism and challenges since it may encourage and incentivize some intended and unintended behaviors and practices, while adding to the cost of doing business. The challenges, however, bring new opportunities for global banking systems to adopt more robust risk management approaches which should serve industry well for capital leveraging and taking higher but still manageable risks. Basel II - superior and all-encompassing architecture It is widely recognized that Basel II is a major breakthrough in theoretical and practical world of banking industry and a dynamic framework which will be able to adapt to ongoing innovation and change. Some of the main features (see annexure) of Basel II are noteworthy: First, while the new Accord maintains the level of capital adequacy requirements at 8% (Tier 2 capital is restricted to 100% of Tier 1 capital) consistent with Basel I, it has shifted emphasis from regulatory to economic capital framework, while giving recognition to new risk mitigation techniques (default protection etc.) and clarifying new trading book capital questions. Careful evaluation of these elements suggests that Basel II is not ideologically about raising as per se capital requirement but focuses on efficient and effective capital allocation. Appropriate and sharpened risk articulation and assessment and safeguards would result in reduced capital requirements. Conversely, ill-conceived financial structures with risky counterparties will attract punitive capital requirements. Basel II in some senses “serves as a more intelligent solvency capital redeployment.” Second, the new Accord has depth and breadth in its architecture and it blends and integrates well, with an element of mathematical rigor, all key prudential and supervision norms, however the rules based approach allows substantive national discretion which has its pros and cons. Basel II at the very basic level consists of the Standardized Approach (SA) which recognizes and defines various asset buckets and assigns them risk weights in accordance with the type and nature of corporate issue and other transactions and delegating its qualitative assessment to external raters. The matrix of risk buckets and weights is considered to have added excessive complexity for less sophisticated banks. The linkage and delegation of quality assessment to external ratings, while understandable, lends excessive confidence on the objectivity and soundness of rating agencies which, in at least developing countries has only thus far rated a small proportion of corporates and issues. Notwithstanding, the Pillar 1 offers a choice to resort to either a Standardized Approach (SA) which has pre-specified weights or to turn to Internal Rating Based (IRB) approach which involves a foundation and advanced IRB option. These approaches are differentiated on the basis of (i) the available in-house risk assessment expertise, (ii) the size and product mix of the bank, and (iii) overall financial sophistication. There is considerable national discretion for regulators to decide, within the parameters defined under Basel II, on risk weights for different types of finances, treatment of collateral and risk mitigation, etc. The core pillar is bedecked by two other pillars; and all three pillars are interlinked and intertwined and mutually reinforce each other. Pillar 2 (Supervisory Review) underscores need for strengthening the financial institutions’ internal capital assessment processes to capture risks which remained uncovered under Pillar 1 and thus set aside capital in line with the banks’ risk profile and control environment. The supervisory review process validates the bank’s internal assessments by ensuring that the whole array of risks has been taken care of. Pillar 3 (Market Discipline) complements the other two pillars by requiring disclosures and transparency in financial reporting to promote market discipline. Third, the Accord encourages banks to recognize all types of risk and take appropriate steps to mitigate these risks, while providing for adequate capital. Besides the credit risk, the Accord for the first time recognizes the operational risk, however, the degree of guidance and complexity in measurement provided within the framework for these risks varies. The Credit Risk (the risk of default by the counterparty) is dealt with most comprehensively in the Basel II in line with legacy of the first Accord as well as the banks traditional edge and competence in credit risk assessments. The inclusion of Operational Risk, a fundamental improvement over Basel I, captures risks associated with bank’s internal control processes and systems and corporate governance policies and practices. Operational risk calculation explicitly requires capital for “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events” risk. This definition includes legal risk, but excludes strategic and reputational risk. Three approaches underlie measurement of capital against operational risk: (i) Basic Indicator Approach (BIA) – capital for operational risk should be equal to the average over the previous three years of a fixed percentage (denoted alpha=15%) of positive annual gross income, (ii) Standardized Approach capital charge for each business line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business line. Beta (ranging between 12-18%) serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line; and (iii) Advanced Measurement Approach - the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement system using the quantitative and qualitative criteria for the AMA. Overall the approaches for operational risk assessment are not as nuanced as for credit risk, however the AMA approach does allow for more fine tuning. Once again the banks with better risk assessment would opt for the advance approaches. Market Discipline pillar underscores need for transparency and disclosure of data and technicalities. The evaluation of banks’ risks and its systems and capital adequacy by the market will help ensure integrity and validation of other pillars. For this pillar to work, it needs to be supported by proper accounting rules and more elaborate disclosure of bank’s strategies and approaches adopted, risk profile and capital strategy through economic and credit cycle, information of the stress tests, and PD/LGD data. Fourth, within the pillars, the Accord offers a range of options and incentivizes banks to move from vanilla SA which assigns high risk weights and capital standards to adopting IRB and within it further having the option to choose either the Foundation versus Advanced IRB. These options have clear trade offs but most importantly, IRB offers greater capital relief relative to SA. Nevertheless, IRB systems will only be feasible if they are supported by databases and history on credit losses, rating models and risk management systems etc. and their soundness and integrity has been validated by supervisors. Banks operating in less developed countries, having limited in-house expertise, and small to medium size are in general opting for SA. The advantage of SA is its relative ease of implementation by even small and mid-sized banks. The main problem, however, is that it would usually result in much higher capital requirements as compared to IRB. There is much less fine tuning of the risk weights, and banks have to rely on external rating agencies. The banks adopting this approach would thus be at a disadvantage against their competitors. Jurisdictions that will stick to the SA for too long may find that their domestic banks are losing ground to the foreign banks operating globally who are more likely to adopt IRB. Fifth, the IRB approach is being preferred by large global banks, which already competitively price credit risk. The key parameters under IRB approach are PD (probability of Default), LGD (loss given default), M (Maturity) and EAD (Exposure At default). Under the FIRB, the banks calculate PD of their portfolio, while the other parameters i.e. LGD and EAD are prescribed by the regulator. Minimum PD is 0.03% for banks and corporates; no floor has been prescribed for sovereigns. The LGD for senior exposure is 45% and the subordinated exposure attracts a lower recovery of 75%. These rates should be re-examined by the regulators taking into account the ground realities of their respective jurisdictions. 1 The Advanced IRB provides discretion to banks, and as such there is an incentive to move too quickly to AIRB without adequate preparation. The balancing act has to be performed by the regulator, on one hand it has to promote the efficiency of banking capital and pursue more fine tuned risk assessment, and on the other it has to ensure that banks have sufficient resources and expertise to undertake this complex task. The AIRB approach has very high sensitivity to the changes in LGD and M given the differences in PDs. In a paper by ING Bank 2 , it is shown that at higher LGD levels e.g. 75% there is a particularly strong impact on the risk weights of bonds of lower rated issuers. On a similar note the variations in maturity M, have greater impact on low rated borrowers as compared to high rated borrowers. It implies that in case of a BBB- rated borrower, the risk weights will be highest for subordinated loans (LGD 75%) having long maturity (e.g. 5 years). At the same time for short term secured loans (i.e. with low LGD) the difference in risk weights will not vary a great deal with the quality of borrowers. The use of AIRB would thus produce winners and losers in the banking sector. The low rated borrowers and users of long term funds would face much higher costs of funds, whereas public sector and other high quality borrowers would gain. Regulators have to ensure that instead of marginalizing the low rated borrowers any further, policies are in place to enhance the overall credit profile of the business sector in the country. ING Bank. Estimating the Basel Effect, July 2006 Ibid The choice of the approach will also impact sovereign borrowers. Some countries like Hong Kong and China will gain, because the risk weights associated with their sovereign loans will be lower, whereas Turkey and Indonesia will face higher risk weights. According to ING report, the risk weights of OECD and Non-OECD countries would vary depending on the approach applied by the banks. The table below will give some RW of selected countries: The Accord clearly discourages certain exposures as banks earn more pejorative capital treatment for equity style risks which were under-capitalized in Basel I. An ING study has observed that a number of European banking groups have unwound their industrial and non-strategic financial equity holdings as a part of preparation for Basel II. Given the objectives and scope of Basel II and its architecture, the Mckinsey study (2004) highlights that there is a “Business Case for Basel II” 3 as the accord could impact profits and generate gains from reduced capital charges which of course need to be netted from funding costs. For some banks, given the risk sensitive nature of Basel II, the regulatory capital could be substantially reduced by up to 50 percent in segments such as residential mortgages, which would translate in to savings on funding costs. However, such savings would be subject to conditions: such as requirement that regulatory capital should be higher than economic capital 4 and presence of regulations such as leverage ratios which may prevent banks from reducing their regulatory capital significantly. The McKinsey’s research identifies four important Basel II-related risk-management efficiencies which could together raise pretax earnings by 3 to 6 percent. These include: (i) Reduced charge-offs through better default-prediction and collection processes (ii) Improved pricing discipline on loans and risk selection through risk-based pricing to and reduced risk from new business opportunities. Kevin S. Buehler, Vijay D’Silva, and Gunnar Pritsch, “The Business Case for Basel II.” The McKinsey Quarterly 2004, Number 1 The amount of risk capital, assessed on a realistic basis, which a bank requires to cover the risks that it is running or collecting. Typically this is calculated by determining the amount of capital that the firm needs to ensure that its realistic balance sheet stays solvent, over a certain time period, with a pre-specified probability. Firms and financial services regulators should then aim to hold risk capital of an amount equal at least to economic capital (iii) Reduced operating expenses by streamlining loans and underwriting processes (iv) Reduced operational loss expenses through the use of proper mitigation techniques. Substantial savings can also be achieved through freeing up of regulatory capital, depending on the risk characteristics of loan portfolio. For example, a bank carrying substantial mortgage loan portfolio would free up regulatory capital when it moves to Basel II. In case of operational risk, for big banks that must adhere to Basel II, moving to a proposed advanced measurement standard might generate savings from 20 to 25 percent of the capital requirements for operational risk if regulatory capital exceeds economic capital. Realizing these savings, however, would require substantial investment. For large, diversified global banks, the cost of implementation is estimated at $100 million but can be as high as $250 million, and the process could well take up to three years. For diversified regional banks, the cost is estimated at $25 million to $50 million. 5 It is important to remember that many banks would incur much of this cost even without Basel II, since they must upgrade their risk-management capabilities to keep pace with changing markets and remain competitive. Basel II implementation – opportunities and challenges Globally there is a deep interest in Basel II. World wide there is a strong commitment for it but the pace of implementation would vary from economy to economy and bank to bank. Presently, on one hand there are differences in economy and institutions’ risk management processes, state of tech know how, customers portfolio, and on the other hand, the state of development of rating agencies, external auditors, and above all, regulators varies across economies. By virtue of their better infrastructure, resources, and size of operations, the large internationally active banks particularly in Australia, Japan, Singapore, Hong Kong and Korea are expected to adapt to the new regime in relatively shorter span of time. Meanwhile, economies with less sophisticated, small and fragmented financial structure would be implementing Basel II gradually and remain confined to adoption of SA. Notwithstanding, in next few years, Basel II will drive and shape the bank’s business strategies, policies and structure, its risk measurement and capital calculation methods, its internal controls and processes, data requirements, and IT systems. Although the ultimate aim is to achieve the intended benefits by way of enhanced risk management and lower capital requirements, the actual Basel II implementation is turning out to be complex and challenging involving substantial funds outlay for changes in IT, internal controls and processes and human resources. These challenges offer opportunities to the banks as well, to strengthen and transform themselves to better compete both within and outside domestic markets. Banking industry worldwide today faces several issues and challenges which unless effectively addressed would impact the pace of adoption and implementation of Basel II. These include 1) Good and Reliable Data and Information 2) Development of sound risk-management system 3) Asymmetry in supervision 4) Imperfect Markets 5) Pro-cyclicality 6) Access to finance for disadvantaged 7) Operational costs 8) Cross-border challenges. 9) Challenges for the corporate Sector 10) Cost and volume of capital 11) Relevance of Basel II assumptions in the Asian context Kevin S. Buehler, Vijay D’Silva, and Gunnar Pritsch, “The Business Case for Basel II.” The McKinsey Quarterly 2004, Number 1 12) The Problem of Adverse Selection Good and reliable data and information is critical to proper risk assessment. In absence of this, Asia’s banks by and large are initially adopting SA for measuring their credit risk. Under SA, the role of the External Credit Assessment Institutions (ECAIs) and external auditors magnifies but coverage and penetration of both is limited. In the absence of reliable ratings for different assets, banking industry will not be able to fully exploit the flexibility of Basel II and most credit risks will tend to end up in the unrated 100% category and as a result there will be little change in capital requirements relative to Basel I. Furthermore, the erratic behavior of loss data due to frequent volatility of economic cycles would deter the proper assessment of risks under IRB and hence the actual capital allocated might not be truly reflective of economic capital. In view of these, national regulators are striving to encourage both further development of national rating and scoring mechanism and encouraging banks planning to adopt IRB to collate reliable and longer trail of data on its basic inputs. The application of more advanced approaches also depends on business continuity planning and sophistication of the IT resources among banks as well as regulators. Development of sound risk-management systems The foremost challenge facing the banks in implementation of Basel II is to develop well-functioning, efficient and integrated risk-management systems. While the treatment of market risk remains the same under Basel II, banks need to strengthen their risk-management systems to properly define and assess credit and operational risks and to recognize the inherent interdependence of such risk. To capture credit risk under IRB, banks will have to generate exposure data and calibrate it properly to differentiate between borrowers’ default risks – a complex task in developing countries given the level of industry expertise, lack of historical data and absence of adequate technology. Most challenging is estimation of operational risks since most banks do not have required systems and technology to calculate operational risk or determination of capital standards. By increasing the sophistication of the operational risk assessment and management processes, banks can save on capital charge for operational risk. To strengthen risk-management systems, banks and supervisors invariably require capacity building both in terms of human and technology resources to enable them to properly assess the risk-profile and associated capital requirements. Supervisors and banks will have to achieve synergies in their operations to meet the high demands of Pillar II. Asymmetry in supervision When different market participants are regulated by separate supervisors, it is difficult to maintain comparable quality of policy formulation and vigilance. The asymmetry of regulatory regime can arise within one country e.g. between banks and securities firms, as well as on cross-border level. The Basel Accord provides an opportunity for developing common standards; yet it requires a much closer cooperation, information sharing and coordination of policies. In many developing countries, only the banks are coming under the ambit of Basel II and not other financial services providers, thus creating some scope of regulatory arbitrage. 6 The presence of a large number of internationally active banks in the region requires close cooperation among supervisors across the globe to resolve the home-host issues. It would become all the more important for the jurisdictions where the approaches for Basel II would differ. Imperfect markets The functioning of risk assessments system of banks is affected by distortions in markets namely dominance of large players, high asymmetry of information, and lack of market depth. The price manipulation by significant market players can distort the true market value of securities’ portfolio. To make any meaningful assessment of market risk and encourage market discipline, the imperfections have to be removed from the financial markets. The regulator should have the capability to assess the price risk, and identify situations in which market values of portfolios have been over/ under stated by the regulated institution through price manipulation. Challenges and implications of Basel II for Asia by Y. V. Reddy 3 May 2006 Pro-cyclicality One of the initial criticisms on the Basel II Accord was related to pro-cyclicality. The new accord could generate more pronounced business cycles in an economy particularly in recessionary period when the borrower’s credit risk increases, as measured by IRB, and the banks will curtail lending, while in boom time they will expand lending. However, under the new accord the deterioration of a portfolio should begin to be reflected in the bank’s capital adequacy ratio at a much earlier stage, and no further deterioration should occur in the capital adequacy ratio at the moment it is recognized as an accounting loss. 7 Pro-cyclicality can be addressed by several ways. For example supervisors have discretionary powers under Pillar 2 to demand additional capital during a business cycle expansion or banks can adjust the value of probability of default (PD) in IRB system based on the historical trend in business cycle. However, the adjusting of the IRB parameters has to be consistent and transparent. Access to finance for the disadvantaged Keeping in view that the new accord would require banks to hold higher capital allocation for assuming higher credit risk, there is a concern that small businesses and poor segments of the society would receive no or very costly credit. Even under the old framework, the problem of access to finance for low income segments is quite significant for developing countries. Given the wider prevalence of poverty, particularly in the South Asian region, the governments’ efforts to combat poverty might receive serious blow and hence cannot be addressed in isolation. However policies should be made to bring more segments in the ambit of financial services, without seriously compromising the banks’ risk profile. Operational costs The installation of risk assessment systems would obviously carry massive initial costs. Some of these costs would be explicit e.g. cost of IT systems, hiring of new staff, trainings etc. There will be, however, several implicit costs e.g. adjustments in historical processes, and frequent adjustments of the new systems in the beginning of the learning curve. Moreover, compliance failures can result in incurrence of legal costs. In order to contain the costs of implementations for the banking sector, the banks should aim to 8 (i) devise simpler work flows to keep processes easy to understand, (ii) have frequent proactive interaction with the regulator to ensure that compliance systems are developed correctly the first time, (iii) ensure that legal department works closely with compliance and risk management, and (iv) create swift corrective procedures for any compliance failures. Cross-border challenges The challenges discussed above become more pronounced in a cross-border environment. One of the main benefits of Basel II is to provide a common language to banks and regulators to communicate about risks embedded in an entity or transaction globally. However the difference in readiness across countries would make this quite difficult to achieve. The differences in preparedness of banks would hinder information sharing across sectors and across borders. Moreover, this may also create restriction in credit flow from banks of developed countries into the emerging economies, because these banks may be discouraged due to high capital allocation for such investment. The most basic step is to ensure that whatever is the stage of development vis-à-vis the Basel II implementation, at least adequate information disclosure rules (Pillar III) are in place. This would help in building the confidence level of foreign donors and banks. Challenges for the corporate sector Since the risk-sensitivity is at the core of Basel II, the flow and cost of credit to firms is going to vary depending upon their respective risk-profile. Those with high risk and low credit worthiness are going to be loser whereas the other with low risk and high credit worthiness shall derive benefit, as banks would have to allocate their capital accordingly. Basel II – towards a new common language; by Ryozo Himino, BIS Quarterly Review September 2004 Basel II Banking Revolution for Asian Banks, by Li-May Chew This impact can be deduced from the emerging, peculiar clientele structures for the banks adopting SA and those going for the IRB. The IRB bank would find little attraction in lending to low rated borrowers because they would have to incur a capital charge which would be higher than 8%, while SA banks might be indifferent regarding their lending to such borrowers because they anyhow would have to incur the capital charge of 8%. By the same token, IRB banks will be forced to attract high rated borrowers through more favorable pricing of products whereas the SA bank would not be able to compete with the IRB bank on price to capture those high rated customers. Consequently, high rated customers would tend to converge into IRB banks and the low rated customers with the SA banks. This not only holds serious connotation for small, local banks of the developing economies because of the higher risk of default and possible deterioration in their asset quality but also for the non-financial firms on low rated spectrum as they might witness serious constraints in their access to credit at fair terms. Cost and volume of capital Some studies have pointed out that Basel II would impact cross-border capital flows to developing countries, particularly reducing access and raising the cost of commercial loans from developed markets. This is largely because developing countries carry low sovereign ratings which attract higher capital charge. Yet another possible implication is that international banks might find reduced incentive to expand their operations into these countries, thus further exacerbating their problem of low capital. However, the situation might favor those countries of the region, which are enjoying superior sovereign ratings by virtue of their economic and financial strength. Under the SA, countries like China, Singapore, Taiwan, Malaysia, etc. are going to benefit, as they will attract less than an 8% charge 9 . Relevance of Basel II assumptions in the Asian context The risk weights/ implied correlations for different exposures under standardized or IRB approaches are based upon certain assumptions which may not be applicable in the Asian context. For example, 35% risk weight for mortgage lending is based upon PD estimates and LGD of rather developed European/US markets and may not be adequate as the losses in secured real estate lending in countries like Japan, Korea, Taiwan, Thailand and Indonesia have at times exceeded 35%. 10 Therefore it highlights the need for the supervisors in Asia to assess whether these assumptions are equally applicable to their jurisdictions as well or not. The problem of adverse selection Under IRB, high quality corporate lending attracts a lower capital charge, while low quality borrowers require a higher charge than the 8% charge under Basel I. Under IRB therefore banks would prefer high quality over low quality borrowers, while under SA banks will have relatively greater incentive to lend to lower quality borrowers, particularly those that are not externally rated, given that these will continue to attract an 8% capital charge irrespective of the underlying risk. The possibility that high risk borrowers will migrate to banks following SA is a concern for Asia given the risk it poses for less sophisticated banks. Conclusion Basel II is recognized to have “revolutionized” the risk assessment, management and mitigation systems and offered financial industry innovative and sophisticated approaches to weighing these risks. Concurrently, Basel II has catalyzed new supervisory approaches which have encouraged regulators to start thinking of aligning their national regulations along the Basel II Accord. Most countries have now defined a road map and timetable for adoption of Basel II by industry and to position themselves to conduct the required due diligence for supervision of more advanced approaches to regulatory framework. However, the progress on Basel II implementation varies among the regions reflecting mainly differences in their financial and technological readiness. The speed of ING Bank. Estimating the Basel Effect, July 2006 FitchRatings Special Report “Asian Banks and Basel II”, January 2005 adoption could be explained by a succinct analogy that one can travel a certain distance by taking the high-speed autobahn while in Europe, however, the same distance would require a lot more time in developing countries context given the quality of the roads. | state bank of pakistan | 2,007 | 1 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 56th Annual General Meeting of the Institute of Bankers Pakistan, Karachi, 12 September 2006. | Shamshad Akhtar: Basel II implementation issues, challenges and implications Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 56th Annual General Meeting of the Institute of Bankers Pakistan, Karachi, 12 September 2006. * * * The implementation of Basel II is a subject which has gripped a lot of interest both internationally and within Pakistan. Different efforts are underway within the country and across the globe to ensure an effective adoption of this new international regulatory and supervisory architecture. In my remarks this morning I would like to briefly talk about the significance of ‘risk management’ underlying this framework. I would then like to discuss the important contributions of this architecture, and finally conclude with the issues, challenges and implications pertaining to its implementation. I would also like to touch briefly on where the region and the world is in the adoption of Basel II. It has to be acknowledged at the outset that one cannot dispute the inevitability of risks, and different types of risks, in bank operations. With growing complexity of operations and product innovations, financial institutions have progressively become more exposed to a diverse set of risks. These risks stretch from credit risk to interest rate risk, liquidity risk, foreign currency risk, strategic risk, compliance risk, reputational risk, country risk and operational risk. The menu continues to become larger with each passing day, and with the developments in financial markets. These risks stretch quite far and deep, and have the inherent potential to significantly undermine the viability of the financial and corporate system, as well as that of the concerned institutions. There is a very high cost associated with what we believe are the uncalculated risks. These arise largely because of a number of issues, ranging from the inadequacy of internal controls and inadequate use of Information Technology, to the weak professional management of the institutions. Such a large and diverse portfolio of risks gives a vivid description of the complexity of risk management as a subject. Yet these risks are far from being independent and require a holistic approach for their mitigation and management. It is both the financial institutions’ and the regulators’ responsibility to achieve an optimal management of these risks. We have an intrinsic interest in the financial health of each institution because all these institutions together define the financial stability, smooth functioning of the payment system, and eventually promote economic growth. The past two decades have witnessed significant developments in the field of risk management. While financial institutions, dominated mainly by the large banking organizations, have invested heavily in strengthening their key internal processes to manage and measure risks, bank supervisors have been equally upto the task of devising more responsive and sophisticated solutions to the emerging challenges. Let me highlight the fact that the entire process of development of the theoretical and practical literature on banking regulations and supervision owes its origin to the Basel Capital Accord which was introduced around 20 years ago. We all need to thank this innovation because it has served the banking industry well in the two last decades or so. But with the advent of the Asian financial crises in particular, and a number of other crises, the Latin American, the Russian, etc., the banking industry as a whole has come to recognize that Basel I fails to properly align capital with the actual risk profiles of the banks. It has created a wide gap between regulatory and economic capital and there are perceptions governing the dead-weight cost of regulations that have gotten stronger with the rapid pace of innovations. This cost is now impeding the efficient functioning of markets. This has laid the foundations of a very long-drawn process for Basel II, which recognizes the perceived shortcomings of Basel I and progressively addresses its inherent weaknesses, while gearing the risk management framework for the emerging financial engineering and innovation. Basel II Accord, first of all, aims to align banks’ capital with their basic risk profiles. It is very elaborate and far superior in terms of its coverage and details. It exploits effectively the new frontiers of risk management. It seeks to give impetus to the development of a sound risk management system which hopefully will promote a more efficient, equitable and prudent allocation of resources. It is perceived to be the harbinger of the future disposition of bank supervision, and an evolutionary path for the banking industry. It is a product of a long, arduous, exhaustive consultative process. Not only has the Bank for International Settlements (BIS) produced a voluminous document which has been revised several times, incorporating comments of the various stakeholders, but every jurisdiction in the world has produced an equivalent amount of documentation to define the ground rules for its own implementation. In my view, what is important to acknowledge is that Basel II has fundamentally altered the conventional rule-based and reactive approaches to designing a regulatory framework, to a superior and relevant regulatory and supervisory mechanism which is today more comprehensively assessing the various types of risks which I have mentioned and is inherently proactive. There are three pillars of this architecture. The first pillar refers to the minimum capital requirement, which includes an acknowledgement of the variety of risks and treatment of those risks. The second pillar is the supervisory review, and the third, market discipline. All the three pillars complement and mutually reinforce each other. I would now like to turn to discussing briefly where I think some of the important regional economies are in terms of their preparation for Basel II before I conclude by discussing the issues and the challenges for its implementation. Let me first talk about Pakistan. Whereas the State Bank of Pakistan has chalked out a roadmap for the transition of the banking system to this new capital regime, we intend to, like so many other economies, first adopt the standardized approach to credit risk and operational risk from January 1, 2008 and then move forward with the adoption of the internal ratings based (IRB) approach from January 1, 2010, subject to due diligence of the banks with international presence. Once SBP is satisfied that commercial banks have the appropriate models and risk management capacities, permission will then be granted for them to proceed with the IRB approach. With respect to this game plan, the first phase of a parallel run involving relatively simple approaches has already taken off from July 1, 2006 and will continue for one and a half year. Similarly, the second phase for the adoption of advanced approaches will begin in January 2008 and will last for two years. The transitional period is expected to provide the banks and the supervisors, hopefully ample time to fine tune and strengthen their systems, and hone their technical and human resource capabilities. Among others, we rely on IBP to help in this process. IRB approaches present an incentive to all banks, including Pakistani banks, to economize on capital. The large banks are expected to become more inclined towards this. However, as I stated earlier, State Bank would like to ensure adequate preparedness of the industry before we endorse the move towards IRB, and before we declare victory on this important subject. All other countries of South Asia like India, Bangladesh, Sri Lanka etc. have issued their plans along similar lines. There are, of course, some differences regarding the pace and sequencing of the timetable depending on financial conditions and the type of banking activities in these countries. East Asian countries, including Malaysia, Indonesia and the Philippines, which are broadly implementing initially the simple approaches followed by a gradual transition to IRB approaches, have adopted their own course, depending on the prevailing situation. I know also that the extent of adherence to the existing regulatory framework differs from country to country in these regions. What is, however, different from the South Asian and some of the middle income East Asian economies, is that some of these economies, such as Japan, Hongkong, Taiwan, Singapore and Korea have large financial sectors, given their state of development, and have proceeded with a swifter adoption of IRB approaches, almost consistent with the implementation schedule of Basel II. But again, the process of implementation is dependent on the state of technology prevalent in the banks in these countries. China has been pursuing a very cautious and steady approach in respect of Basel II, and it plans to put in place first of all International Accounting Systems and then a robust risk management system before it graduates to Basel II. Let me now turn to the issues, challenges and the implications of Basel II. In some senses Basel II is a revolution in regulation and risk management. According to the KPMG international whitepaper, depending on its current risk management processes, size, customers, portfolio and markets, a particular bank is likely to experience varying effects of Basel II on at least four levels, namely internal processes, customers, businesses and global interaction. However, it is not just the banks that will be impacted in the Basel II environment. I believe this accord would also affect the behavior of a number of other industries, including credit rating agencies, external auditors, banks’ customers, regulators and finally the corporate sector at large. What are some of the key challenges pertaining to the Basel II Accord ? The list that I am about to cover is by no means an exhaustive one. First of all, I would like to underscore that there is an absolute need to instill a well functioning, integrated and efficient risk management system at the macro level by the supervisors and by the institutions. Second, we need absolute accuracy and reliability of information. Third, we need asymmetry in supervision; we need to recognize that the markets are imperfect. Fourth, industries face pro-cyclicality which needs to be recognized and due consideration needs to be given to incorporating this phenomenon. Also, there are serious implications for access to finance for certain sectors, groups and the disadvantaged segments of the population, given that there is going to be a huge operational cost for the banks and the regulator with the implementation of Basel II. And lastly, there will be cross-border challenges for not only Pakistan but a number of other jurisdictions, including the developed countries. Let me first briefly touch upon the risk management aspect. I think it would be fair to say that there has been, as I said, a revolution led by innovation in the risk management field. Not only have we identified, quantified and developed various models in risk management but we have also nurtured the aspect of risk management in a number of institutions all over the world. So I don’t see it as being an impossible task for economies. There are complications in its implementation where there are inherent weaknesses of different types. We all know that the world has suffered repeatedly from the accumulated huge portfolio of non-performing loans. And the non-performing loans would be a reality even if we were to absolutely eliminate the vested interests from the banking system which encourages willful default, a factor quite familiar to us. Defaults are inevitable because of the conventional corporate risks as well as the business cycles that industries face. What is important in going forward is to be able to define and capture these risks effectively, and to appropriately weigh these risks and make effective provisions. It is really in this context that Basel II defines and lays the ground rules for risk management. Banks all over the world have been more cautious in their credit appraisal and monitoring system and in assessing the gaps in their risk management systems. I think the most important factor in positioning ourselves effectively is education, which alone will help us to understand what the risk management architecture is all about. Let me now talk briefly about the second item. The success of Basel II depends exclusively on the accuracy and reliability of good quality data. We need adoption of the international financial accounting and reporting systems. We need to assess the risks accurately. And there has to be intellectual honesty in reporting all this. Besides the internal assessment of the reliability of information from a regulator’s point of view, the requisite comfort will be achieved only if an independent agency is able to do a due diligence of the company and its inherent risks. Within Pakistan there are only two credit rating agencies and I am not sure that with the universe that they capture, whether we are well positioned to go forward in even adopting the standardized approach effectively. In addition to the credit rating institutions, we need to exploit more effectively the role of the auditors of the borrowing entity. It has to be acknowledged that the data stream currently available is not fully comprehensive to serve our requirements. So it is not just about developing information flows; it’s about changing the quality and the timely reporting of this data. Another important aspect of reliability is business continuity planning and sophistication of the IT resources, both in the State Bank as well in the banking industry. And again, we need to cover a lot of ground here. The third item which I mentioned is asymmetry of supervision, which occurs when different market participants are regulated by separate supervisors. This makes it difficult for us to maintain comparable levels of vigilance and quality of objectives in policy formulation. The asymmetric regulatory regime can be within the country, for example between banks and securities firms, as well as at cross-border levels. The Basel Accord provides an excellent opportunity for developing common standards. Yet it requires much closer cooperation, information-sharing and coordination of policies. In many developing countries only the banks are required to comply with Basel II, and not the other financial services providers. This carries the risk of promoting regulatory arbitrage. In the context of Pakistan, it is important that the coordination of policies at the regulators’ level i.e. SECP and SBP, be pursued actively. This will be part of our deliberations with our co-regulator. Let me now talk about the fourth item, i.e. imperfect markets and the challenges they pose. The functioning of the risk assessment systems of banks is clearly affected by the nature of innumerable types of distortions in the markets. In Pakistan, like everywhere else, there are several problems that can create these distortions. These can pertain to the dominance of large players, or they could be related to the high asymmetry of information or the lack of market depth and so on and so forth. Price manipulation by significant market players can also distort the true market value of the securities portfolio. To make any meaningful assessment of market risks and encourage market discipline, market imperfections have to be first of all recognized and then it is the job of the policy-makers to ensure that it puts in place a legal and regulatory framework which could minimize these distortions. Clearly the banking sector has a role to play in this regard as a responsible citizen of the financial services industry itself. The regulator also has to do a lot of work in this area. It has to be capable of assessing the price risk and identifying situations in which market values of portfolios have been overor under-stated by the regulated institutions through price manipulations. In this context, market surveillance by the regulator needs to be enhanced, an area which is clearly a shortcoming currently. The fifth item relates to business and economic cycles and their behavior. The basic criticism on Basel II from all quarters is related to pro-cyclicality. The new accord makes the business cycle in an economy much more pronounced. It can create problems for policy-makers and also for economic stability. The arguments suggest that in times of recession as the borrower’s credit risk increases, as measured by either of the approaches, the banks will curtail lending, while in a booming economy they will expand lending. The proponents of Basel II, however, have argued that under the new accord the deterioration of a portfolio should begin to be reflected in a bank’s capital adequacy itself at a much earlier stage and no further deterioration should ideally occur in the capital adequacy ratio when it is recognized as an accounting loss. Several options have been proposed for this purpose. For example, discretionary powers granted to supervisors under pillar II, such as the ability to demand a buffer of additional capital during a business cycle expansion, is one way of addressing pro-cyclicality. Another is to adjust the value of the probability of default in the internal ratings approach or advance approaches which draw on the historical trend analysis of the business cycle. Whatever we do, we have to somehow come to grips with this phenomenon. The sixth point is how does Basel II introduce complications for access to finance. This is an area where we have to be careful because there is a lot of scope to enhance funding to the desired sectors and to specific groups of individuals which are currently under-served. First of all it has to be recognized that the banks do have to enhance business and coverage in these vulnerable sectors and vulnerable segments of population. So will this mean that they would require higher capital allocation for assuming what has got to be a higher credit risk? Yes, of course, but this will clearly and hopefully not be a deterrent in encouraging credit flows to the small businesses and poor segments of the society, because we have to somehow accommodate this through better credit appraisal and credit vigilance rather than by adding excessive capital. One aspect which has been clearly underdeveloped in this architecture is how should the credit scoring mechanism be adopted for the small companies? Some advancement has been made in this area in Latin America, and SBP will have to actually look at this area quite closely. I am not advocating a fundamental deviation from Basel II, but rather proposing to find a robust and a workable solution to what I believe is a daunting problem. Another aspect that I will touch upon is the operational cost of Basel II. As we know, the installation of the risk assessment system, the cost of the IT system, hiring of new, technically more competent staff, etc., entails a heavy cost for banks as a pre-requisite for the adoption of Basel II. In Europe, the cost of Basel II implementation was estimated to be over US$ 15 million for some large jurisdictions alone. It is this phenomenal cost which has deterred the United States; it is still deliberating on how to adopt Basel II and has declared that it will adopt a variant of Basel II for its own banks. Finally, my last point is about the cross-border challenges and with this I would like to conclude. The challenges discussed so far become more pronounced when we have free cross-border capital flows. One of the main areas of concern which has been studied extensively, relates to the higher capital requirements in the advanced countries due to the flows that they have towards the developing countries. The conclusion derived from the empirical evidence was that there will be a decline in the banking flows from international centres to the developing countries because of the higher risk perception of their financial systems, and lack of appropriate rating and risk management systems. If not effectively addressed, this will be clearly a deterrent for the western economies to actually send flows to these jurisdictions. The issue surrounding cross-border flows pertains to the difficulty in information-sharing across sectors and across borders. Lack of complete accessibility to information or sharing poor quality information will restrict the credit flows from banks of developed countries into the emerging economies. The most basic step is to ensure that no matter what the stage of development is vis-à-vis Basel II implementation, we should at least ensure accurate information disclosure in accordance with the rules defined in pillar III. This would help, along with the regulators’ strong approach to this architecture, in building the confidence level of the foreign donors and the banks. In my recent meetings with various banks, I have observed that they are taking some important initiatives with respect to the implementation roadmap of Basle II. But clearly the quality and level of these initiatives varies from institution to institution. Large banks that today have more resources, thanks to high profitability, are moving forward progressively. The small banks clearly do not have the capacity and will have to benefit from the learning and the architecture being developed by the large banks which they can adopt with some modifications to suit their requirements. In conclusion, I would like to urge banks to make speedier and concerted capacity building measures for training human resources in targeted fields. IBP and NIBAF will have to transform themselves to actually come up to the challenge of the requirements of Basel II. Banks will have to develop internal risk models and advance risk management systems. But most importantly, I implore banks to strengthen their internal control systems, which are generally substantially weak. We also have to encourage better coordination with our fellow regulator of the securities market. We have to bring in more competition in the credit rating business and in the auditing field. Simply put, we have to set new standards and work hand in glove with the financial industry. | state bank of pakistan | 2,007 | 1 |
Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Banking Association, London, 12 November 2006. | Shamshad Akhtar: Pakistan banking sector – the need for second tier of reforms Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Banking Association, London, 12 November 2006. * * * Introduction 1. Banking sector of Pakistan has been transformed within a short period of 5 years (CY2000-05) from a sluggish and government-dominated sector to a much more agile, competitive and profitable industry. Speed and sequencing of banking sector transformation and its role in promoting economic growth is now a leading story of a sector success. Within Pakistan it offers a story of what effective leadership of regulator and change management and corporate governance can achieve and offer. Outside Pakistan it is serving to offer rich lessons in what difference governance of regulator can make and how bank restructuring and privatization can change the landscape of the industry. At this session of UK’s Pakistan Banking Association I propose to share with you few key elements of this success story. I would however be amiss if I did not share with you the profitability and gains in banking industry and its role in promoting economic growth. 2. The banking industry in Pakistan will continue to enjoy these trends and has promising prospects. However, sustainability of banking sector performance is dependent on continued macroeconomic stability, stronger vigilance on the sector to ensure effective compliance of industry with the prudential regulatory and supervisory framework, and banking sector’s maturity to reorient their business models to enhance their penetration ratio and address the asset: liability mismatches. At Pakistan to ensure macroeconomic stability coupled with effective risk management and mitigation will be critical to Pakistan’s future and a precondition for sustainability of banking sector reforms. 3. The astounding growth of banking sector has stimulated and leveraged growth across the board. Major reforms in the banking sector have resulted in a more resilient and efficient financial system that is better placed to absorb significant macroeconomic shocks. Confidence in banking sector performance and prospects remains strong and scope for expansion and diversification remains phenomenal. This is supported by a combination of factors: 4. Banking sector liberalization and restructuring was well sequenced and well designed. In early 2000, financial sector reforms received strong impetus from high degree of political commitment as well as macroeconomic stability, both a prerequisite for smooth and effective implementation of financial sector reforms. The pace and sequence of bank restructuring was possible as the Government created fiscal space for absorbing the costs of the nonperforming and legacy loans. In parallel the financial deepening process triggered by financial liberalization reinforced and was supported by the rising economic growth and activity. 5. Financial liberalization process in Pakistan has been remarkable. It not only resulted in privatization of large public sector banks but the process of privatization was effectively conducted offering new management in most cases relatively cleaner bank where the key issues of NPL resolution and rationalization of work force were dealt with upfront or ongoing flexibility is awarded through special schemes to deal with the outstanding issues. Augmenting the private sector involvement, the entry requirements for new private banks were relaxed but made more stringent both in terms of capital requirements and fit and proper criteria for both management and Board of Directors. 6. Accompanying financial liberalization process was a strong effort on the part of central bank to bring the prudential regulatory and supervisory framework for banks at par with the BIS standards. Pakistan is fully/largely compliance with the 28 of the 30 Basel Core Principles for effective Banking Supervision and the remaining 2 principles relate to consolidated supervision, and are under consideration for future compliance. 7. Growth in Banking Sector and its profitability is unprecedented. Banking assets rose three-fold over the last 5 years and industry size is reaching Rs4 trillion. The banking sector’s assets to GDP ratio grew from 47.2% in CY00 to 55.6% in CY05 since the growth in banking assets outpaced the nominal GDP; these trends are in sharp contrast from the declining trend in banks’ assets to GDP ratio during the second half of the 1990s. Supported by privatization and consolidation, assets of the banking sector have shifted from public to private sector and there is a decline in asset concentration within the banking sector. This changing structure had far-reaching implications for the banking sector profitability. 8. Return on banking assets before taxes have grown to 2.6% (1.8% after tax) relative to 0.2% in CY00 and return on equity has been 25.4%. Improvement in profitability has been supported by high economic activity but it is important to recognize that sustained economic growth, rather than sporadic improvement in real GDP, helps the financial institutions to earn higher profits. In quantitative terms, one percent rise in the real GDP growth tends to improve the profitability by 113 basis points. In addition, low interest rates and inflation for most of the period in the last four years also supported the financial sector profitability, as one percentage point increase in real interest rates and inflation tends to reduce the ROA by 27 basis points in each case. Pakistan’s economy to a higher growth trajectory during the last four years contributed significantly towards the improved profitability of the financial sector. As per the latest study conducted by the World Bank, Pakistan has been ranked second in performance and efficiency indicators (India being the first) among the South Asian countries. 9. Bank’s profitability has also been driven by changes in assets and liability management; key trends in this area have involved: (i) rise in share of earning assets to 82% indicating a rise of 7% over CY00 but much more relative to pre-reform period; (ii) rising focus on business income has helped raise advances/total asset ratio from 43.8% in CY03 to 54.4%; (iii) while corporate loans remain an important share of lending, the rise in share of SME, consumer finance and agriculture which typically carry higher charge than corporate loans; (iv) deposit as a % of liabilities rose by almost 10% since CY00 and reached 84% in CY05 consequently borrowing to liability ratio declined and banks have access to cheaper deposit funds as a large proportion of deposits were either non-interest or low interest bearing short term deposits, while the share of fixed-term deposits of six-month and above has witnessed a substantial decline. The average cost of resource mobilization for banks (deposits plus borrowings) has fallen from 6.6% in CY00 to 2.5% in CY05; and (v) Operating expenses to income declines from 106% in CY98 to 91% in CY00 and to further 51.2% in CY05 and total expense to income is in the range of 65%. Privatization has significantly contributed in improving profitability of privatized banks, though it has not reduced but enhanced the intermediation spread. 10. Improvements in financial health of banking sector continue. On the wake of this reforms process overall financial health of the banking system improved well and further strengthened since year 2000. Capital adequacy ratio of the banking system now stands at 11.9 percent from 10.9 percent in year 1999. Loan infection ratio has significantly came down to 2.1 percent closer to the internationally acceptable level, as compared to very high infection ratio ( at 15.3 percent) in year 1999. These indicators seem more attractive while looking at the commercial banks perspective only and loan infection ratio for commercial banks stands as low as 1.4 percent in June 2006. Profitability indicators have significantly outpaced the international averages and the ROA after tax of all banks in Pakis tan now stands at 2.1 percent as compared to net losses in year 1999. In terms of their core business activity, the banks are now operating at the capacity significantly higher than was in 90s and the loan to deposit ratio now is around 70 percent. A recently released study conducted by the World Bank on “Getting Finance in South Asia” also evaluates Pakistan, after India, as having higher capital adequacy, lower non-performing loans and stable liquidity position among the South Asian countries. 11. To tackle the problem of non-performing loans, a multi-track strategy was adopted which included enacting of new laws, creation of institutions to pursue recovery of bad loans, and an incentive package for genuine cases (rescheduling of loans of those borrowers who were unable to pay due to economic constraints). Specifically, a new law under the title “The Financial Institutions (Recovery of Finance) Ordinance 2001” was promulgated. 1 The new recovery law provided a mechanism for expeditious recovery of stuck up loans, e.g., the law provided a comprehensive procedure for the foreclosure and sale of mortgaged property, without the interventions of a court of law, and automatic transfer of all cases pending in any other courts to banking courts for their early resolution. 12. Furthermore, amendments were made in the Banking Companies Ordinance 1962 (BCO) to; provide legal coverage for expeditious recovery of loans. To deal with the historical portfolio of stuckup loans of the nationalized commercial banks and DFIs, the Corporate and Industrial Restructuring Corporation (CIRC) and Committee on Revival of Sick Industrial Units (CRSIU) were set up. While NCBs and DFIs were able to clean their balance sheets by transferring a part of their historically stuck up loans to CIRC which would then pursue their recovery independently, CRSIU was set up to valuate the possibilities of restructuring the loans of those industrial units that had became non-operational due to unsustainable debt and were otherwise viable. On the incentive side, while concessions were offered to those borrowers who were keen to regularize themselves, cases of willful defaulters, after due course of law were referred to the National Accountability Bureau (NAB). 13. While political resolve was necessary to tackle the issue of the NPLs, it was equally important to have a dependable infrastructure to provide accurate information on the past credit history of the borrowers. Such information generation entails substantial cost for the lenders, and at times, a lender may opt not to incur this cost, thereby exposing it self to credit risks. The need for setting up a centralized database of the borrower’s credit history was realized early in the reform process and the Credit Information Bureau was set up at SBP. Over the years, the scope, coverage and efficiency of this bureau has been enhanced to meet the needs of the growing financial sector. 14. Within South Asia, Pakistan’s banking industry fares well relative to all financial indicators too. Stepping back, the disproportionately high growth in advances, while improving the profitability, has raised the risk exposure for financial institutions. However, the simultaneous improvements in capital adequacy and relatively better quality of the fresh loans have mitigated the risk so far. Sustainability of banking sector reforms requires second tier of reforms 15. To ensure growth, high profitability and improvements in financial health are sustainable, it is critical that Pakistan maintains macroeconomic stability which lends investor confidence. Not only have the first phase of structural reforms launched in 1999 still to be completed and impact of its implementation yet to take firm roots, SBP has recognized the added urgency to take stock of our achievements and to evaluate where gaps still exist and to design the strategy and road map for the next phase of reforms. Pakistan banking sector is about to enter a long-term secular growth trajectory (Merill Lynch, 2006) 16. Explosion in banking industry has proven that the sector potential is high. The sector is further expected to receive an impetus as Pakistan has a large base of young population (69.5 million having less than 19 years of age - as per Census of 1998) and the country’s per capita income have risen to US $ 526 doubling relative to FY2000 and reaching US $ 847 annually with promising prospects of these levels set to double by 2015. An evaluation of banking sector reforms reveals that preoccupation with the privatization of banking industry and clean up of past nonperforming loans, the reforms executed thus far are partial and incomplete. The diagnosis reveals that while there remain outstanding issues in Pakistan’s banking industry resolution of these offer significant opportunity to the banks to exploit the untapped markets. 17. First, although the banks have witnessed a substantial rise in profitability and improvement in capital adequacy ratios, the asset: liability management practices discussed above have increased the risk exposure of the banking sector, especially in the wake of monetary tightening since Q4-FY04. Few trends were noteworthy: (i) The fall in the share of longer-tenor fixed deposits led to an emergence of maturity mismatch in banks’ balance sheets. In particular, the incremental advances and investment had longer maturity compared with the incremental bank deposits. SBP encourage banks to attract long Vide Ordinance No. XL VI of 2001 dated 30 August 2001 term deposits by reducing cash reserve requirements (CRR) for long tenor deposit while raising CRR on shorter tenor deposits. Besides improving the maturity profile of banks’ liabilities, this measure was intended to reduce the stickiness of bank deposits. Responsiveness of bank depositor to interest rates is expected to drive down the interest rate spreads. (ii) Advances to total assets rose due to strong credit growth and impacted banking systems credit risk and liquidity indicators considerably from CY03 onward as reflected by the rise in advances to deposit ratios and decline in liquid assets to total assets ratios. Surge in advances, with a relatively larger exposure towards high-risk cliental (such as agriculture, SME and household sector) also exposed the banking sector to higher credit risk; the increased maturity mismatches, i.e., higher average maturity of assets than liabilities, have raised liquidity risk. So far the banking sector has effectively coped with the increased risk exposure. While nonperforming assets registered a downward trend from FY01 onward; banks witnessed a strong growth in capital, which stemmed from substantial improvement in profitability and increased in minimum-paid capital requirement. 18. As expected, the indicators for productivity and capital adequacy have shown a positive relationship with ROA of financial institutions.2 The latter reflects that a well-capitalized financial sector is able to tap business opportunities more efficiently and have more flexibility in dealing with problems arising from adverse developments in the operating environment of the financial sector. This also supports the ongoing policy of strengthening the capital base of financial institutions through raising paid-up capital requirement. 19. Second, banking sector reforms have not penetrated deep down or spread across population and regions. Vast majority of the population does not have access to financial services. Country is characterized by lowest savings rates and access to finance remains weak. Few selected indicators are quite illustrative of the situation: Of the 156 million people, the number of deposit holder as per Statistical Bulletin is 26,321,688 which also include multiple accounts by same persons/entities. For a country with a population of approximately 156 million these numbers are abysmally low since it only accounts for less than 17 percent of total population. Enhancement in deposit mobilization and in particular promoting long term resource mobilization – this will require banks to raise deposit rates to stimulate low savings rate which have been partly hurt by low returns and partly by high propensity to consumption. Equally important are steps being taken by central bank to stretch maturity of deposit by charging lower reserve ratio’s for long dated deposits. 20. As per Credit Information Bureau (CIB) records the number of borrowers from the banking system is under five million i.e. 4,781,509 as of end June 2006, which accounts for only 3 percent of the population. Not only is the population underserved but banks are catering to largely urban or semi urban areas and concentrating in similar locations/segments with limited reach to the middle and lower strata of society. Notwithstanding credit to previously underserved markets such as consumer, housing, small- and medium-sized enterprises (SME) and agricultural sectors has expanded markedly and is now being provided by a broad range of financial institutions. Despite this large segments of the economy continue to operate with little formal credit. Credit penetration of banking sector is lowest in Asia pacific: number of borrowers is barely 5 million. Credit/GDP ratio is only 27% of GDP. While rising from under half a percent total consumer loans remains only 3.9% of GDP. Mortgage market currently is only $1 billion. Formal microfinance network which has witnessed significant growth reaches only 770 households with limited coverage to women. 21. In developing a program for access to development finance, SBP is adopting a four-pronged approach: (i) Encouraging the Government to divest its remaining stake in banks. Plans to privatize Smalland Medium-sized Enterprise Bank (SMEB), Industrial Development Bank of Pakistan (IDBP), House Building Finance Corporation (HBFC), Investment Corporation of Pakistan (ICP), and National Investment Trust (NIT) are on cards. (ii) Promoting microfinance industry development In order to avoid the simultaneity problem between equity ratio and profitability, we have included one period lag of EAT as an explanatory variable in the equation. (iii) Leveraging Islamic finance to extend outreach to unbanked people and regions where Shariah compliance products may offer an incentive and appeal to augmentation of financial services (iv) Launching efforts to promote new business models and technologies that will broaden access to financial services in a sustainable and cost-efficient manner. This will require some adaptation of relevant regulations. The progress achieved thus far can be solidified by revising key financial sector legislation, most notably the SBP Act and Banking Companies Act, in accordance with best practice to avoid relapsing into past practices and unwarranted government interference. 22. Third, Banking consolidation is critical to enhance bank’s economies of scale and cost effectiveness while developing strong and robust banks that can withstand business cycle downturns. Central bank has encouraged the consolidation process by enhancement of minimum capital requirement (MCR) in a phased manner to be raised each year by Rs1 billion from Rs2 billion to Rs6 billion by 2009. As of end of September 2006, all the banks, except four, were meeting the Rs2 billion capital requirement and the average capital held by the banks remains higher than Rs3 billion. The process of banking sector consolidation is ongoing but is yet to fully unfold. While some banks have already complied with new MCR, others are following the timetable and another set is seeking mergers with stronger banks. The mergers and acquisition wave is facilitating the process of consolidation. While some small banks are up for sale as they cannot meet capital requirements or do not see themselves as withstanding competition, others like foreign banks are acquiring banks given the attractiveness of Pakistani banks and their profitability and their desire to expand their outreach. Several mergers have taken place and more are expected in near future. The way the financial sector scenario has emerged over the past few years with number of mergers and acquisitions, it is expected that the process would continue at least for the next 5 years. We would have even fewer banks than today owing to capital requirement of 6 billion rupees by the year 2009. A typical figure could be 25 to 30 banks by end of year 2010. In the near future, we foresee at least three mergers/acquisitions transactions per year. Although number of small banks would reduce but the number of foreign institutions are likely to increase. 23. This is largely because while conventional banks are being consolidated, SBP has been licensing both Islamic and Microfinance Banks. The ultimate aim is to have fewer and well capitalized banks of sound repute having a broad based clientele and geographical reach. It is only the sound, and adequately capitalized banks that can take up the dynamic role required in a developing economy like Pakistan. Consolidation is also critical factor to deal with any effects of the reversal of business cycle. At the moment, the economy is enjoying high growth, and the future outlook is quite buoyant. Sound policy making, however, demands that the institutions are strengthened during the boom period to make them resilient against cycle reversal. The rise in interest rates can become a forbearer of economic contraction or at least limited market correction. As such it is important to pursue policies that encourage creation of reserves on the balance sheets of the banks that will act as a cushion in the time of crisis. The recent step of tightening up of classification criteria of NPLs is very timely. 24. Fourth, while banking sector’s profitability has improved, there is need to further enhance competitiveness in the industry Currently, there is high sector concentration as the top five banks (out of total 39 banks) hold more than 50 percent of the industry assets, advance and deposits. The wave towards consolidation of banks is expected to enhance competitive pressures – for instance foreign banks are enhancing their outreach by acquisition of some strategic small banks which have a good branch network and few newer, relatively smaller, private banks have spread their reach to most major cities. These banks are now providing clients an option to diversify their business and not exclusively dependent on nationalized and large privatized banks that were the only sub-groups that had nationwide branch network. 25. Fifth, adoption of new Basel II accord brings in a comprehensive risk management system and links economic capital with the risk assessments. Banking industry worldwide today faces several issues and challenges which unless effectively addressed would impact the pace of adoption and implementation of Basel II. In Pakistan the roadmap has already been given, and the standardized approach will commence from January 2008, while parallel run have been started from July 2006. The SBP’s strategy is to work very closely with the banking industry to ensure that Basel II implementation is well planned and formulation of a Steering Committee is already underway under the guidance of SBP. However simply upgrading banking sector will be quite impossible to undertake unless the allied/support entities (e.g. credit rating agencies, IT systems etc) are also developed. 26. There is, however, a need to provide institutional support for those sectors that are complimentary to the banking sector success yet sufficient market mechanism has not taken roots. At the moment market development is limited in Credit Rating Agencies, private sector Credit Information Bureaus, and independent debt/financial advisories etc. The gaps in the rating agencies are of particular concerns for SBP, given the heavy reliance of Standardized approach under Basel II. Conclusion 27. Central bank is now in midst of evaluating and stock taking of financial sector reforms. While the transformation of financial system is impressive, it is far from complete. Not only is the change more visible in banking and equity markets relative to institutional finance as insurance and pension reforms have lagged and corporate debt market remains small, but the change is more fundamental in the banking relative to even equity markets. Consequently it is no surprise that the banking system assets remain the larger component of financial asset and cater for bulk of financing requirements of the country. The banks also have been engaged in taking advantage of low hanging fruit and have leveraged lack of competition for resources and businesses to the best of their advantage. However, these trends are not sustainable as the economic and business cycles accompanied by changing interest rate environment eventually both global and based on domestic market fundamentals are a reality and call for the banks to be thinking of their long term interests. Banking sector’s long term sustainability requires a more fundamental change accompanied by (i) Greater degree of consolidation to provide a stronger and robust banking system; (ii) A system that is well diversified and competitive; (iii) Stronger corporate governance and risk management aligned to principles of Basel II; and (iv) Financial system which is socially inclusive and facilitates access to financial services. Although finance has help promote economic growth, but its contribution to providing access to finance to poor and disadvantaged region is limited. | state bank of pakistan | 2,007 | 1 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Capital Markets Conference organized by Pakistan Business Council and IFC, Karachi, 5 September 2006. | Shamshad Akhtar: Pakistan’s capital markets – mobilizing for growth Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Capital Markets Conference organized by Pakistan Business Council and IFC, Karachi, 5 September 2006. * * * Good Morning everyone. At the onset I would like to thank Mr. Saleem Raza for inviting me to speak at this conference, and I would also like to acknowledge all the distinguished participants. A lot has been done in Pakistan in terms of financial sector reforms. These reforms have been substantive both in the banking sector as well as in capital markets. We have implemented what you may call the ‘first generation of reforms’ and now we are positioning ourselves for the next ten years. I think there is need to give another jolt to the system and enhance, broaden and deepen the reforms. The first phase has yielded positive results and we are reaping the benefits of that phase. It is in the context of the second generation of reforms that we need to put together all the ideas that come out of international evidence and structure the way forward. This I believe is very important and I hope that today’s forum will give us the opportunity to debate these issues because it’s all about policy choices, and we have to choose a route which is more conducive for Pakistan. Personally I am fascinated and amazed by the changes in the global financial landscape. I think if effectively exploited, these opportunities will augur well for emerging markets in general, and for Pakistan in particular. A few points to note: (i) First, capital today is more mobile than it ever has been and can be readily deployed internationally. I say this because after the East Asian crisis there has been a lot of emphasis on capital flows and their resurgence. Just looking at the numbers from IIF, private capital (net) flows to emerging markets surged in 2005 to $400 billion 1 with 55% by way of equity flows (almost three fourths being FDI and remaining portfolio investment) and 45% private credit flows via commercial banks or other Financial Institutions. (ii) Within this overall global framework there are certain dilemmas, and one of the major issues is that of global imbalances. These imbalances have changed the global and financial market dynamics. Emerging market economies, traditionally the recipients of foreign capital, are a source of net foreign capital outflows and collectively finance the large and growing U.S. current account deficit. More importantly, the accumulation of East Asian reserves and their rise to US $1.7 trillion reflects the real potential of this region to self-finance its requirements and to offer other Asian economies capital, the source of which otherwise has been, in case of South Asia, the industrialized West. So I see the opportunities for Pakistan, to first of all tap the overall pool of resources and within that context, also start looking towards the East Asian region where there is a substantial surplus of available resources. (iii) Third, the enhancement of overall global liquidity, besides serving capital deficit in parts of the world, has cross-border spillovers and largely stems from growing financial integration, particularly among the G8 countries. The level of integration outside these countries varies and there are theoretical studies which point towards that. The fact of the matter is that the financial world is now much more closely integrated than ever before. The integration of financial systems has played a role in enabling the global imbalances to persist and to be easily financed without blocking growth. However, emerging markets which are capital deficient, with external vulnerabilities, do face the risk of exchange rate fluctuations (because of either the dollar weakening viz a viz other currencies, or internal country dynamics) and asset price volatility because of adverse movements in relative stock prices. Generally, the global environment remains benign although there was a very hot debate at the recent BIS annual meeting which I attended, where there was a huge concern that expectations of inflationary tendencies remain both at the regional and international level, and consequently most economies have actually tightened their monetary policies, or at least have withdrawn monetary stimulus on a timely basis which would improve the long term global economic growth prospects and Institute of International Finance (IIF), March 2006. interest rate scenario. Moderation of long term interest rates in many ways is central to the pricing of assets, both real and financial. The world wide movement in interest rates, and also in Pakistan, will help achieve a more realistic realignment of prices. This in turn facilitates global financial stability which is critical for emerging markets, including Pakistan, to benefit effectively from capital flows. These trends that I have talked about offer Pakistan tremendous opportunities, provided that Pakistan pursues and sustains market confidence. Besides political stability, there is need for Pakistan to adhere to its (a) prudent macroeconomic policies, (b) further deepen and diversify financial markets, and (c) to reinvigorate structural reforms that foster productivity gains which will also keep the financial sector alive. These factors are a prerequisite for Pakistan to: • attract and maximize capital flows; • mitigate macroeconomic risks stemming from capital flows; and • develop a well balanced and vibrant financial sector With this global perspective, I would like to offer some views on financial market development in Pakistan. Financial market development in Pakistan has, and will remain, the primary driver of economic activity. I always say that we have changed the economic dynamics in Pakistan. Normally the real sector leads financial market development but in Pakistan financial market development has stimulated the real sector. Over FY00-06, Pakistan has attained an average economic growth of over 5% which, among other factors, has been helped by the growth in overall credit in the range of 16.1% per annum. Private sector credit growth has actually far exceeded these average growth rates in recent years (average annual growth observed in the range of 18.3%). Bank credit has grown rapidly, serviced diverse needs and ventured into new areas such as consumer financing, which has stimulated the demand for durables. However, over half of the credit still flows towards the large corporate sector and in terms of tenor, bulk of the credit is for less than 1-2 years. Furthermore, private sector credit still does not meet the full requirements of the economy. For example, the investment requirements of the infrastructure sector are enormous which conservatively are estimated to be in the range of US$ 39 billion, and in the agriculture sector bank credit meets perhaps half of the real demand, although its share has grown phenomenally. Across the board credit flows to the corporate sector, infrastructure, and agriculture sector, etc are likely to rise as the investment environment improves further. So what do we need to do here? We need to position our banking sector to deliver these diverse sector requirements. Does the financial sector have the potential to meet these investment requirements which are critical to stimulate economic growth to achieve above average trends ? My inference is that there is need to introduce more depth and breadth in financial markets. The M2/GDP ratio – an indicator of financial deepening – has grown in Pakistan, but when Pakistan’s financial system structure is compared with the structures of the East Asian Economies given in the recently published World Bank report, we get an indication of where we stand in the year 2005 : • Bank assets as a proportion of GDP in Pakistan are 56% relative to China (200%), Malaysia (162%), Hong Kong (443%), Singapore (185%) and Philippines (61%). • Equity Market capitalization as a percentage of GDP in Pakistan was 31% in 2005. Although now it has increased to 40% and in fact, went up to 44% in April 2006, but it is still substantially low relative to Malaysia (141%), Thailand (67%) and Korea (90%). • Likewise, the volume of bonds outstanding as a percent of GDP is merely 5.5% in Pakistan compared to Malaysia (90%), Singapore (68%) and China (27%), although in China the bulk of these bonds are sovereign. While Pakistan has definitely improved quite a bit, when we compare ourselves to the region, we are still lagging far behind and for me this is where we should strive to make more inroads. In my view, not only is there more room for banking assets to grow, but more fundamentally, there is now need to finally jolt the non-bank financial sector more strongly. It is indeed noteworthy that the growth of KSE 3 Conservative estimates, as stated in the Medium Term Development Framework, 2005-2010, Planning Commission of Pakistan. Karachi Stock Exchange market capitalization has risen from under 2000 points to over 10,000 points in the last few years, and went on to record highs of 12,274 points on April 17, 2006. Average daily turnover is remarkable, which, at 525 million shares, makes KSE one of the most liquid markets. Likewise the P/E ratio of 9.45 is extremely attractive when compared with average price earning ratios of neighboring countries. Likewise, KSE’s dividend yield ratio also offers good prospects relative to other emerging markets. However, I still maintain that Pakistan’s capital market lacks sufficient depth, breath and maturity. It is prone to structural vulnerabilities and manipulation. This is confirmed by the decline in the number of listed companies from 762 in the year 2000 to 658 in 2006. Moreover, as I have already mentioned, market capitalization as a percentage of GDP is still low and there are very few listed debt securities. But there are promising prospects and with various stakeholders’ efforts, the stock market has achieved many milestones. The Stock Exchanges have fully automated the trading system with a T+3 settlement cycle. The shares are traded in dematerialized form and settlement takes place in a paperless environment through the Central Depository Company and National Clearing and Settlement System. The recent step of implementing the Unique Identification Number (UIN) will substantially strengthen the disclosure regime and will go a long way in bringing more transparency in trading, work as an effective deterrence against market manipulation, and will be very helpful in investigating and probing any wrongdoing. Besides the need for broadening and deepening of reforms, we need to further enhance the efficiency of financial markets and institutions to lower intermediation costs. By and large, Pakistan’s financial sector has performed fairly well within the South Asian context as the system has benefited from the (i) privatization of banks, (ii) consolidation of the banking sector, (iii) strengthening of the prudential regulations for the banking industry; and (iv) introduction and enforcement of corporate governance. According to World Bank’s ranking, Pakistan is marginally behind India in access to finance and efficiency, whereas it ranks the highest in corporate governance in the South Asian region. Final Ranking of SAR Countries Description B'desh India Nepal Pakistan SL Access to Finance 0.57 0.67 0.33 0.55 0.80 Performance & Efficiency 0.51 0.73 0.40 0.70 0.66 Stability 0.50 0.97 0.43 0.68 0.40 Corporate Governance 0.68 0.84 0.68 0.90 0.69 Total 2.25 3.21 1.84 2.83 2.55 Score [Total Points/4 (core indicators)] 0.56 0.80 0.46 0.71 0.64 Rank Source: The World Bank The efficiency of the banking system has improved, and can be gauged by the lower intermediation cost, which has fallen to 2.7% relative to 3.4% in the year 2000. Average earning per share (EPS) has increased. Deposits and Assets per employee have also risen. Likewise, the cost to income ratio has decreased to 42% from 72% in the year 2000. Although some of the efficiency indicators have shown improvement but the problem of high spread belies the story. The very high spreads undermine the efficiency of the banking sector. In the context of the equity market, I believe that the lack of depth and breadth and weaknesses in the price discovery mechanism, with multiple exchange floors and gyrations in equity markets driven by speculative tendencies, undermine the process of stock valuation. The end result is that it is costly for companies to raise capital from stock markets which keeps individual investors, with less appetite for risk, totally out of these markets. Further enhancement of market depth and liquidity by way of listing of more primary issues, promotion of the secondary market in debt securities and strengthening of regulations and their enforcement would help mitigate perceptions and risks. Let me now move to another point that I would like to convey. While in Pakistan there is an emergence of interdependence of the banking sector and capital markets, globally, regulatory frameworks allow a more systematic fostering of the financial sector inter-linkages. This has helped to exploit different segments of the financial sector to mutually reinforce and innovate institutions, markets and products. In Pakistan, the relationship of the banking sector with the capital markets has many facets and I would like to take a few minutes to talk about that because it indicates some interesting trends. State Bank has allowed banks and DFIs to establish subsidiaries for conducting brokerage business and some banks have already purchased membership rights of the stock exchanges and have established subsidiaries. Corporate Governance standards of these subsidiaries and their systems and procedures are expected to be much better and advanced than their peers. This will not only improve the image of capital markets but will also encourage other brokerage entities to improve their corporate governance, systems and procedures. Banks and DFIs have also been allowed to establish Asset Management Companies (AMCs) to float and manage mutual funds. A number of banks have established AMCs and have launched both openended and close-ended mutual funds. This clearly will have an additional impact on improving the corporate governance of listed companies since they own substantial holdings, have significant incentive to ensure that the companies invested in are managed properly, have the requisite negotiating powers as well as the expertise to safeguard the interests of minority shareholders. In addition to this type of inter-relationship between the banking sector and the capital markets, there is another direction in which we have nurtured the relationship. First of all, the prudential regulatory system actually sets the exposure limits of the ownership and cross-share holding and has been set in place to safeguard the interest of the banking sector, which I believe is more stable than the remaining parts of the financial sector. In this regard, the following limits have been prescribed by State Bank of Pakistan for banks and DFIs for their activities related to capital markets: • For lending against shares, banks/DFIs are required to maintain a minimum margin of 30%. • The total investment in shares has been capped at 20% of the equity in case of banks and at 35% in case of Islamic banks and DFIs. • The investment in a single company by any bank/DFI has been limited to 5% of their equity. • The total exposure which a bank can take on a single company in the shape of direct investment in its shares or by lending against the security of its shares has been capped at 30% of the paid-up capital of the company. • Banks/DFIs are also required to obtain prior approval from State Bank if they wish to invest in any company in excess of 5% of their own paid-up capital or 10% of the capital of the company. The reason why I have mentioned these details is because I wanted to show what this prudential regulatory structure has resulted in. Empirically we know that direct investment in the shares of listed companies has grown from approximately Rs. 16 billion in December 2001 to Rs. 38.9 billion by December 2005. Likewise, financing against quoted shares has grown from under Rs. 5 billion to approximately Rs. 39 billion over the same period. The bulk of the liquidity in the capital markets is in the form of CFS 4 or what was earlier called as Badla. (Rs. Million) Continuous Funding System Year Dec 2001 Dec 2002 Dec 2003 Dec 2004 Dec 2005 Financing against Quoted Shares 4,598 7,371 13,393 35,506 38,872 Investment in Shares* 16,132 23,164 29,797 24,623 36,370 Another important statistics worth quoting is that financial institutions represent one fourth of the total market capitalization. The reason why I am going through all of these statistics is to illustrate that there is a regulatory framework that guides this interdependence and defines the regulatory architecture, and moreover, there is a movement towards greater interdependence and inter-linkages. But is this sufficient or should we do something more? What lessons can we learn from international markets? In other jurisdictions and particularly in developed markets, the relationship between the capital markets and banking is much deeper and clearly more interdependent. This has encouraged the development of the mechanism for risk sharing and risk transfers, such as derivatives and securitization, which allows proper financial leveraging by enhancing the risk-bearing capacity. Of course emerging worries about the associated risks and their different dimensions have motivated a fundamental rethinking of the Basle capital adequacy standards, regulations and supervision. Besides complexities of capturing and estimating all types of risks, concerns regarding contagion of volatility in one segment of the market to another, have motivated BIS to define more elaborately the requirements for safeguarding the financial sector by introducing stringent prudential regulation, restraints on counterparty exposures, using joint conglomerate supervision systems to keep a vigilance on risk exposures and, verifying the corporate governance standards by trying to keep them as uniform as possible. Now where do we need to go from here? I think there are two important messages that I would like to convey. The first basically relates to the need for re-examination of the legal and regulatory framework. This brings me to a 2002 paper of mine which I had presented in Japan. At that time there was a big debate after the financial crises on what Asia needs to do to diversify its financial sector. One of the major stresses was on the need to nurture more systematically the interdependence of the capital markets and the banking sector. International evidence suggests that in United States, amendments were made in banking laws which were seen as a way to enable the US banks to remain globally competitive. Adopting this new law resulted in ending 60 years of segregation of activities of banking and securities markets. The US congress recognized that many of the arguments raised in successfully segregating both the activities in the past were no longer credible. So although the new law in the United States today enables banks through financial holding companies’ structures to engage in security market activities through an affiliated brokerage firm, nevertheless the banks are still prohibited from directly engaging in retail securities. Financial holding companies and subsidiaries engaged in brokerage activities are required to register with the US Securities and Exchange Commission. Where brokerage affiliates operate on bank premises, they are required to notify the customers that their securities products are not insured by the Federal Deposit Insurance Corporation (FDIC) and that these are not deposits or other obligations of the bank and are subject to investment risks. Securities affiliates of the bank may also engage in underwriting as long as certain funding and capital restrictions are satisfied. In most continental European countries, the banking legislation does not distinguish between the commercial and investment banks. Any institution authorized to operate as a bank may offer a wide range of financial services. Banks must comply with standard prudential requirements while engaging in these activities and universal banks may also be able to control the equity participation in the industrial firms. The implementation of the relevant European Union directives and the rise of mergers and acquisitions between banks, securities companies and insurance companies support the universal nature of European banking. The US and European banks are able to offer sophisticated financial products, establish international conglomerates putting pressure now on Asian banks to improve the product offerings in their own markets. Although universal banks already exist in many Asian countries, in general, Asia lags behind in this aspect. Not all Asian countries permit universal banking. For example in China, the law strictly segregates banking and securities related activities based largely on the conflict of interest concerns and unique situations arising from the Government’s dominant role in the banking sector and the securities markets, both in the capacity of owner as well as regulator. To me whether we take this route or that route, it is important for us to have some reflection because we need economies of scale, and we need credit diversification and efficient delivery of financial services. In order for us to compete, we need to look at the other structures. Similarly, we all know about what has been going on in the insurance and pension system as reforms there have been delayed so much that I feel that we should now look at more innovative structures. Before we delve into any of these areas, as regulators, we need to reflect about which regulatory framework would be appropriate. Finally the other point which I want to talk about is the need for us to be risk-takers in the financial markets. As a central bank, I feel that we have done our job by introducing the necessary regulations and the framework for derivatives and products of that nature. These regulations provide guidelines for transacting OTC derivatives in the country and currently permit three types of derivative transactions: 1. Foreign Currency Options (FX Options), 2. Forward Rate Agreements (FRAs) and 3. Interest Rate Swaps (IRSs). So far we have managed to grant the status of the authorized derivatives’ dealers to three banks: Standard Chartered Bank, Citibank and United Bank Limited. The use of financial derivatives is a recent phenomenon in Pakistan and the first such real derivatives transaction took place in August 2003 which was a Rs. 100.0 million FRA. During the last one and a half years, the derivatives market has grown considerably. Besides the plain vanilla products as mentioned a minute before, the market is slowly and gradually moving towards more complex and exotic structures. All approvals are reviewed & approved under specific transactional approval process by the Derivatives Approval & Review Team (DART) at SBP. I know that some people would like to see this fast tracked and we have taken steps to do so. Though the specific transactions approved thus far are more complex and include variations of Cross Currency Swaps (CCS), IRS with embedded option, etc, the total volume in derivatives is still very low. In FX options the Pak rupee equivalent is merely 177 million and FRAs 9.650 million and so forth. The numbers are still very small despite having grown substantially. The point of going through these statistics is to highlight that there is a lot of work to be done in this area. In conclusion, I would like to say that Pakistan has phenomenal opportunities in what has been going on globally in terms of private capital flows in terms of the savings that exist due to reserve accumulation in the region. Secondly, we have to be proud of what we have achieved but at the same time we need to remember that there is still a lot more to be done. There are emerging trends of the nexus being developed between the capital markets and the banking sector and other segments of the non-banking sector. However, it is merely a small fraction. Moreover, there are clearly lots of lessons that can be drawn from international and regional experiences of how we can foster these interlinkages and safeguard these effectively with the appropriate regulatory framework. I believe with us moving towards Basel II, while also positioning ourselves at the central bank with better supervision of the joint conglomerates, we should be able to offer these safeguards and oversee things more effectively. So I would like to encourage this forum to deliberate more on how we can go about nurturing this and what further steps are needed to promote innovation in the markets. Thank you very much. | state bank of pakistan | 2,007 | 1 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual Corporate Governance Conference, Dubai, 27 November 2006. | Shamshad Akhtar: Shariah compliant corporate governance Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual Corporate Governance Conference, Dubai, 27 November 2006. * * * The Corporate Governance (CG) for Islamic Financial Institutions (IFIs) is assuming growing significance with the steep growth in Islamic Finance system both regionally and now globally. This industry has become a major source of wealth creation and financing of investment projects world wide and cumulative worth of its transactions are reaching a trillion dollar. IFIs provide a viable option to savers and investors who are inclined to deal with exclusively Islamic financial system given their religious and ideological stance. To the extent that an IFI is principally a company structure it ought to align, adopt and abide by the generic global corporate governance principles and models including the OECD principles of Corporate Governance, originally issued in 1999 1 and other elaborate guidelines that have emerged internationally as well regionally. Islamic finance, however is a specialized industry which is based on Quran and Sunnah. It offers a distinct view on eligible financial transactions and implicitly brings to forefront a rich and superior architecture and texture to the field of corporate governance. The driving force of corporate governance for IFIs on one hand is the concept of justice, moral obligation, accountability, and equality that are fundamental to Islamic ideology and on the other hand, is the nature of permissible transactions which tend to have different risks associated with it than conventional banking business. Long before the age of complex legal documentation and financial revolution, Islam prescribed the concept of writing contracts in financial transactions, and insisted that no party of any contract or exchange should be exploited. This legacy provides IFIs the foundation of good corporate governance which can be well blended and integrated and would reinforce modern principles and models of corporate governance. The uniqueness of corporate governance for IFIs stems from two principle elements: (i) faith-based approach that mandates conduct of the business in accordance with Shariah principles; and (ii) profitmotive that recognizes business and investment transactions and maximization of shareholder’s wealth etc. At times these elements could be perceived to be in conflict with each other and as such corporate governance framework for IFIs has to treat these tensions effectively, while providing an enabling framework that allows ample opportunities of growth and strength of the system. At present Shariah Compliance standards vary across jurisdictions (see Attachment) since in absence of a well conceptualized framework, countries evolved their own framework drawing from their own needs and experiences. At the same time, IFIs encouraged product innovation which moves away from fixed-interest (riba) loan transaction to promoting a contractual arrangement for profit-sharing in businesses. The inherent risks exposures (legal, credit, market etc) in financial instruments is very different from risks associated with loans. An appropriate corporate governance framework would need to recognize these elements and identify risks and challenges associated with the different Islamic contractual arrangements and instruments. IFIs reputation is highly dependent on the perception of customers with respect to Shariah Compliance and issues surrounding investor’s protection given the traditional reliance on the deposit products etc. Key challenges that Islamic banks face need to be tackled effectively. These challenges are interlinked and mutually reinforcing and range from: Reputational risk arising out of any uncertainty on Shariah compliance. Success of an Islamic financial system is based on stakeholders believe that the system is Shariah Compliant. This single factor intensifies the role of good corporate governance to ensure that the faith of stakeholders is not compromised and the system sustains and grows smoothly. The reputational risk factor i.e. loss of OECD Principles of Corporate Governance 2004; Include (i) Ensuring the Basis for an Effective Corporate Governance Framework, (ii) The Rights of Shareholders and Key Ownership Functions, (iii) The Equitable Treatment of Shareholders, (iv) The Role of Stakeholders in Corporate Governance, (v) Disclosure and Transparency, and (vi) The Responsibilities of the Board. faith has to be managed right from the inception of an IFI and the Shariah Advisor/Board are assigned to perform their duties. Commitment of dedicated, qualified directors who understand and can assess Shariah Compliance would facilitate effective oversight and protect the industry from overall reputation risks. Qualifications/experience of Shariah advisors is the key to judge and support the development of Shariah compliant financial services. In absence of this, there is a risk that for short term profits/gains the shareholders/BOD may become willing to compromise on the Shariah principles. The presence of Shariah literate directors would discourage precedence of profit motive over Shariah Compliance. From the regulatory point of view, the licensing stage is of particular importance whereby the licensing authority should demand a clear demonstration of sponsors’ commitment to Islamic banking. Demarcation of responsibility and accountability between Board, Management and Shariah Advisor. Akin to the demarcation issue in a conventional bank between Board of Directors and the Management; is the demarcation essential between the role and functions of Shariah Advisor or a special Shariah Board (as the case may be) as distinct from the Management/BOD. Due to faith-based nature of the business, it is evident that the Shariah Advisor will review most aspect of the businesses but the involvement could vary and focused on approval of basic structure of products and other special activities rather than interfering in day-to-day operations of businesses. Notwithstanding, Shariah Advisor has to be more mainstream than an advisor in a conventional bank. To perform their functions effectively, there is need to enhance the pool and capacities of Shariah scholars in financial business as currently the most experienced Shariah scholars are represented on Shariah Boards of different institutions. State Bank of Pakistan has taken a lead in this direction by requiring that the banks appoint one Shariah Scholar for a single bank only, according to the Fit and Proper Criteria, as a result of which, all the 18 licensed Islamic banking institutions have appointed their own Shariah advisors and new institutions are appointing Shariah advisors. This policy also ensures full time availability of these advisors to guide and monitor the banks on daily basis. Investment policy to comply with Shariah criteria. An IFI can not invest, whether through financing or share purchase, in the companies which are engaged in non-halal businesses. This adds a new dimension to corporate governance which the Board and the management of the IFIs have to fulfill. The investment policy, which has to be consistent with Shariah, is a part of the encompassing corporate strategy to be approved by Board. Investors’ protection. Under the principle of Mudaraba, Investment account Holder (IAH) as Rabb-ul-Mal bears the risk of capital invested by the IFI as Mudarib. This equates the IAHs’ investment risk with the shareholders of IFI who bears the risk of losing their capital as investors in the IFI. Given the IAH would be more risk averse than owners of IFIs, the supervisory authorities should play a role in protecting the interests of the IAH vis-à-vis the shareholders of IFIs with regard to their rights and safeguarding against commingling of funds and/or conflict of interest of shareholders.’ Way for central banks offering Deposit Insurance schemes would be to devise Shariah compliant-Deposit insurance schemes for depositors of IFIs to provide a safety net, while ensuring stability in the financial system. On the financing side, if the funds are invested on Musharaka or Mudaraba basis, the safety of the funds invested would depend on the governance of the borrowing enterprise. The IFIs should be expected to conduct active monitoring of enterprises they invest in under Musharaka or Mudaraba. IFIs relationship with such enterprises ought to be of long-term nature with active involvement in governance in contrast to a short-term, transactional relationship. Among others, some expertise about business of such enterprises would be prerequisite for IFIs for them to assess appropriately business risk and to effectively monitor their operations. Disclosure and transparency. Transparency and disclosure of a structure of product and its strengths and weaknesses are critical and IFIs should be mandated to this discipline. IFIs should further conform to the highest international standards and practices for financial and non-financial reporting and disclosure. Moreover, IFIs should be transparent in the adoption and application of Shariah rules and principles issued by its Shariah scholars. These should be made publicly available through appropriate channels. In line with the IAHs’ rights of monitoring the performance of their investments, they should be entitled to be informed of the methods of profit calculation, asset allocation, investment strategies and mechanics of smoothing the returns (if any) in respect of their investment accounts. Corporate governance framework should ensure, in order to provide relevant information for investors’ decisions, that the disclosure is timely and accurate on all material matters, is in accordance with high quality standards of accounting and disclosure and the audit and review of these disclosures by independent, competent and qualified auditors is carried out. The external auditors of Islamic financial institutions also need to develop expertise to conduct Shariah Compliance Audit and report on their findings to the Shareholders and general public. Harmonization of Shariah rulings. One of the issues faced by Islamic financial industry is lack of standardization of Shariah rulings within the same jurisdictions and among various regions. The diversity provided by different schools of thoughts on same issues at times creates confusion in the minds of general public, but if properly harmonized across the globe, can become a great strength for the Islamic financial services industry thereby providing different options suitable to the varying needs of customers. AAOIFI 2 has taken a lead by preparing Shariah standards approved by 14 renowned Shariah scholars across the world. Some countries have recognized these standards in their regulatory framework, and adoption of these standards in other countries will pave the way not only for Shariah compliance but also product innovation. In addition, the central banks/regulatory agencies monitoring the performance of Islamic financial institutions also need to establish their own Shariah Board for guiding them in formulation of policies and rules as well as for resolution of conflicting Shariah opinions. Vigilance and oversight of the supervisor. As in any conventional bank, the role of the supervisor is critical in ensuring smooth functioning of the institutions. The key element of Shariah supervision is existence of a mechanism that ensures that the Islamic financial system continues to remain viable and growing without compromising the principles of Shariah. This leads me to share with you the experience of Pakistan in the area of Islamic banking. Managing corporate governance in Pakistan’s IFIs is critical given the surge in their assets from Rs6.9 billion in CY02 to Rs100 billion by end October, 2006, growing at an average annual rate of above 300 percent. Growth in assets was well supported by a sharp increase in deposit base; which increased from Rs5.0 billion in CY02 to Rs70.0 billion (annualized growth rate of over 85%) by the end October, 2006. This rapid growth allowed IFIs to increase their share in the overall banking industry to around 2.6 percent. 3 Positioning itself effectively the State Bank of Pakistan has established a dedicated Islamic Banking Department (IBD) that operates in close coordination with Policy and Regulatory Department and Inspection and Supervision departments to facilitate IFIs development. The IBD coordinates with rest of the SBP and banking industry to provide valuable regulatory guidance related to overall Shariah Compliance and specific issues/ challenges being faced by the Islamic banks in Pakistan. Pakistan has adopted a three tiered, somewhat unique, Shariah Compliance Mechanism and process to ensure a deeper and extensive Shariah compliance supervision on an on-going basis. The Shariah supervision mechanism consists of three basic elements. Shariah Advisors for banks undertaking Islamic Banking, a Shariah Compliance Inspection and a centralized Shariah Board for the country at SBP. The first is appointment of Shariah Advisors at each bank undertaking Islamic Banking operations. The fit and proper criteria of the Shariah Advisor are determined by SBP. This criterion is, apart from the usual aspects of integrity and honesty, based on a person’s qualifications both in terms of education and experience in understanding the Islamic financial transactions. Another importance aspect is the person’s qualifications and experience in issuing Fatwas relating to financial transactions. The fit and proper criterion determined by SBP allows for inclusion of all school of thoughts and also includes scholars that have experience and qualification of international level. These Shariah scholars are chosen by the banks, approved by SBP and appointed by the banks to over see their Islamic banking operations. Therefore they serve as SBP’s eyes and ears at the operational level of Islamic Banking operations in the country. The second element is Shariah Compliance Inspection. The inspection manual, which is very comprehensive, was compiled by Ernst & Young out of Bahrain in collaboration with their affiliate in Pakistan. The Shariah Compliance Inspection is needed to ensure that specific terms of Islamic contracts, fatwa on the transaction, as well as the sequence of execution of the agreement are Accounting and Auditing Organization for Islamic Financial Institutions, headquartered in Bahrain. Its Shariah Board consists of 14 Shariah scholars across the world. Table is attached as annexure conducted according to Shariah principles. We are in the initial stages of rolling out Islamic accounting based on AAOIFI standards and the Inspection is geared towards auditing the transactions according to these standards. Next year in addition to the normal SBP inspection, all banks conducting Islamic banking will also have to undergo the Shariah Compliance Inspection. The third element of our Shariah compliance Supervision is the all important Shariah Board. We have instituted a Shariah Board 4 at SBP. One of the unique features of the Shariah Board is the composition of its membership; because the board includes not only Shariah Scholars, but also a chartered accountant, lawyer, and central banker. We believe that Shariah is the pivot around which Islamic banking revolves but in addition there are other disciplines that are critical to the success of executing the Shariah standards. As such we believe that all such critical disciplines must be represented within the Shariah Board so that the rulings emerging out of the Shariah Board are not only 100% Shariah compliant but these are also compatible with the legal and financial infrastructure available to the Islamic banks. The Board is responsible to give ruling on any conflicts arising out of the Shariah Compliance Inspection. It is responsible to provide guidelines to SBP for Shariah aspects of regulations. It helps in product development and provides support for approving any new products developed by the commercial banks. This Board has been functional for almost three years now. The feedback from the industry and SBP experience with the Shariah Board has been excellent. In fact the Shariah Board has played a key role in ensuring an issueless promotion of Islamic banking in the country. All three elements are interactive, and together form the comprehensive Shariah Compliance Supervision mechanism. Each element has been performing its role very effectively. We have been able to make sure that the whole is far greater than the sum of the parts. As such we are very confident that our Shariah Compliance Supervision is second to none and the mechanism we have put in place has worked very well and will continue to do so. This can serve as a model for any other Central Bank that may want to institute Shariah Compliant supervision in its jurisdiction. To facilitate the growth of Islamic banking across borders, I would like to emphasize the need for increasing international cooperation between supervisors in different areas including Corporate Governance. We need more dialogue between supervisors across regions for mutual learning and evolution of international best practices. Our Shariah Board has five members. The chairman is a Shariah scholar of outstanding repute, Dr. Mahmood Ghazi. We have one more Shariah scholar as a member. It is Dr. Imran Usmani, son of the most respectable Maulana Taqi Usmani. We have a lawyer member on our Board, very well versed in laws pertaining to Islamic financial transactions. We have the country’s most eminent Chartered Accountant as the fourth member of the Board. This gentleman also leads the committee of Institute of Chartered Accountants of Pakistan that is adapting the AAOFI accounting standards in the country. The fifth member of the Board is SBP’s Director of Islamic Banking Department, who represents the interests of both the Islamic commercial banks and the State Bank of Pakistan on the Board. ANNEXURE - Growth of Islamic banking in Pakistan Description Dec.-03 Dec.-04 Dec.-05 Jun-06 Oct-06 Total Assets (Rs. in Bn) %age of Banking Industry 0.5% 1.4% 2.1% 2.3% 2.6% 0.4% 1.2% 1.9% 2.1% 2.5% %age of Banking Industry 0.5% 1.3% 1.8% 2.0% 2.1% Full Fledge Islamic Banks Conventional Banks with Islamic Banking Branches Total No. of Branches Deposits (Rs. in Bn) %age of Banking Industry Financing. & Invest. (Rs. in Bn) Note: Two more full-fledge Islamic banks have been granted licenses, which have not started operations as yet. In addition, two more conventional banks have plans to open Islamic Banking Branches this year. Shariah Compliance Framework –Country wise Shariah Committee Country Islamic Banking Law At Central Bank at bank Level Fit & Proper Criteria for Shariah Advisor/ Committee Shariah Compliance Inspection Approval by BNM Governance through Shariah Committee AAOIFI AAOIFI Shariah Standards Accounting Standard All Products approved by SAC, Accounting Standards Role of Shariah developed by MASB Committee defined by BNM Malaysia Islamic Banking Law 1983 Shariah Advisory Council Shariah Committee Bahrain Regulations for Islamic Banks Shariah Supervisory Committee Shariah Supervisory Board N.A Internal and External Shariah Audit as per AAOIFI standards Indonesia Laws for Islamic Banking Introduced in 1992 & Amended in 1999 National Shariah Board Shariah Supervisory Board NSB approves appointment of SSB members Internal and External Shariah Audit Fatwa on products issued by NSB AAOIFI Iran Usury free Banking Act Council of Guardian N.A N.A No Guidelines provided by Council of Guardians Not Known No SFSB Approves Islamic products introduced by Financial Institutions Not Known Essentials for Islamic modes AAOIFI standards are being adapted by a committee of ICAP Brunei Islamic Banking Act Cap.168 Pakistan Banking Companies Ordinance, 1962 and Policies for Islamic Banking in 2001 & 2003 SFSB approves appointment of Shariah financial Shariah Shariah supervisory Board Advisory Board Advisory Board (SFSB) members Shariah Board Shariah Advisor Manual developed Fit & Proper in 2004, now being Criteria by SBP implemented | state bank of pakistan | 2,007 | 1 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Investment Conference organised by Euromoney, Islamabad, 22 February 2007. | Shamshad Akhtar: Pakistan – an investment friendly destination Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Investment Conference organised by Euromoney, Islamabad, 22 February 2007. * I. * * Introduction Pakistan has undergone significant economic and political transformation. Sound macroeconomic management, backed by market oriented policies and a conducive incentive regime, together with political stability and effective regulatory framework have enabled Pakistan to emerge as a viable and investment friendly destination. Today, I propose to (i) review recent developments and their implications on macroeconomic stability, which has been the subject of much debate with the rising fiscal and current account imbalances; (ii) share the story of Pakistan’s economic turnaround and transformation and the factors driving it – this turnaround has helped the country achieve a higher sustainable economic growth that has raised income levels while making some inroads into poverty reduction and employment generation; and (iii) finally offer a perspective on what lends confidence in sustainability of high economic growth, while underscoring that this is possible only if key challenges are effectively addressed to unleash the full economic potential of the country that offers lucrative opportunities for foreign investment. II. Macroeconomic management Macroeconomic stability is here to stay. After a period of low fiscal deficits which scaled down to its lowest level (2.4 percent of GDP) in FY04 and emergence of a surplus on external current account, of 4.9 percent of GDP, in FY03 Pakistan opted to concentrate on stimulating broad based growth and dealing with its increasing infrastructure and social constraints that, unless dealt with immediately, threatened growth prospects. To achieve these goals, Pakistan has had to offer fiscal and monetary stimulus over FY02-FY04, which did complicate macroeconomic management. Indeed, a widening of macroeconomic imbalances relative to the FY04 period was inevitable as the country had to break away from the past to put the economy on a more robust and sustainable path. To set the economy on this course, the Government launched an all time high and aggressive public investment program of $7.3 billion (allowing it to grow by 32.2% in real terms) that constituted 28% of total expenditures. A significant part of these development expenditures was devoted to completing ongoing and launching new development initiatives for physical and social infrastructure. At the same time, liberal and diversified availability of private sector credit stimulated growth across the board in a number of sectors. The growing investment and consumption demands and requirements have widened trade deficit as imports grew by over 35% in the preceding two years (FY05-06). While macroeconomic imbalances enhanced demand pressures, they have stimulated economic growth to 7.4% on average over FY05-07. Macroeconomic stability was managed by a combination of policies and availability of foreign inflows supported by enhanced investor confidence and presence of global liquidity. Firstly, the central bank has adopted a hawkish monetary stance for almost two years which has now paid dividends as inflationary pressures emerging from rising aggregate demand have been mitigated – CPI and core inflation on a year-on-year basis is down from 11.1% and 7.8% in FY05 to 6.6% and 5.3%, respectively effective January 2007 – an all time low relative to June 2004. Secondly, higher remittances inflows (rising from $1.1 billion in FY01 to $5.5 billion in FY07) have helped finance, on an average, 98% of trade deficit. Thirdly, the privatization program was pursued effectively along with a drive to attract foreign direct investment – both of which mobilized cumulatively $10.0 billion and helped finance 75% of the country’s external current account deficit during FY05-FY07. Fourthly, the reduction in debt/GDP ratio in line with the dictates of the Fiscal Responsibility Act has helped enhance the sustainability of macroeconomic imbalances. Finally, due to strong foreign inflows coupled with effective reserve management Pakistan has, over 6 years, built up its SBP reserves, which are set to reach over $14 billion by end June 2007 thereby offering more than 6 months of import coverage. Positive economic developments over the past few years have facilitated Pakistan’s return to international credit markets and all the sovereign issues have been over subscribed with tight spreads – enabling establishment of a yield curve in a remarkably short time. Together, these developments have jolted up the investment/GDP levels, which are expected to grow to 21% in FY07, after stagnating at the level of 17% over the previous five years. These achievements appear more significant if viewed in context of Pakistan’s proven economic exogenous shocks such as the rising international oil prices which accounted for 1.9% of GDP (and 20% of the trade deficit), and expenditure demands for earthquake related relief and rehabilitation efforts that accounted for another 0.8% GDP. Continued economic vigilance on emerging trends is however critical to strike a balance between growth and macroeconomic sustainability. III. Economic turnaround and transformation High economic growth is accompanied by structural changes. Compared to the rest of Emerging Asia, recent economic growth track record puts Pakistan’s GDP growth rate in the top half of the region’s fast-growing economies. Underlying this has been a significant, albeit slow, structural transformation. The main features of this transformation have been: (i) The emergence of a vibrant and buoyant services sector, which grew by 8.8% in FY2006 and now accounts for 52.3% of GDP – this has been led by developments in the finance & insurance, wholesale & retail trade, transport, storage and communication sub-sectors. (ii) Growth in large scale manufacturing sector (over 14% on average over past three years compared to average growth of 3.5% in the 1990’s) led by textile sector, which benefited from opportunities emerging from post MFA regime, 36.8% growth in automobiles, 45.5% in electrical goods, 19.6% in cement, and 32.1% in fertilizer etc. in the last three years. Besides new capacity additions, this growth was stimulated by rising real consumption expenditure and construction demand. Capacity enhancement and utilization is at an all time peak. Industrial growth is accompanied by a degree of industrial diversification and emergence of new entrepreneurial class, though more effort is warranted to move Pakistani industry away from its traditional dependence on resource-based and low technology based processes. (iii) Having achieved self-sufficiency in major crops well in 1980’s, Pakistan’s agriculture sector has benefited from improvements in pricing regime for major crops, deregulation of inputs and trade liberalization. Excluding crop failures due to bad weather, agriculture grew on average in last 3 years by over 3.8%. According to Food and Agriculture Organization (FAO) Pakistan is ranked 4th in cotton, 5th in sugar, 9th in wheat and 12th in rice production in the world. In addition, Pakistan is ranked among the top ten producers in several of the minor crops, which are mostly fruits and vegetables. The remaining half of the agriculture value addition is contributed by non-crop sector mainly livestock, which has helped Pakistan rank as the 5th largest producer of milk. IV. Factors contributing to economic turnaround Enhanced market orientation and openness. Opening its markets in late 1980s, Pakistan has amplified and deepened its structural reforms over the last 5 years. Keeping aside ideological or philosophical consideration and the Government’s fiscal compulsions, industrial, trade and price liberalization has infused high degree of competition which is auguring well for efficient allocation and use of resources. Private sector is allowed in all strategic sectors such as oil, gas, telecommunication and other services sector on a competitive basis which are supported by sound sector policies. Service providers in telecom are emerging as large giants and have enhanced country’s wireless penetration to reach 29% in November 2006 with the total cellular subscribers at 46 million. Moreover, the intense competition has also reduced call costs, increased outreach and offered increased services to the customers. The increasing penetration will invariably play a part towards increasing the market potential of a host of other activities conducted through cell phones such as banking, remittances etc. Since early 1990s, Privatization Commissions has processed 161 privatization transactions resulting in sell off of public assets of Rs. 378 billion. All manufacturing sector, 80% of the banking assets and strategic stakes of utility companies have been sold off to private sector. With scaling back of government’s role, the share of private sector in investment has risen steadily from merely 7.8% of GDP in 1980’s to over 13% of GDP in FY 2006. At the same time the share of public consumption expenditure has reduced over time to less than 10% and now private consumption expenditure accounts for more than 90%. Banking sector is catalyzing real sector development. Banking sector reforms are far reaching. Aside from their impact on depth and efficiency of financial intermediation, the profitability of banks has allowed them to earn high returns, which has attracted foreign interest and encouraged existing owners to expand and/or strengthen their businesses. Banks have not only cleaned up their own balance sheets but have impacted real sector development in a number of ways. The private credit growth in last few years has been significant reaching over 30% in FY06. Private credit grew from insignificant levels to over Rs. 400 billion in FY06. The credit expansion fuelled economic activity, while reviving and enhancing industrial and other capacities. Credit diversification has helped achieve a degree of economic diversification too. While the corporate sector accounts for almost half, within it all segments of industry received higher credit. Of the total outstanding, agriculture credit constituted 6.4% but more phenomenally, it grew by almost 4-5 times. Credit was also made available to non-crop sector by laying down guidelines for promoting credit access to livestock, fisheries and dairy sector. Improved access to SMEs was also possible and its share in total outstanding grew to 16.1%. Consumer financing, which was not available in the past, rose to 14.3% of the total outstanding. Companies’ access to required level of financing, foreign loans, swaps and derivatives etc. have all been accommodated to allow market to innovate and expand. There is considerable scope for banks to enhance their business through extending financial penetration and outreach both across country and sectors. Banking sector has grown both in size and strength and is positioned well to meet economy’s requirements as it grows. Ownership and structural changes in banking system will facilitate this process. Foreign interest and presence has grown and at present foreign stake comes to 47% of total paid-up capital of all the financial institutions regulated by State Bank of Pakistan. Structural changes have been significant. Besides higher standards of corporate governance at management and board level, the banks are adhering to SBP prudential regulations which are consistent with BIS standards. Technology is being fast adopted and over 45% of bank branches are connected with head office, along side growth in ATMs, debit and credit cards. Foreign investment is flowing in. Economic activity has and will be further boosted by efficiency gains once the full impact of foreign investment is realized after the completion of projects financed by FDI. During FY04-06, Pakistan has cumulatively attracted $8 billion foreign investment flows – 26.5% was sale proceeds of public assets and 49.2% from FDI, with remaining coming from foreign portfolio investment. These foreign inflows have come into banking, telecom and oil and gas sectors primarily. Prospects are that Pakistan will attract about US$6.0 billion in FY07 – an all time high annual flow. Going forward, foreign investment is expected to be more diversified and will support infrastructure development, manufacturing, tourism and hotel industry etc. The strong interest in Pakistan stems from (i) growing investor confidence in the economy, (ii) comfort to foreign investors that they are treated at par with domestic investors (and in some respects even better), (iii) high returns on investments as evident from exceptional corporate and banking profitability and (iv) supportive and stable policies. Besides full foreign ownership, investors can repatriate their capital, dividends and profits and there is no restriction on the level of royalty payments. Foreign investors are eligible for low import duties between 5 and 10% on plant and equipment and a first year tax allowance on profits of between 50 and 90% of the cost of plant and equipment. Measures have also been taken to introduce an Intellectual Property Rights regime compatible with the WTO. Rules governing FDI have been significantly liberalized. Furthermore, the investment climate has improved as a result of policy initiatives such as the streamlining of procedures required to start a business and the measures taken to minimize the time that businesses spend dealing with government inspections. To facilitate foreign portfolio investment, Special Rupee Convertible Account (SCRA) has been established to allow remittances and non-residents to bring money in and out of Pakistan. The amount accumulated in this account can be used for purchasing as well as trading shares quoted in the stock exchange as well as other approved securities. Foreign exchange regime has also been liberalized and exchange controls have been lifted. Business processes are being rationalized and simplified. Reforms, both of incentive and administrative regime, have helped Pakistan to improve its ranking in the Survey conducted by the World Bank on ‘Doing Business in 2007.’ Pakistan now ranks 51 in the time to import (which has reduced from 39 days to 19 days) as trade logistics and customs procedures were streamlined and scores well on the indicators related to starting a business (54th out of 175) and protecting investors (19th out of 175). V. Growth sustainability and prospects Pakistan’s real GDP growth rate has risen in recent years, averaging 7.4% in the preceding three years. This is well above the long-term (50 years) average growth rate of 5 percent. The strong growth momentum has stressed the productive capacity of the economy as evident in macroeconomic indicators such as rising inflationary pressures and a widening external current account deficit. These developments naturally raise questions regarding economy’s potential to sustain this momentum. The current growth momentum in the range of 7% can indeed be maintained, though this requires: careful calibration of macroeconomic management and removing bottlenecks that are impeding growth and economic diversification. With declining poverty 1 and growing employment opportunities, viability of Pakistani market is further enhanced as domestic private consumption has been supported by improved incomes and remittances. To ensure sustainable economic growth, Pakistan will need to maintain macroeconomic stability by gradually reducing the twin deficits. Besides prudent expenditure management, this will require broadening of the tax base to effectively finance growing expenditure obligations. Sustainability of external current account deficit calls for raising exports earnings to finance the increasing imports requirement. Imports will remain strong as the economy’s requirements for capital and intermediate goods for industry grow. Balance of payment position will benefit from industrial diversification which is critical for export diversification as well as for encouraging import substitution (particularly in food commodities) where Pakistan has competitive advantages. Any pressures on aggregate demand because of slippages will need monetary tightening as central bank would remain committed to the objective of price stability. To realize these goals, Pakistan needs to now direct investment flows, both domestic and foreign, to areas which can help stimulate industry and its diversification, and help remove gaps and bottlenecks in the infrastructure. Pakistan offers opportunities to exploit gas and coal reserves suitable for power generation and hydroelectricity generation. The geographical proximity to energy rich regions, Iran and Central Asia, position Pakistan to emerge as a regional hub for energy. The investment requirements for the development of energy sector are in the range of $20 billion in medium term to around US $150 billion by 2030. National Trade Corridor Plan (NTCP) equally offers opportunities to connect all major physical infrastructures such as ports, roads, railways, aviation etc. Besides connecting Pakistan with its neighbors it will enhance trade and improve market access, while saving fuel and transport costs. Pakistan has set up an infrastructure Project Development Facility to facilitate initiation of these projects through credit enhancement and financing institutions are geared up to adopt different approaches and modalities to leverage and intermediate financing flows for infrastructure. Opportunities also exist to enhance production by enhancing productivity, efficiency and economic diversification. To diversify, Pakistan has to make inroads into the medium and high-end technology products such as electronic goods, automobiles, engineering goods etc. and to look for newer markets. In agriculture, implementation of mega water resources projects will enhance crop yields. Besides increasing value-addition, market-based pricing (e.g. as done for rice and wheat), improvements in transmission of pricing signals to farmers (e.g. through introduction of a commodity futures market), development of crop insurance (particularly to encourage the raising of new cash crops such as oilseeds) and improvement in transportation and storage infrastructure will contribute to enhancing agricultural productivity. Development of agro-based industry and processing and packaging of products would further stimulate export of these products to the neighboring Middle Eastern markets. With a strong base of economically active population, Pakistan has an edge as it is a low wage economy – average wage is close to $75-$100 a month for unskilled workers, $100-$200 for skilled and for managerial workers, it ranges from $200-$500 a month. To enhance skills, an aggressive technical education and skill development program exists under the Medium Term Development Framework. Investment climate will benefit further from the ongoing efforts and strong commitment to rule of law, developing a competent and efficient government sector, less cumbersome regulations and control of corruption. The overall poverty has reduced from 34.46% in 2001 to 23.90% in 2005. The percentage of population living below the poverty line in rural areas has declined from 39.2% to 28.1% while that in urban areas has declined from 22.7 percent 14.9 percent. In other words, rural poverty has declined by 11.2 percentage points and urban poverty has reduced by 7.8 percentage points. Finally, besides banking sector, the large financing requirements of infrastructure and of agriculture sector (ranging above Rs130 b) can be met but require financial diversification. The long-term domestic debt market is still under-developed and corporate debt issues account for less than 1% of GDP. Similarly, Pakistan boasts an extremely liquid equity market but it remains dogged by high degree of speculative transactions that have led to periodic bouts of instability and claims of market manipulation. Given the importance of long-term debt markets to support investment, particularly in infrastructure projects, to increase domestic savings, and improve the risk profile of commercial banks (which currently face mismatches in lending and deposit profiles), Pakistan needs to foster development of long-term institutional savings industry (pension and provident funds, mutual funds, etc.), implement capital market reforms aimed at encouraging investment rather than speculation, and improve risk management in the financial sector to ensure financial sector stability. Conclusion In conclusion, Pakistan offers endless possibilities with its vast untapped resources. The country is set to grow at a rate of 7% per annum which should help to further raise its per capita income from US$847 per annum to US$ 1557 by 2015. Demand is expected to get stronger as incomes rise further and assuming current population growth trends persist. Pakistan’s strategic geopolitical position, due to its proximity to India and China as well as to the oil rich Middle East and untouched central Asia with vast natural resources, potentially carries opportunities which to date have not been properly exploited. Promising for private sector would be the large infrastructure projects which would offer high return in long term but would help enhance access and efficiency in movement of goods within and outside Pakistan. If done right, Pakistan can easily integrate itself into the export value added chain of the region as there is adequate room for further growth; investment in these sectors is thus highly feasible. For example, Pakistan still stands relatively low in terms of motorization when compared globally and even within the region. Automakers need to take this into account as the demand clearly exceeds supply. Likewise the supply of electronic goods is still short of the potential demand and any increases will be absorbed by the population which is growing and expected to double over the next 25 years. In future, the demand for energy, cement, fertilizer, and leather products is expected to increase. The energy demand over the next five years is expected to grow at a rate of 7.4 percent per annum and over the next 25 years it is expected to be 7 times the present demand.2 Thus the sectors, particularly those discussed above, remain attractive for foreign investors due to strong consumer spending patterns and rising industrial activity depicted by past trends and strong future demand. Likewise, banking sector has to position itself to extend its outreach, which will play a key role in sustainability and in diversifying risks. For long term sustainability and to maximize the development impact, small and medium enterprises should be encouraged and further developed as they will be able to fast restructure themselves as and when warranted and will play a more critical role in employment generation. Besides bringing in much needed capital, increased foreign presence is expected to help Pakistan integrate better globally and regionally, enhance skills and techniques and transfer and increase usage of technology. It is our belief – so far reinforced by experience – that private sector participation and foreign investment are going to be the cornerstone of our future economic strategy. According to Planning Commission, presently the energy demand measured in MTOE was around 50 MTOE in 2004 which will increase to 79 MTOE by 2010 and 361 MTOE by 2030. | state bank of pakistan | 2,007 | 3 |
Lecture by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Graduate Institute of International Studies, Geneva, 1 February 2007. | Shamshad Akhtar: Pakistan – banking sector reforms: performance and challenges Lecture by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Graduate Institute of International Studies, Geneva, 1 February 2007. * A. * * Introduction In recent years, growth and turnaround in Pakistan’s banking sector has been remarkable and unprecedented. Classified as Pakistan’s and region’s best performing sector, the banking industry’s assets have risen to over $60 billion, its profitability is exceptional and at an all-time high, nonperforming loans (NPLs) are at an all-time low, credit is fairly diversified and bank-wide system risks are well-contained. Almost 81% of banking assets are in private hands. Likewise, the present foreign stake comes to 47% of total paid-up capital of all the financial institutions regulated by State Bank. Given its achievements, Pakistan’s banking sector reforms offer a useful insight into design-specific lessons for countries venturing to restructure and reform their banking sectors. Dwelling on these lessons, I propose to further outline the significant impact and benefits of banking sector reforms of Pakistan on its population and economy. While a lot has been done and achieved, sustainability of banking system requires the banking industry to position itself to address the emerging challenges and complications, commonly observed in the post-banking liberalization era. Recognizing this, the State Bank of Pakistan (SBP), in partnership with the industry, plans to implement the outstanding reforms agenda, while also taking new initiatives, to broaden and deepen the banking system. B. Banking sector design-specific lessons The first lesson learnt from Pakistan’s banking sector reforms is that the reform strategy needs to be broad based and well sequenced. The reforms must be all-encompassing; resultantly the process is arduous, complex and continuous. Pakistan’s banking sector reforms have been launched and implemented over 1990s. The pace and sequencing of these reforms were aligned and sharpened to provide a major impetus towards the end of 1990s. Deregulation and restructuring took a strong foothold in Pakistan as the Government decided to privatize banks and allow liberal entry of new banks. Simultaneously, SBP removed all restrictions and barriers on banks’ conduct of business by 1997/98 which included: (i) removal of floor and caps on interest rate structure by 1997-98; (ii) abolishment of concessional lending schemes (except for Locally Manufacturing Machine and Export Finance scheme); and (iii) lifting the cap for project financing. Accordingly, banks and NBFIs were able to set their lending rates in relation to the demand/supply conditions in the market. While promoting banking sector liberalization, SBP ensured introduction of effective and comprehensive regulation, consistent with international standards and best practices, and implemented institutional restructuring and strengthening. Carrying forward the bank restructuring process in 2007, the Government is planning to float Global Depository Receipts (GDRS) of few large banks by offering a proportion of their shares in international markets. This should help to further dilute government holdings in large banks. Taking cue from the minimum capital requirements (MCR) imposed by SBP, market led mergers and acquisitions (M&A) are helping consolidate and, as such, develop stronger and robust banking sector. The second lesson is that effective monetary policy and conducive economic environment facilitate transition and augment impact of reform. The dismantling of credit ceiling, both at sector and bank level, and the switch to market based indirect monetary instruments improved the quality of monetary management. These measures, along with the move of the Government to market based pricing of central bank borrowing, helped reduce fiscal subservience of monetary policy. Macroeconomic stability (following the lowering of fiscal deficit and external current account deficit over FY2002-03) provided an environment for central bank to ease monetary policy, which helped bring down interest rates to historical low of 5.05% 1 by June 2004. The third lesson that emerges from the banking sector reforms is for the regulator to have effective powers and capacity to lead and implement reforms. Prior to the reforms, SBP’s autonomy was limited and its supervisory domain was undermined by the Pakistan Banking Council (PBC), a body formed to oversee the affairs of the nationalized commercial banks (NCBs). Moreover, the supervisory framework lacked proper risk mitigation elements and supervisors lacked requisite supervisory skills in this regard. In addition, the regulatory capacity was inadequate to regulate a market oriented financial system. In 1997, SBP legislation was amended to enhance SBP’s independence and to empower its Board more effectively in monetary management matters. Furthermore, PBC was abolished and central bank staff was trained in relevant areas to build capacity at all levels. There has been considerable accomplishment in terms of central bank obtaining the necessary understanding and leadership for steering the process of bank reforms. SBP is now equipped to deal with numerous transition challenges that are commonly observed, given the state of economic development, governance and political economy, in developing countries. Another lesson learnt from Pakistan’s banking sector reforms is that bank privatization succeeds if accompanied with appropriate debt and labor restructuring. In early 1990s, the Banks (Nationalization) Act, 1974 was amended to empower the Government to sell all or any part of the share capital of NCBs and to allow entry of new banks. The Privatization Commission Ordinance laid down the legal framework for privatization and provided for the establishment of Privatization Commission, which facilitated banking sector privatization. The process was led by competent transaction teams who conducted valuation and structured deals in a transparent manner. Pursuant to nationalization, weaker banks were merged with relatively bigger banks involving regrouping of 11 banks into five large banks. Of these, four banks were subsequently privatized and strategic shareholding of two large banks is now with foreign parties. In addition, the Government has offloaded 26% stake of the largest bank, National Bank of Pakistan through the stock market. Presently, the top five banks cumulatively account for 52.6% of banking assets. In parallel to privatization of NCBs, SBP over the last 16 years or so licensed 28 new banks, of which six are microfinance banks and five Islamic banks. Success of Pakistan’s privatization program emerged from a well coordinated effort to recognize upfront need for change of management, debt and labour resolution. The Government facilitated bank restructuring process by recapitalization of banks through (i) equity injection of Rs46 billion in some of the public sector banks and write offs equivalent to Rs51 billion, (ii) lay off of close to 35,000 employees in two phases 2 from public sector banks and (iii) closing of over 2000 unbanked branches. To reduce the level of NPLs, the Government and SBP coordinated to establish the Committee for Revival of Sick Industrial Units (CRSIU) and the Corporate and Industrial Restructuring Corporation (CIRC) which together have enabled debt recovery of Rs15.1 billion, while settling write offs to acquire the NPLs of public sector banks. Creation of a National Accountability Bureau (NAB) Cell at SBP to expeditiously process the cases of wilful defaulters has further facilitated debt resolution. Moreover a special law, the Financial Institutions (Recovery of Finances) Ordinance, 2001 was enacted with a view to facilitate speedy recovery of loans. SBP also introduced a special scheme to speed up the recovery of NPLs. Under this scheme, borrowers were allowed to settle their obligations on the basis of Forced Sale Value vis-à-vis outstanding amount, whichever is lower. Borrowers were required to deposit 10% down payment at the time of signing of settlement agreement and repay remaining amount in 12 quarterly instalments. The scheme encouraged a lot of defaulters to come forward and settle their long outstanding liabilities. Finally, it is important to recognise that quality of ownership and professional management are key to success of privatization. While launching privatization of state owned banks, in early 1990s, the Government eased entry requirement and allowed issuance of a number of bank licenses. Under the criteria, Guidelines for Setting up Commercial Banks, Pakistan has for long allowed and had foreign banks in the country. Banks are encouraged to be set up as local subsidiary along with strategic holding of up to 49% or they can conduct banking business in branch mode or as a wholly owned, locally incorporated subsidiary provided these are: (i) banks from countries belonging to Weighted average marginal lending rate In the first phase (1997) 24,000 employees were laid off and in the second phase around 11,700 employees were relieved. regional groups and associations of which Pakistan is a member and (ii) foreign banks with global tier1 paid-up capital of US$5 billion or more. Moreover, on a case to case basis foreign banks may be allowed to open a wholly owned subsidiary. Aside from change of ownership to private sector, central bank through its fit and proper criteria has encouraged appointment of professional management and Boards at the banks so that those charged with the responsibility of management and oversight have due competence, integrity and qualifications. C. Trends, impact and benefits of reforms The sustainability of transformation in banking sector, in any environment, is critically dependent on reforms’ success in (i) promoting higher degree of depth and efficiency in financial intermediation process by effective resource (deposit) mobilization and channelling these resources to productive sectors at competitive pricing, thus playing a critical role in promoting economic growth; (ii) strengthening the financial performance and soundness of banks; and (iii) extending the outreach of financial services to under-served/un-banked segments of the society. Depth and efficiency of financial intermediation in Pakistan has improved. This is captured by the rise in: M2/GDP ratio from 36.6% in FY00 to 44.2% in FY06; bank assets to GDP ratio from 49.1% in 1997 to 55.6% in 2005 and deposit to GDP ratio – an indicator of the level of financial savings – from 38.7% in 1997 to 43.1% in 2005. More significantly, equity market capitalization grew from merely 10.3% of GDP in 2000 to 37.1% of GDP in 2006. Equity markets benefited from sizeable growth in banks and their performance. Now banks constitute almost 25% of market cap at Karachi Stock Exchange and valuation of their shares is quite high with commercial banks’ P/E ratio of around 10x in December 2006. Despite significant improvement in financial indicators, relative to its regional comparators, Pakistan’s financial market has a relatively lower depth and penetration (see para. 24 below). Moreover, Pakistan’s financial system continues to be predominantly bank based with the bond markets barely constituting 5-7% of GDP and the low pension and insurance coverage. Profitability and financial soundness of banks is impressive and Pakistan’s performance indicators in this area are amongst the best in its regional peers. The profits of commercial banks crossed over $1 billion for the first three quarters of calendar year (CY)2006. Over CY2000-September 2006, return on assets of banks rose from negative 0.2 to 2.1 and return on equity from negative 3.5% to 26.1%. Banks’ profitability has been driven by a combination of factors. These include (i) a rise in earning assets of commercial banks to 85% in September 2006 which is significantly above the prereform period and a rise in advances to total assets from 49.1% (CY2000) to 55.1% (Sep 2006), (ii) a decline in the total and operating expense to income with latter being half the pre-reform period, (iii) a rise in the SME, consumer finance and agriculture sector lending which constitutes over one third of total outstanding advances and typically is priced above the average lending rates and those prevailing for larger corporate clients, (iv) a high share of non interest bearing or low yield deposits, while share of fixed term (above 6 months maturity) deposits declined and (v) a substantial growth in service charges which are emerging as a new source of revenue as electronic banking is taking hold. A SBP study has highlighted that privatization has had distinct impact on profitability of the banking sector, though its impact on efficiency is relatively weak. This is largely as older and larger banks need more lead time to enhance their capacities and develop their internal control systems to improve efficiency. It is expected that over the period there will be more progress in these areas. Industry wide capital adequacy ratios (CARs) are high while NPLs have scaled down. Risk weighted CAR for banks has increased from 11.3% in December 2005 to 12.7% by 30 September 2006: Tier 1 capital to risk weighted assets rose from 8.3% to 9.8% and capital to total assets from 7.9% to 8.8%. Aside from recapitalization, banks’ capital adequacy ratios have benefited from new capital injections and/or re-ploughing of profits as banks are required to raise their capital base. Debt settlement and recovery (see para. 12 above) coupled with introduction of sound prudential regulations, vigilant supervision and stricter enforcement of these regulations have facilitated a sharp fall in NPLs to total loans and net NPLs to net loans ratios to 7.7% and 1.8%, respectively over CY2000-September 2006. State Bank of Pakistan: Financial Sector Assessment (FSA), 2005: See Annex A. Growth in private sector credit and underlying sector diversification has improved. Set to expand businesses, in the last three years, banks have recorded a record growth in private sector credit which reached close to Rs402 billion ($6.7 billion) in FY06. This has helped serve the economy well in a number of ways. It has fuelled economic activity, revived and enhanced industrial capacities, met crop and non-crop requirements and has supported steady growth in services sector whose contribution to GDP has grown to 52.3%. Presently, the corporate sector accounts for almost half of the total credit outstanding, credit to agriculture sector now accounts for 6.4%, SME-financing accounts for 16.1%, and consumer financing accounts for 14.3% of the total credit outstanding. To enhance the reach of the banking system and serve the society’s credit requirements, SBP encouraged systematic development of microfinance sector as well as Islamic financial institutions. Primarily in informal sector, the microfinance industry is now being nurtured in formal sector. The Microfinance Ordinance, 2001, supported by SBP’s dedicated prudential regulations, provides the legal and regulatory framework for microfinance banks, which is consistent with the best practices. To date, SBP has approved licenses for six microfinance banks 4 but these banks have only recently been operationalized so their impact has yet to emerge. Islamic banking is gaining a foothold in Pakistan as SBP has issued licenses to six Islamic banks and allowed a number of conventional banks to offer Islamic window. SBP is working with the industry to promote Shariah compliance regulatory and supervisory framework. While still at a nascent stage, constituting only about 2.3% of industry assets, the growth in Islamic banks has far exceeded the growth observed in larger Asian markets. Consolidation of banking sector helps develop a stronger and robust banking system but it requires regulator’s determination and industry’s dynamism to launch effective mergers. To encourage a consolidated banking sector, SBP called for a phased increase, over a period of five years, in the MCR of commercial banks to eventually reach at least Rs6 billion ($100 million) by the year 2009. Domestic private banks have either injected own capital or sought alliances and partnerships to augment capital; alternatively domestic or foreign banks have stepped in to acquire mid- or small-sized banks to expand their capital and outreach. Excluding specialized financial institutions (such as microfinance and Islamic banks who have been allowed new licenses) SBP has imposed an embargo on new conventional bank licenses. The process of capital enhancement and consolidation has progressed well. Of the total 39 commercial banks (excluding microfinance banks that enjoy lower capital requirements), eight banks have complied with 2009 stipulated capital requirements and 16 banks have raised capital to meet 2006 MCR, while other 11 banks are well on their course to meet the prescribed MCR. There remain four banks that are either in the process of being privatized, such as SME Bank, or those with specific mission/objective, such as the First Women Bank, who remain below the stipulated requirements. While capital injections have been spurred by the possibility of recourse to capital markets or foreign interest in banking system, the impetus to consolidation emerges from the wave of M&A, which in turn is driven by foreign interest in Pakistani banks triggered by their profitability. There has been a growing foreign interest. Existing foreign banks have by and large enhanced their presence and stake in Pakistan and some new foreign banks have entered for the first time. Since the year 2000, 30 M&A have taken place. At present foreign stake comes to 47% of total paid-up capital of all the financial institutions regulated by State Bank. The most sizeable deal of $513 million was struck by the Standard Chartered Bank which acquired a mid-size strong local bank (Union Bank). This is being followed by others such as ABN-Amro, NIB and Citibank etc. that are contemplating acquisitions. This M&A wave will help further consolidate the banking sector. Principally driven by high investor confidence and economic prospects, the current M&A wave is also triggered by the need for banks to meet higher capital requirements and also growing competition which will make it increasingly difficult for small banks to survive. Together the growing trend of M&A and recent issue of GDR of MCB Bank at the London Stock Exchange have attracted close to $1 billion inflows and another equivalent amount is yet to flow in. Four microfinance banks (Khushali Microfinance Bank Limited, First Microfinance Bank Limited, Tameer Microfinance Bank Limited and Pak Oman Microfinance Bank Limited) are working at national level while two (Rozgar & Network) are operational at district level. D. Sustainability of banking sector reforms Prospects for the continued and sustainable banking sector growth are promising. What lends confidence to bankers that are fast expanding their stakes and interest in Pakistan is the (i) high and sustainable economic growth that the country is set on; real GDP in the past 2 years grew by 8.6% and 6.6% and is now set to register another 7% growth; (ii) real consumption expenditure is on the rise and leading the demand growth, boosted by doubling of per capita incomes to $850, a fourfold increase in remittances over few years, rising industrial capacities for consumer durables, automobiles, etc. and growing role of consumer financing and personal loans in meeting the demand for consumer goods; (iii) in recent years, investment spending has gained substantial momentum and will be rising further as the Government and private sector launch and implement large infrastructure projects. The Government has plans to add 5000 MW new power capacities in private sector along with a number of hydel projects, highways and port infrastructure, while catering for the development of large urban infrastructure to upgrade large cities; and (iv) foreign direct and portfolio flows is at an all time high and is expected to further grow given the economic potential and high returns on equity in both corporate and banking sectors. The scope for enhancement of banking business is phenomenal as the level of financial exclusion is exceptionally high despite the growth in banking. Today, penetration ratio of financial services is low judged by any measure. Thus far less than 20% of the population has access to financial services given Pakistan’s low depositor base and number of borrowers are under 5 million (3% of population). More graphically, there are only 171 deposit accounts per 1000 people and 30 loan accounts per 1000 people. Like wise, only 30% of the adults have bank accounts. Credit/GDP ratio at 27% is low judged by country and sector financing requirements or judged by levels prevailing in emerging markets. Consumer financing penetration ratio is 3.9%; steps are being taken to relax exposure limits for consumer financing selectively for banks based on a uniform criteria whereby banks with experience, stronger risk management controls and track record will be able to expand this business. Commercial banks barely provided $1 billion for mortgage markets. The microfinance industry reaches only 770 households and agriculture and SME financing reaches to 300,000 borrowers each. A number of development initiatives are underway to support banking sector to enhance its outreach. A strategy for microfinance industry is in the offing which advocates up scaling the outreach to 3 million people or more over next five or so years by allowing flexibility to microfinance institutions to commercialize their business and remove any distortions that stand in the way, while looking for partnership with well experienced international microfinance institutions to transfer the requisite approaches and modalities that have worked well in other environments. At the same time, work is underway to promote mobile banking which ought to help expand outreach of financial services. In the SME sector, banks are now allowed cash flow based lending and several business development initiatives are underway. In agriculture, pilot programs are underway at federal and provincial levels to develop land records and titling to ensure that an effective collateral registry system evolves. In housing, banks are being encouraged to provide housing finance; however, banks fund long term housing loans through short term demand and time liabilities that in turn pose an asset liability mismatch on their books. Therefore, in order to mitigate asset liability mismatches, besides provision of fixed rate mortgages, deliberations are underway for establishment of mortgage refinance company in Pakistan. Work is also underway to privatize outstanding financial institutions engaged in development financing business such as the SME Bank, Industrial Development Bank of Pakistan, House Building Finance Corporation and Zarai Tarakiati Bank Limited. SBP has established a dedicated Development Finance Group to help improve the enabling environment for development financing and coordinate intervention and initiatives which could enhance outreach, while developing capacities across the board in banking sector and also providing specialized training in some sector areas. Given the financial sector’s dependence on the banking sector, as evident from the low bond market to GDP ratio, efforts are underway to enable the development of alternate sources of long term funding. Among others, an Infrastructure Finance Taskforce is now deliberating the possibility of supporting establishment of long term infrastructure lending institutions and equipping them with the desired project appraisal and risk management capacities. There is scope for enhancement of efficiency in financial intermediation which should augur well for deepening and sustainability of financial sector. Trends of over 16 years reveal that Pakistan’s interest rate structure has been quite volatile and unstable. After a period of exceptionally high interest rates, which were a manifestation of the public sector banks’ inefficiencies, misallocation of credit and reckless lending accompanied by large defaults, Pakistan’s lending rate fell but the real lending rate was kept so low that, despite low inflation over 2000-2004, it virtually turned negative. Aside from volatility in interest rate, Pakistan’s banking system over 1990s maintained high spreads. Subsequently, low interest rates pursued by central bank coupled with enhanced competition helped narrow spreads to 5.39% by December 2004. However, a reversal in trends was notable as spreads rose again to 7.4% by the end of November 2006 with commercial banks re-pricing their loans in line with the upward adjustment in SBP repo rate (policy rate) from 7.5% in April 05 to 9.5% in July 06 in the wake of growing inflationary pressures, without a concomitant rise in deposit rates. Banking spread will eventually be aligned as competition deepens both for deposit and loan products. Fall in cost/income ratios coupled with sizeable balances in savings or short term deposit accounts (with less than 6-months maturity) or transactional accounts – which offer low returns below the inflation rate – should facilitate decline in spreads. However, a factor to consider here is the high administrative expense to total expense ratio because of rising remuneration of banking professionals and high operating costs. SBP is keen to evolve a more stable and positive real interest environment over longer run and as a starting point has incentivized banks, through a combination of measures, to change the maturity mismatches on their balance sheets. On one hand, SBP has used differential and concessional cash reserve requirement (half of the level applicable to deposits below 6 months) for term deposits above 6 months. On the other hand, SBP is using moral suasion to encourage banks to offer different products which offer better returns to depositors. Improved efficiency in financial intermediation process and a shift to long dated deposits will augur well for sustainability of banking system. The latter should also help reduce the inherent asset-liability mismatches as the proportion of longer maturity deposits rises and encourages banks to lend long. Efforts to strengthen risk management through effective implementation of prudential regulations, financial infrastructure and technology and internal controls within commercial banks should further augment sustainability of banking system. To consolidate and strengthen the risk management capacities of banking sector, SBP and banks have taken a number of initiatives. In line with the MCR, banks are to fully comply with the enhanced requirements by 2009. Banks are maintaining high CAR ratios (see para. 18). Moreover, improved credit risk management and strong vigilance has helped keep NPLs at manageable levels. Over the last few years, about half of all bank branches are online with their respective head offices, providing management with real-time information. Besides overall improved service delivery, banks have actively pursued Debit and Credit Cards business in urban centres. E-banking is mandatory for banks to enhance interconnectivity of ATM switches in order to fully exploit ATM network of all the banks. SBP issued Guidelines on IT Security and started on-site IT inspections to ensure whether banks were adequately managing the risks associated with online banking. In SBP’s on-site inspection, the quality of internal controls play a prominent role in determining the over all rating of the bank. The Internal Control Guidelines issued by SBP provide a minimum set of standards banks have to adhere to in this regard. While the level of sophistication varies from bank to bank, internal control systems have yet to be fully in place. In coming years, commercial banks would continue to develop their infrastructure, technology and human resource capacities to adopt and implement Basel-II in a phased manner. Banks are required to adopt Standardized Approach for credit risk and Basic Indicator/Standardized Approach for operational risk from 1st January 2008. Subject to development of their in house systems, they would switch over to advanced approaches from 1st January 2010. In line with the Pillar 3 (Market Discipline) of Basel Accord II framework, SBP has revised the format of annual accounts to improve disclosure requirements. Further development of online management information system would enable banks to maximize benefit of eCIB (Credit Information Bureau), operationalized in 2006. SBP is now in the process of introducing a Real-Time Gross Settlement (RTGS) system 5 for large value payments in the inter-bank market. Banks holding accounts at SBP would be able to operate their accounts in real time from their own premises. RTGS will help overcome the liquidity and settlement risks as banks would be able to settle their transactions affecting their accounts at SBP (e.g. inter-bank lending/borrowing) immediately after the terms of the transaction have been agreed and executed between the banks. A Payment Systems and Electronic Funds Transfer Act 2006 after its passage by the Parliament will lay down legal framework for online banking. With 81% of banking assets now in private hands, the government guarantee or backing of the deposits of NCBs has been withdrawn. The implied government policy of rescuing the failing banks at the expense of taxpayers’ funds has now given way to a banking supervision approach based on international best practices. SBP has instituted an all-embracing framework viz. Institutional Risk Assessment Framework to further strengthen the existing supervisory mechanism and to mitigate the variety of risks banks are exposed to. The framework envisages a collaborative and seamless supervisory focus amongst various supervisory departments within SBP to ensure cohesive and proactive monitoring of risks within banks and DFIs. The framework, being highly technology driven, provides for the timely flow of information and enables SBP to institute more efficient and effective banking supervision and continuous monitoring both on the part of SBP and institution themselves, integrating off-site surveillance, on-site examination and current market information. The new dynamics, however, pose a challenge and SBP will need to work on developing appropriate safety net for depositors, especially small depositors, without creating the problem of moral hazard. Concurrently, the Board of Directors as well as top management of a bank should be held liable for their mismanagement and poor decisions. In this connection, SBP has now for sometime enhanced banking surveillance which, among others, involves conducting regular stress testing to measure system wide sensitivity to different risks including credit risks, market risks, liquidity risks and operational risks. Now banks are to be encouraged to estimate their risks to capital, liquidity crisis at the earliest stage, execute prompt corrective action in order to curb the problem at the onset, and settle depositors’ claims in a timely manner, in cases where the corrective actions result in liquidation/restructuring of the banks. Regulatory measures are now in place to curb practices of anti-money laundering as well as terrorist financing. These measures make SBP compliant with the recommendations of international bodies to prevent these high risk activities. There exists a comprehensive set of regulations on KnowYour-Customer (KYC), Customer due Diligence, Suspicious Transactions Reporting and correspondent banking has been put in place in line with the recommendations of the Financial Action Task Force. All financial institutions (FIs) have to confirm the true identity of every prospective customer and verify the documents obtained from new customers/account holders. All suspicious transactions are to be reported by banks to SBP and, after due analysis, such cases are handed over to NAB or other relevant authorities for further action. The capital base of exchange companies has been strengthened and they are subject to KYC and record keeping requirements with appropriate reporting to SBP. All such companies are now subject to both off- and on-site inspections and any violations by banks or exchange companies make them liable to penalties. Lastly, but most importantly, effective implementation of corporate governance is the key for sustainability of banking sector. Pakistan has an elaborate corporate governance framework. The key objective of the framework is to ensure that the owners and managers of a bank are fully committed and have sufficient capacity to operate the bank prudently. The Banking Companies Ordinance 1962, the primary legislation governing banks, lays down several governance requirements. It includes the rules for appointment/dismissal of directors, disclosure of share ownership, dividend policy, appointment of external auditors etc. Further instructions in these areas are provided through Prudential Regulations issued by SBP. Most critical in this context are the exposure limits (see Box below), guidance provided on the role and responsibilities of the Board of directors, and fit and proper test criteria for Chief Executive Officers, Board members and key executives. This criteria is in addition to the minimum qualification requirements. To facilitate this process a complete on-line, real time banking solution Globus is under implementation which will provide a strong back end system for SBP’s banking operations. SBP has maintained a fairly elaborate prudential regulatory framework consistent with BIS standards. Regulations define instructions for all types of financing and prescribe specific exposure limits depending on the nature of risks involved. Most critical for containing the risks are the following requirements: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) Bar on stock brokers, money changers, etc. from becoming part of the management and Boards of banks; For individual single borrower, exposure cannot exceed 30% of FIs’ equity (subject to a maximum 20% fund exposure) and exposure to a group cannot exceed 50% of FIs’ equity (subject to 35% fund exposure). FIs’ exposure shall not exceed 10 times the borrower’s equity, fund based exposure shall not exceed 4 times the equity, current ratio of borrower shall not be lower than 1:1 and subordinated loans have been allowed to count towards equity of borrowers; Unsecured/clean exposure against single facility has been restricted to Rs500,000 but aggregate exposure of clean lending is limited to equity base of FIs; Investment in shares of a company cannot exceed 5% of the FI’s paid up capital or 10% of capital of investee company, whichever is lower. Furthermore, total investments in shares shall not exceed 20% of banks’ equity – strategic investment is excluded from the 20% aggregate exposure limit and there is a holding period of 5 years; Contingent liabilities cannot exceed 10 times the equity of FIs; FIs have been barred from taking exposure in their own shares/other financial instruments or the shares/instruments issued by borrowing entity or its subsidiary. Banks cannot take exposure on any person against the security of shares of any commercial bank/FI in excess of 5% of paid up capital of the share issuing bank/FI. Banks cannot hold shares in any company whether for pledge or as a mortgagee or an absolute owner, exceeding 30% of the paid up capital of the company or of their capital, whichever is less; Guidelines on internal controls are an integral part of guidelines for risk management systems and underscore transparency and disclosure requirements to minimize the hazards of asymmetrical information and adverse selection; and Standard provisioning requirements are in place. Listed FIs are also required to comply with the Securities and Exchange Commission of Pakistan’s (SECP’s) Code of Corporate Governance for Listed Companies; although the banking law and SBP’s directives override it wherever there is a discrepant stipulation. SBP has issued a Handbook on Corporate Governance for Banks/DFIs containing international best practices and is involved in awareness building through conferences and regular interaction with the banking professionals, including partnership with the Pakistan Institute of Corporate Governance, which was established with SBP as a founding member. The efforts of SBP and banking industry have yielded results in bringing about a positive change in the corporate governance practices of banks. Banks are now managed and run by better cadre of professionals and stakeholders now play an active role and take a keen interest in the affairs of banks. The Boards meet regularly and participate in both setting strategic direction for their institutions and providing desired oversight. Managements at majority of banks are equipped with professional competence and high degree of integrity. The increasingly intense competition among banks has resulted in improved and swift decision-making processes. The outside pressures have been marginalized. Financial reporting standards mirror international best practices, resulting in enhanced disclosure and transparency. In compliance with the elaborate corporate governance framework of the regulators, banks have displayed high level of eagerness to up-grade their systems. A quick glance at the corporate governance practices adopted by banks brings to fore the following major areas where banks have shown increased, albeit slow, compliance with the existing codes and standards: • • • • • • • • • • • • Banks seek prior clearance from SBP for the appointment of directors and CEOs; Banks follow the fit & proper test criteria for the appointment of key executives who should not be holding an office in another financial institution; The scope of the Board’s policies has been enhanced to cover a broad range of areas such as internal audit and control, risk management, human resources, credit, investments, etc.; Boards now include experienced non-executive directors; Boards meet more frequently; Banks record detailed minutes of the Board meetings; Boards constitute specialized committees with well-defined objectives, authorities and tenure, comprising of non-executive directors to review different critical functions; Banks ensure that executive directors are not more than 25% of the total directors on the Board; Banks ensure that their cross shareholding in other financial institutions does not exceed more than 5%; Directors of the same family do not get representation of more than 25% of the total directors on the Board; Auditors are appointed from the SBP’s approved panel and they are rotated at an appropriate interval; and Banks publish and circulate on quarterly basis unaudited financial statements of the banks along with the directors’ review. Improvement in corporate governance has helped impart a high degree of financial stability. The balance sheet of the banking system has expanded at a fast pace. Since December 31, 2002 till December 31, 2005, the balance sheet has recorded a growth of 64.5%, which in all respect is quite significant. Deposits of the banking system registered unprecedented growth of 69% since 2002. Profits of the banking system scaled new heights. Return on assets (after tax) increased to 1.9% in 2005 (and further increased to 2.1% by Sep 2006) from 0.1% in 2002. Credit activities got a tremendous boost as banks responded zealously to meet the sharp rise in demand for credit. Loan portfolio of the banking system got doubled in the last three years. Unlike the past trends, the credit growth was fairly diversified. This led to substantial increase in the exposure of the banking system to new emerging sectors like consumer, agriculture and SMEs sectors. Greater compliance with the corporate governance standards has helped keep NPLs to low levels and improve the management performance. As of December 2005, the key management performance indicators of the banking system confirm the impact of strengthened corporate governance and risk management practices within banks. For example: • Intermediation cost has fallen to 2.7% as compared with 3.4% in 2000. • Average earnings per share have increased to Rs5.7 from Rs3.2 in 2003. • Deposits per employee rose to Rs30.2 million from Rs14.2 million in 2000. • Assets per employee increased to Rs39 million from Rs19.1 million in 2000. Conclusion Pakistan, like the rest of Asia, is growing fast and the rise in per capita income, emergence of middle income group and relative wealth increases are together bringing with them new demands for retail banking industry. The transformation of Pakistan’s banking sector, given the success in developing a stronger and robust system, offers some interesting perspectives and lessons for banking sector reform. The sector now faces interesting emerging challenges and risks that are not uncommon in financial systems in post reform period. Going forward, Pakistan’s financial sector strategy for next decade or so will aim at addressing the emerging challenges while laying the foundation for a deeper and efficient financial system which is competitive and financially inclusive. Banks are now aggressive and recognize that having cleaned up their loan portfolios and balance sheets, they need to re-position themselves to take advantage of the boosting economy. Over the next few years, commercial banks will have to focus on product innovations and diversifying their reach to infrastructure, housing, SME and microfinance industry while exploring and reaching out to new and under-banked regions. The investors and the industry are seeking better investment and financing alternatives and solutions, with demand for private debt, asset based and mortgage based securities, credit derivatives and hedge products etc. now emerging from different segments of economy and population. Banks will need to poise themselves to meet these demands for continued growth. | state bank of pakistan | 2,007 | 3 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Institute of International Bankers Annual Washington Conference, Washington DC, 5 March 2007. | Shamshad Akhtar: Pakistan – regulatory and supervisory framework Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Institute of International Bankers Annual Washington Conference, Washington DC, 5 March 2007. * I. * * Introduction Pakistan’s financial sector has undergone a phenomenal structural change. Key elements of this change are: (i) Privatization of banking industry which only 6 years or so back was 90% in public sectorprivatization was accompanied by significant debt and labor resolution and restructuring, (ii) Free and flexible entry of foreign banks raising foreign shareholding to almost half of the banking sector assets, (iii) Development of a strong banking system as capital base has strengthened and the ratio of Net NPLs to Net Loans today is at an all time low of 1.8% for all banks and 1.3% for commercial banks. (iv) Enhancement in financial depth and private credit ratio – there is however considerable room for further expansion of these indicators, (v) Substantial credit diversification at sector levels which is helping support broad based economic activity, (vi) Strengthening of regulatory and supervisory framework along with the stricter enforcement by a vigilant and strong central bank that is fully independent and accountable to its Board, and (vii) Changed perception and approaches to safety net for depositors and prompt corrective actions. With most banking system now in private hands, the government’s implicit guarantee for deposit no longer exists and now the owners and the Board of Directors as wells as top management of a bank are liable for their actions. Notwithstanding, central banks surveillance system plays a key role in identification of the problems, e.g. threat to capital, liquidity crisis at the earliest stage, and execution of prompt corrective action – the objective being to curb the problem at the onset, and if required appointing official liquidators for settlement of depositors’ claims in a timely manner, in cases where the corrective actions result in liquidation/restructuring of the bank. The trends and performance of banking sector has been influenced by a variety of factors, in particular higher and sustainable economic growth supported by effective macroeconomic management and comprehensive and sophisticated prudential regulatory and supervisory (PRS) framework. In designing PRS, central bank has been realistic and rigorous, while recognizing need for flexibility so critical given the characteristics, structure and state of financial sector and the prevailing governance and market practices. Adopted effective January 2004, the PRS has since continuously been updated substantively to respond to the emerging developments in the sector and to conform to the International standards. Pakistan’s PRS aims to: promote and preserve financial sector stability, encourages banks to function purely on market principles and operate in a fair and efficient manner guided by high standards of corporate governance with emphasis on complete disclosure and transparency. To ensure effectiveness of this framework, central bank has now put in place an elaborate framework of banking surveillance and supervision. In setting this PRS, the main challenge has been to evolve and develop a well balanced PRS which allows for (i) an open, liberal and competitive neutrality of regulatory framework that promotes financial sector growth, diversification, and innovation, (ii) healthy competition and risk taking to ensure a sustainable and aggressive income stream, and (iii) opportunities for enhancing the franchise value of banks. On the other hand, it is critical for regulatory framework to recognize the need for augmenting more prudent behavior and ensuring effective risk management especially critical in fast expanding financial markets and also safeguarding social obligations and consumer interests. By and large Pakistan’s PRS is now market friendly and all credit and lending cum deposit rate prescriptions and dictates have been withdrawn and banks are now free to operate as long as they comply with regulatory framework. II. Regulatory framework Recognizing the ground realities, Pakistan’s financial regulatory framework at this stage restricts banks from engaging in non-related commercial activities to avoid conflicts of interest between banks and diverse businesses such as securities and insurance underwriting, and real estate investment etc. This is largely done to avoid at this stage the complexities emerging from cross ownership and large conglomerates. Except in case of multilateral borrowings, banks are generally prohibited from assuming any obligation or guarantees on behalf of Non-bank Financial Institutions (NBFIs). Banks and development finance institutions (DFIs) exposure to equity market is governed by a PR which disallows exposures against the security issued by the bank itself or those by prospective borrowers themselves or provide unsecured credit to finance the floatation of securities or take exposure against non-listed securities and sponsor directors’ shares. Banks investment in any single scrip is limited to 5% of their own equity with total investment in listed shares is capped at 20%. The margin requirement against the security of shares of listed companies has been set at 30%. Notwithstanding these broader restrictions banks are allowed to set up or take higher stakes in their subsidiaries that can be formed for specified purposes like asset management, brokerage, etc.. This allows banks to diversify their business interests but operating as a separate business entity. Consistent with normal practices, the regulatory framework for banks is all encompassing and covers a broad spectrum of elements which can be classified in six different categories defining; (i) entry requirements, (ii) risk management guidelines, (iii) corporate governance framework, (iv) industry specific guidelines, (v) operational guidelines and (iv) anti money laundering regime. Bank entry and licensing requirements. SBP has the sole authority to set criteria and approve or transfer ownership of bank licensing. Presently, banks/DFIs are required to, in a phased manner, to meet capital requirements which have reached $50 million as of December 2006 and will be doubled to $100 million by 31 December 2009. Among others, higher capital requirements are intended to accelerate the process of banking sector consolidation. Of 39 institutions, 32 banks are well on their way to meeting stipulated capital requirements with 8 banks already complying with the 2009 capital requirements. To the extent capital of banks is being enhanced through M&A process it has facilitated a degree of consolidation among conventional banks. SBP has now for few years invoked partial suspension of issuance of new bank licenses. After a period of liberal licensing, SBP is no longer issuing conventional bank licenses in order to encourage sector consolidation. Responding to this, market has been dynamic as evident from the wave of aggressive 25 odd mergers and acquisitions some of them led by strategic foreign banks. Foreign interest in Pakistani banks is driven by strong business prospects given thus far financial penetration ratio has been considerably low and there exists large potential untapped retail market as well as high profitability with return on equity close to 25%. Foreign banks can either conduct business in branch mode or set up a wholly owned locally incorporated subsidiary provided they are member of a regional group or association or if foreign banks have a global tier-1 paid up capital of US$5 billion or more. Other than these categories a foreign corporate/ body desirous of conducting banking business in Pakistan should set up local subsidiaries with a maximum of 49% share holding. Currently of the 39 banks in the country, almost 14 have foreign shareholding with few of them either fully or partially foreign owned or other smaller strategic stakes. Foreign interest in banking system has been substantial and since 2002 cumulatively has attracted foreign capital inflow of over $2 billion (including funds raised and expected to be raised from GDRs floatation of banks in international markets). Standard Chartered Bank acquisition of mid size Union bank itself has mobilized significant proceeds. Besides, ABN-Amro, Citibank, HSBC, Saudi American Bank and Temasak all have an interest in expanding businesses and/or acquiring domestic stakes, while three banks are offering GDRs in international markets. Foreign interest in Islamic banks is quite strong with four of six banks being foreign owned. Not only is entry easy through M&As in Pakistani banking sector, but license are being issued for Islamic banks as well as microfinance banks – two areas which hold phenomenal prospects for augmenting financial penetration, while serving the development needs particularly for the underserved segments of population. Thus far 6 Islamic banks and 6 microfinance banks have been allowed with former expected to constitute at least 10% of total banking sector by 2010 and microfinance reach to enhance to additional 3 million customers. Evading licensing restrictions, the Government has continued to set up bilateral government-to-government joint venture-DFIs. Risk management. Banks are allowed to take appropriate and diversified individual, group and sector risk exposures, while nurturing effective governance standards that would ultimately set the stage for a more stable and mature financial market, which can then be allowed greater flexibility. Aside from standard limits on single and group exposures ( limited to 30% and 50% (including 20% and 35% fund based exposure), respectively), banks exposure on contingent liabilities cannot exceed 10 times of its own equity. Likewise, clean lending to single persons is limited to Rs0.5 million and in aggregate it cannot exceed the equity of the banks. Furthermore, Banks/DFIs exposure to a company cannot exceed 10 times of borrowing entities’ equity and the entities current ratio cannot be lower than 1:1. Corporate’s subordinated loans are included in their equity determination. Banks are required to obtain CIB reports for loan transaction above a limit (currently set at Rs500,000) and audited balance sheet from borrowers whose transactions value exceeds Rs10 million. Since consumer financing is still relatively an emerging area, SBP lays down an elaborate risk management framework for it. Although banks are allowed clean lending for personal and consumer loans within limits (Rs 500,000), these loans cannot be used for real estate purchase or subscription of IPOs. New entrants in the first and second year are not allowed to lend more than 2 and 4 times their bank equity, respectively. For subsequent years, so long as classified loans under consumer finance are 3%, banks can offer up to 10 times their equity and if these classified loans rise up to and above 10% the limits is scaled down to 2 times the equity of bank. Banks are expected to develop effective MIS reporting and risk management system for consumer financing. Subject to adequacy of these system and experience in consumer financing, SBP has relaxed the exposure limits on consumer financing. However, banks not meeting these requirements or illustrating poor track record of consumer financing could face restricted exposure limits. Banks have adapted well to these prudential norms and NPLs related to consumer loans have been low (3% of total NPLs) despite the share of consumer financing in total outstanding advances has risen to about 14%. These stringent PRs were instituted to ensure prudent risk behavior, however, in cases where justified, central bank can relax these exposure limits for temporary period, if financial strength of company’s balance sheet is expected to improve or there is need to finance a strategic project backed by public sector guarantees. Banks are free to extend loans against hypothecation of stocks and/or receivables and to set margin financing requirements on financing facilities keeping in view risk profile of borrower. Classification and provisioning for assets conforms to international norms. Loans overdue by 90 days are subject to 25% provision (up from 10%) – effective 31 December 2006 and those overdue by 180 days require 50% provisioning and those above 360 days have to be fully provisioned for. Corporate governance. A recent World Bank study on South Asia “Access to Finance” ranked Pakistan corporate governance standards highest among South Asia. This is further supplemented by the 2005 ROSC assessment of corporate governance standards which have given higher points, relative to the world average, to Pakistan on majority of its principles. Among other efforts, this is an outcome of effectiveness of an elaborate Corporate Governance Framework laying down specific corporate governance guidelines for banks which further has infused greater discipline among bank-finance dependent corporate sector. Besides the legislative stipulations of Banking Companies Ordinance (BCO), 1962 that provide rules for fit and proper criteria of Management and Board of Directors (BoD) as well as their appointments/dismissal, disclosure of share ownership, dividend policy, and appointments of external auditors etc., SBP has introduced a Handbook of CG for Banks which, among others, defines the role and responsibilities of BoDs; the fit and proper test criteria prescribed for Chief Executive Officers, Board members and key executives; restriction on shareholdings by the director; dealings of the banks with directors; and requirement of credit rating. Furthermore SBP, in collaboration with the ICAP (the premier accounting body of the country) and the commercial banks, has facilitated adoption of International Accounting standards (IAS) by the banks. In 2006 (Feb) the reporting formats were revised to incorporate the significant regulatory developments and the modifications in the International Financial Reporting Standards (IFRS). With these changes, the quality of disclosure by banks in their annual accounts is at par with international best practices. To ensure the quality of external auditors for banks SBP requires an audit firm to be approved from SBP Panel of Auditors. The firm is classified in categories A, B, and C depending on a criterion developed internally and the criteria takes into account the number of qualified accountants, international affiliation, quality review by ICAP, and past experience. The classification also prescribe the size of the bank a firm can audit, e.g. large banks can only be audited by firms in category A. Industry-specific PRs. Replacing all prescribed sector ceilings or subsidized lending, SBP encourages competition amongst banks to meet the diverse set of development requirements. Given the gap in supply and demand for credit delivery, SBP has formed consultative groups to identify issues impeding the outreach of financial services for agriculture and rural sector, SME and microfinance sectors. Agriculture sector financing has more than doubled over the last few years, but remains below the overall credit requirements of the sector. Commercialization of agriculture financing, crop loan insurance program and improvements in land registration and passbook system in rural areas have been found to be more effective mechanisms to retail agriculture credit, though flow of non-farm credit has remained low. Recognizing commercialization of microfinance businesses is key to its financial and social sector sustainability; SBP has set up a regulatory regime for Microfinance banks (MFBs). Currently about 6 MFBs are governed and regulated by the MFIs Ordinance, 2001 that encourages a paradigm shift in microfinance industry, while laying foundation for systematic growth of the sector. MFBs capital requirements are set lower than commercial banks (Rs250 million) and they are required to maintain equity equivalent to at least 15% of its risk-weighted assets. Under PRs, MFBs are required to set 10% of deposit liabilities in liquid assets and transfer 20% of its annual profits after tax into reserve fund until it reaches equivalent to its capital base after which this allocation is reduced to 5%. MFBs have to set up Depositors’ Protection Fund or scheme for the purpose of mitigating risk of its depositors, to which MFB/MFI shall credit not less than 5% of its annual profit after taxes. MFBs have to set aside general provision of 2% besides other stringent provision requirements. MFBs need to lend maximum loan size of Rs150, 000. SBP has further issued NGOs/Rural Support Programs/Cooperative Transformation guidelines for their upgradation to MFBs. Fit and proper criteria have been laid down for CEOs and Management of MFBs. Guidelines have been issued for commercial banks interested in engaging in microfinance business. SBP unique and rich regulatory framework offering a model of development of MF. Under SBP regulatory framework, banks can offer new financing schemes and innovative products to meet the financial requirements of SMEs, while providing themselves a viable and growing lending outlet. Under PRs, banks are encouraged to extend cash flow based lending and they can take clean exposure secured only against personal guarantees of SMEs owners for up to Rs 3 million, however, clean funded exposure should not exceed Rs 2 million. For eligibility SMEs ought to declare that it has not availed clean facilities from any other bank/DFI. The maximum exposure of a bank / DFI on a single SME shall not exceed Rs 75 million. The total facilities (including leased assets) availed by a single SME from the financial institutions should not exceed Rs 150 million provided that the facilities excluding leased assets shall not exceed Rs 100 million. Operational instructions. Supplementing its PRs, SBP has issued guidelines on risk management, business continuity plan, internal controls, and stress testing. Both PRs and guidelines form the basis of our regulatory framework that enables SBP to carry out a proactive role. As the business is expanding and banks are positioning themselves to take advantage of emerging opportunities, the technology adoption becomes imperative to get a competitive edge to deliver services in an efficient and cost effective manner. Accordingly, almost all the banks in Pakistan have embarked upon major IT projects that will improve their operational efficiency and strengthen internal controls. Anti-money laundering and Combating Financing of Terrorism (AML/CFT). Pakistan like other jurisdictions has adopted a comprehensive set of PRs to enhance its vigilance on money laundering and terrorist financing. PRs for AML require banks to ensure Know-your-customers (KYC) before establishing banking relationships, conduct due diligence on an ongoing basis, identify and provide Suspicious Transaction Reports (STRs), ensure maintenance and retention of records, and fulfill specific requirements for compliance officers and wire transfers etc. In July 2006, SBP updated and strengthened these PRs and aligned them further with FATF recommendations. Under KYC-PRs banks have to: ensure true identity of prospective account holders, ascertain nature of the business, obtain introduction of account holder and determination of beneficial ownership of accounts while enhanced due diligence is carried out for high risk customers. At the same time, regulation facilitate interception of transactions, which are, prima facie, associated with money derived from illegal activities by ascertaining customer’s status and source of earnings and investigating transactions that deviate from account history. Banks are required to retain information about each account for a minimum period of five years, of all records of transactions, both domestic and international along with the records on the identification data obtained through KYC/ CDD (NIC, driving license, passport etc.) and record of STR has to be maintained for longer period and can be destroyed only with the prior permission of State Bank. Banks/ DFIs are prohibited to establish correspondent banking relationship with institutions whose KYC/CDD practices are not in order or who are located in jurisdiction identified by Financial Action Task Force (FATF) as “non-cooperative countries and territories.” Banks/ DFIs have been alerted against misuse of correspondent account by third parties e.g. payable through accounts. Approval for establishing new correspondent relationship has to be taken from senior management. Banks are expected to investigate unusually large transactions and all unusual patterns of transactions to identify any suspicious transaction that is required to be reported to concerned authorities. The information to be reported by banks/ DFIs include title, type of account, numbers of accounts involved, detail of transactions, reasons of suspicion. The employees of banks/ DFIs are strictly prohibited from disclosing the fact to any person that certain transaction has been or is being reported for investigation. SBP has established an AML/CFT unit to deal with the issues of money laundering and CFT. This unit monitors and investigates STRs An AML law is under consideration and its promulgation will strengthen further the legislative and institutional framework for AML. Under the Law, SBP will house a Financial Monitoring Unit (FMU) which will be responsible for overseeing and coordinating all activities related to AML in the financial system. Oversight of AML will further benefit as linkages and information exchange among countries is enhanced. III. Banking supervision Like other central banks and supervisory authorities, SBP conducts regular onsite inspections of all financial institutions under its jurisdiction. This involves assessment of banks overall financial health, evaluation of quality of management and role of Boards and sponsors and verification of compliance with legal and regulatory requirements. The inspections are conducted on CAMELS-S methodology whereby inspection team assesses and rates each component viz. Capital Adequacy, Assets Quality, Management, Earning, Liquidity, Sensitivity to Other Risks and Systems and Controls. Increase in size and complexity of financial sector and introduction of new and innovative financial products, has required SBP to enhance the sophistication of approach and methodology of its inspections. Capacity building is being launched to develop SBP skills in risk management, Islamic Banking, treasury, foreign exchange, IT etc. In addition, work is underway to strengthen further its capacities for oversight of Basel 2. Off-site supervision & surveillance. In response to changing realities, lessons learnt and peculiar financial conditions, the off-site monitoring system at SBP has undergone substantive changes since its introduction in 1997. The off-site monitoring system (i) monitors the overall and individual banks financial health, (ii) helps in early problems detection for appropriate corrective action, and (iii) focuses on-site supervisory resources to high risk areas or activities. Off-site monitoring is conducted based on periodical returns of banks. On line submission of the Report of Chart of Accounts will enhance efficiency and quality of offsite supervision. SBP is to start building capacities for more integrated supervision where industrial groups and NBFIs relationship with banks is growing. At this stage, SBP is coordinating with the Securities and Exchange Commission of Pakistan (capital market supervisory agency) for exchange of information of transactions that cut across sectors and involve both banks and NBFIs. Institutional Risk Assessment Framework. Driving inspiration mainly from the Supervisory Framework Rating Assessment criteria of the Office of the Superintendent of Financial Institutions (OSFI) of Canada, SBP has introduced an Institutional Risk Assessment Framework (IRAF) to enhance its supervisory vigilance by integrating and consolidating the information collated through its regular supervisory and surveillance mechanisms. IRAF engenders a risk rating taking into consideration the information available regarding a bank from various sources. It not only embraces the offsite and onsite feedback, it also takes management of banks on board, to establish their rating regarding their compliance with standards, codes and guidelines issued by SBP. To make the supervisory process an all-inclusive exercise, market information regarding the health of banks has also been incorporated in the framework. The supervisory process of onsite inspection, offsite surveillance and IRAF culminates into enforcement actions. The enforcement actions that can be taken by SBP range from imposition of pecuniary penalties to removal of management, board of directors and cancellation of banking license. The results of stringent enforcement actions taken have been encouraging as majority of the banks have displayed extraordinary operational performance over the past five years. IV. Emerging challenges and Issues The increasing growth and complexity in banking sector have now given rise to new issues and challenges. While initially preoccupied with their own primary business of banking, the banks have now cross ownership where industrial and brokerage companies own banks and banks own subsidiaries and associate companies that handle asset management, brokerage, insurance, housing and telecommunications businesses. These close linkages and cross ownership structure among corporate and FIs expose the banks to related party transactions risks. At the same time, growing foreign acquisition and entry of new regional and global players as well as growing domestic banks presence oversees requires SBP to deal with home and host regulator issues. Responding to these structural changes in financial sector, SBP is positioning and equipping its inspection and supervision department to deal more effectively with the emerging supervisory challenges. Consolidated and cross border supervision. Besides developing in-house capacities for joint conglomeration and consolidated supervision, SBP is developing greater interface with other central banks and has signed about 15 Memorandum of Understandings (MoUs) with various central banks/supervisors. These MoUs have a wide variation in scope, ranging from provisions for exchange of information to sharing license criteria, on-site inspection, supervisory cooperation, combating money laundering, nature of action to be taken in case of any irregularity etc. Even where MoUs are not in existence, SBP shares information with the host country supervisors as and when necessary. However, there is scope for greater effective relationship among regulators. Complexities of implementing effective risk management. SBP’s elaborate risk management framework has helped contain effectively all sources and types of risks. To monitor resilience of banking system towards shocks to risk factors, SBP calibrates alternate scenarios subject the overall banking system and individual banks to different degrees of credit, market and liquidity shocks. This stress testing is conducted every quarter. Based on September 2006 data, all banks were generally found to be resilient to credit risks and after shock capital adequacy ratio was found to remain above 11%. For one bank, capital adequacy would decline below these levels if either benefit of forced sale value is withdrawn due to banks exposure to mortgage collateral and for couple of banks shocks to credit quality of consumer portfolio may increase consumer sector NPLs and impact capital adequacy. Banks were equally resilient to interest rate shocks for movement upto 200bp and equity price movements in the range of 20%. Liquidity coverage ratio would come down in case of 10% decline in liabilities. In case of exchange rate depreciation banks are found to actually gain as their foreign currency assets are in excess of foreign currency liabilities. While stress testing results offer broader comfort about banking sector strengths, there is need to recognize that there remain some areas of concerns. For example, banks do face (i) maturity mismatches, of special concern in the rising interest rate scenario; (ii) potential risk of loan defaults in the backdrop of rising consumer finance portfolios and equity markets exposure of the banking system; and (iii) risks posed by weaknesses in internal control system and lack of effective mechanism for containing operational risks. Commercial banks are launching substantive efforts to address these problems and adoption of technological solutions and connectivity of all branches with headquarters of banks will help in this area. Implementation of Basel II Accord. Pakistan adopted a road map for implementation of Basel II Accord. Under this, banks will be adopting the standardized approach from January 2008 based on the spade work conducted since July 2006. There are number of issues in adoption of standardized approach. First, only a small proportion of corporate sector is rated by the rating agencies. In absence of the rating of borrowers, banks may end up allocating more capital than warranted. To ensure coordinated approach to Basel II implementation, SBP has set up a Working Group under the guidance of SBP to remove obstacles in its smooth implementation. Effective preparation for Basel II requires development of allied and support infrastructure that facilitates need for strengthening and enhancing role of credit rating agencies and development of internal controls and IT systems. In absence of credit rating agencies, Pakistan is developing further role of private sector Credit Information Bureaus, and independent debt/financial advisories etc. The gaps in the rating agencies are of particular concerns for SBP, given its heavy reliance of Standardized approach under Basel II. SBP has to further upgrade its capacity for supervisory review (Pillar II) and a core group of supervisors will be trained in this shortly. Lastly, there is need for more intensive capacity building of industry and SBP. Greater international cooperation in strengthening the capacities of developing markets in risk management and emerging supervisory approaches would be key to enhancing effectiveness of vigilance and oversight both at bank and central bank level. Conclusion. Being autonomous and effectively empowered under the Banking Companies Ordinance, 1962 SBP has adopted a rigorous but flexible regulatory framework which helps to keep banks exposure within tolerable range, while allowing them opportunities to enhance and diversify their businesses. Banking sector has played a key role in supporting real sector development whose performance and macroeconomic stability have together re-inforced banking sector performance. All time high profitability and structural transformation of banking sector has attracted substantial foreign capital in banks which given its innovations and practices will augur well for strengthening and sustaining banking sector performance. Proper enforcement of regulatory framework has been helped by a strong SBP’s independent supervisory and surveillance mechanism and validation process of the external auditors. Effective oversight has induced banks to enhance their corporate governance and compliance with laws and regulations that also follow international accounting and disclosure standards. Despite these achievements, both central bank and banks have to continue with broadening and deepening of structural reforms to help enhance financial services penetration and address the outstanding vulnerabilities in the system, while facilitating industry smooth adoption of risk measurement and management systems advocated under Basle II. | state bank of pakistan | 2,007 | 3 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Global Islamic Financial Forum, Governor's: Financial Regulators Forum in Islamic Finance, Kuala Lumpur, 27 March 2007. | Shamshad Akhtar: Building an effective Islamic financial system Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Global Islamic Financial Forum, Governor’s: Financial Regulators Forum in Islamic Finance, Kuala Lumpur, 27 March 2007. * * * Surge in capital from oil rich economies may have spurred the activity in Islamic Finance (IF) but one should not assume that this phenomenon will be the sole catalyst to promote growth in IF industry. The primary driver of IF growth will be the effectiveness with which this industry is consistently, persistently and substantively nurtured, groomed and developed and how successful the industry is in maintaining its robustness, soundness and governance as it grapples with some of the fundamental issues and challenges facing the industry in its evolving and growth phase. What is comforting and encouraging that Islamic world has collectively launched IF with a fair degree of commitment and fervor backed by adequate capital base. The process has been further supported by the right mix and blend of institutional frameworks that have led to gradual development of internationally accepted architecture for regulatory and accounting frameworks for Islamic industry. There is further an intensive effort underway to aggressively explore and exploit the virtues and benefits of this discipline. As one unfolds the mysteries of Islamic tenets and ethical spirit in finance, it offers opportunities for financial innovation and flexibility to structure different types of financial products which, among others, would allow for a shift from debt based financial system more to equity and partnership based. What is further amazing is IFs has promising potential to channel wealth by offering alternate avenues for saving and investment, while dealing with the problems of financial exclusion by extending riba free services to devout Muslims. Critical driver for effective development of IF industry, its growth and sustainability will depend on the ability of the system to offer clients comfort that these financial services do conform to the Shariah injunctions and principles. It is this value addition that will help enhance the outreach and appeal to the larger Muslim population base in particular rural and poor that suffers from financial exclusion. It is equally critical that the IF emerges as a robust, competitive, efficient and well diversified segment of financial industry to be able to compete with the long standing conventional industry. To evolve and develop a strong, healthy and competitive system, IF industry has to (i) Further explore the depth and breadth of IF systems in order to fully unleash its uniqueness and potential, (ii) Develop and implement policies and regulatory frameworks for IF which are complementary to conventional banking system but which are tailored to capture the different types of risks associated with IF, (iii) Recognizing that IF offers an opportunity to diversify financial system to more equity based and better risk sharing instruments than offered by conventional system thereby helping the overall financial system to evolve in a more balanced way, and (iv) Better understand and appreciate the richness of IF which advocates a different liability and asset approach that once effectively acknowledged and applied will offer wide range of opportunities for financial innovation key to the further development and diversification of overall financial system. It is the recognition and implementation of the above goals and objectives that will the lay foundation for an effective financial system. I will now dwell on some of the key preconditions which are critical for laying the foundation for an effective IF system. First, it has to be recognized that depending on their circumstances, regulators have adopted varying approaches to develop IF system. At this stage, it is too early to pre-judge which approach and model will be effective but success would be contingent on how effectively these institutions are nurtured and supervised. In some jurisdictions regulators have allowed dual systems whereby it issues some additional policies and regulations for IFIs over and above the prudential regulatory framework for conventional banks. Within this category there are variations with regard to role of regulator in Shariah compliance. Some countries have declared the entire financial system to be Islamic and in others no distinction is made between Islamic or conventional financial systems, and the decision to establish Islamic bank is with the owners, e.g. Saudi Arabia and UAE. As distinct from these, there is now a wave across developed financial systems, such as U.K and Singapore, to introduce specific legislation and regulations to facilitate IF transactions. Depending on regulators’ adopted policy stance, approaches to issuance of licensing and role of regulator in Shariah compliance varies significantly. For instance, some regulators issue standard form of banking license (e.g. Saudi Arabia) for both Islamic and conventional institutions, while others issue separate Islamic banking licenses (e.g. Malaysia). When regulators apply the same criteria and due diligence for licensing both IFIs and conventional institutions, they strengthen the competitive forces. Use of a separate licensing criterion should be applied carefully; because relatively lax criterion for IFIs will lower industry standards and result in a protected non-competitive class of institutions. Second, for long term sustainability and confidence of IF sector, it is critical that clients and Islamic banks effectively and fully exploit Islamic financial intermediation potential and process based on Shariah principles. Profit sharing is the cornerstone of Islamic financial intermediation process, be it fund raising or funds used or lent among the depositors, banks and the businesses. Lack of appreciation of this and reluctance of banks to experiment and expose themselves to different types of transactions and risks has delayed proper application of IB and as such prevented the desired level of portfolio diversification that IB theoretically have potential for. 1 On liabilities side, while money deposited as amanah is repayable on demand and is backed by 100% reserve requirement, the money held under investment account holders (IAHs) on profit and loss sharing basis and deployed in riskier businesses is not guaranteed and is not strictly a liability. This, however, is not fully recognized by ordinary customer thereby serving as a limitation to business expansion and also carries unintended consequences for IAHs who may not appreciate the risks they are exposed to. While IFIs are now recognizing this liability distinction more and more, the problem emerges more on asset side. As businesses have evolved, IFIs have ended up largely depending on less risky trade and commodity financing which typically are of shorter maturity even though the IF allows for financial intermediaries to structure various transactions (including Musharakah, Mudarabaha, and Ijarah etc.) that allow adequate flexibility for portfolio and maturity diversification. However, high dependence on Murabahah and on short term transactions has limited the asset diversification potential of IFI and their portfolio ends up resembling conventional fixed income securities in terms of their risk-return profile. Islamic banks have been thus far less open to adoption of some profit-loss sharing instruments (i.e. musharaka or mudarabah) because of bank’s low appetite for risk, the associated costs of monitoring such transaction, lack of transparency in markets within which Islamic banks are operating and the reluctance of the depositors/IAHs to take risks. Furthermore, in contrast to conventional banks who are obligated to offer fixed return to depositors, irrespective of the actual return on assets, IF inherently and potentially helps in asset: liabilities match in the balance sheet. All profits and losses on asset side are expected to be shared by the participants and there are no guaranteed returns to depositors or investors. Thus far IFIs have not fully exploited these real distinguishing characteristic and features of IF that assign it distinct edge and advantage relative to conventional banks. Despite the flexibility of the IF system, there is often lack of clarity and lack of differentiation between depositors and investors (i.e. those serving as equity holders or partners in businesses) nor is there full appreciation of the profits and loss sharing arrangements that are typically backed by “pass through” arrangements for the stakeholders. Consequently, the IFIs continue to observe asset-liability mismatches even when there are Islamic products/structures available to address these. Continued partial and adhoc applications of IF-system relative to what it offers theoretically will hinder the effective development of IF system and over the period carries the risks of eroding confidence in the system. Third, to enhance effectiveness of IF it is important that IFIs recognize that the wide array of Islamic financial products do offer opportunities for asset and risk diversification both for the banks balance sheets and that of financial system at large. Proper application of IF alters H. V. Greuning and Z. Iqbal (2007). “Banking and Risk Environment.” In S. Archer and R. A. A. Karim (edt.). Islamic Finance – The Regulatory Challenge. New York: Wiley Finance. inherently the balance sheet risks and has potentially inbuilt risk mitigation. On one hand, it brings to forefront different characteristics and types of risks, while making the risk identifiable and transparent. On the other hand, it provides a better framework for risk sharing and mitigation. What is critical for effective development of IF that both regulatory and supervisory regime recognizes the risk profile of IF and provides adequate guidance on exposures, risk weights and capital to be assigned so that there is uniform application of these standards by industry. There are several aspects that can be discussed and debated in this area, but I will offer only few perspectives: The regulatory regime should be open to providing adequate incentives for risk and profit sharing and the IF industry needs to adopt more conformed standards to enhance system predictability and stability, while promoting greater awareness among fund suppliers about the terms and conditions of profit sharing under different contractual arrangements. For instance as illustrated and well articulated in one of the recent papers of V.V. Sundarajan (2007): for an IAH who largely provides funds on a mudarabah basis and the IFI which invests these funds (often commingled with shareholders’ and other funds) in various IF contracts (like salam, murabaha, ijara, istisna, musharaka etc.) the risk is the expected variance in the measure of profit distribution between IAH and bank. IFIs have to recognize that this uncertainty or Mudarabah risk can arise from a variety of factors both systemic as well as bank specific. Risk mitigation for IAH can be achieved through use of profit equalization reserves (PER), investment risk reserves (IRR) and by variation in modarib’s share. 2 At the same time regulatory regime, needs to offer perspectives on risk determination and capital assignments for the high exposures IFI’s face because of their excessive reliance on Murabah and other trade and sales based transactions backed which are prone to higher degree of volatility and appropriate weights have to be assigned for both associated commodity pricing and counter party risks. While adopting a suitable risk mitigation technique, comprehensive and transparent disclosure of “…… risk profile, risk-return matrix, and internal governance is critical. Among others, this requires coordination of supervisory disclosure rules, and accounting standards, and proper differentiations between consumer friendly disclosures to assist IAHs and market-oriented disclosures to inform markets.” 3 In this regard, IFSB Guiding Principles on Risk Management has served a good purpose. They provide guidance for different risks to which IF industry is exposed and offers guidance on the methodology for credit risk, market risk, liquidity risk, operational risk, equity investment risk and rate of return risk for different types of financial transactions. We are in the process of adapting these guidelines for Islamic Banking Institutions in Pakistan. Finally, as the IF industry diversifies, it will face increasingly more diverse range of risks associated with investment banks, mutual insurance (takaful), and investment companies. Islamic banks, however, remain the core of the industry in many countries and offshore financial centers and account for the bulk of financial transactions and their soundness would remain a key concern for systemic stability. In Islamic banking, the management of risks becomes more challenging due to its peculiar risk characteristics in line with the requirement for compliance to Shariah principles. While the Basel II initiatives on the identification of credit, market and operational risks can be assimilated into Islamic banking, the initiatives have to be complemented with consideration of the other dimensions of risks that are inherent in the IF transactions. Fourth, for effectiveness of IF development, it is desirable that eventually model legislation is developed for IFs to recognize different institutions and products. This will facilitate development of contractual frameworks which has its basis on approved legal framework, which among others will allow for proper enforceability of contract. Strictly speaking even in Muslim-majority jurisdictions, Shariah compliant IFIs/products and services are not explicitly recognized in the relevant laws and statutes. As such, interpretation and recognition of financial products and enforceability of Islamic financial contracts may not be there in the laws and courts which PER and IRR together adjusts for excessive volatility in profit payouts to investors by aligning the payouts to market rates on deposits and redistributing investment and profits remaining income over time to cover for losses that may emerge. See V. Sundarajan (2007). “Risk Characteristics of Islamic Products: Implications for Risk Measurement and Supervision.” In S. Archer and R. A. A. Karim (edt.). Islamic Finance – The Regulatory Challenge. New York: Wiley Finance. Ibid. have traditionally adopted either the common law or civil law framework. For example, whereas Islamic banks main activity is trading (Murabahah) and participating in equities (Musharakah and Mudarabah), banking law and regulations in most jurisdictions forbids or allows restricted exposure of such activities. To address these issues, some counties have adopted separate Islamic Banking laws (e.g., Kuwait and Malaysia), while in others IF system is recognized under a section of the existing banking law (e.g., Bangladesh and Indonesia). Pakistan has also added provisions in relevant banking laws to support financial institutions involvement in Islamic finance transactions. Fifth there is need for dispute settlement and conflict resolution mechanism. In line with Islamic Laws and Statues, an effective Dispute Settlement Institutions that recognizes the intricacies of Shariah principles and contractual arrangements would be beneficial. Among others, this will facilitate resolution of disputes associated with cross border contractual arrangements that could involve more than one jurisdiction each offering their own perspective. Notwithstanding, there is further need for harmonizing the Islamic rules related to financial dealings. While the courts can not be expected to change fast, formation of special bench that deals with, among others, Islamic financial transactions could be a solution. Malaysia has build some legal infrastructure institutions for IF industry and has dedicated high court judges to oversee litigations related to IF. To complement the court system, the Kuala Lumpur Regional Centre for Arbitration has been enhanced to deal with disputes on Islamic banking and finance for both domestic and international cases. Sixth, essential for effectiveness and sustainability of IF industry is need for encouraging this segment to enhance corporate governance and ethical standards in banking. In line with the Shariah rulings, the challenge for IFIs is how to balance the dual objectives of achieving economic gains, while ensuring compliance with Islamic faith. Compliance with Islamic faith goes beyond the elimination of Riba to facilitate equitable distribution of economic resources and non-exploitation of any particular segment of the society. In more concrete terms, IFIs should play a greater role in micro finance, SME lending, rural development, and in funding more socially responsible schemes. IFSB should consider working on social responsibility guidelines for IF institutions, which would aim to foster the larger objectives of equity and non-exploitation. In conclusion, proper and sequenced development of IF would be critical for this industry to emerge as an effective channel for both savers and financier’s. Collectively continued efforts are warranted to ensure that we address the issues and challenges raised above so that there is greater national, regional, and global acceptability and fast integration of IF with conventional industry. Besides the concerns and proposals suggested above there is need to strengthen capacity in IF both at regulator and industry level, while promoting financial literacy among public; develop new generation of Shariah scholars and other academic and special industry experts, and use more effectively standard setters and private sector to work together to helping align IF industry with appropriate enhancements with existing international standards to lend more confidence and allow greater international integration. Finally, most critical is the standardization of Shariah rulings within the same jurisdictions and among various regions which currently offer divergent views and advice given the beliefs of different schools of thoughts on same issues. | state bank of pakistan | 2,007 | 4 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the ACCA Conference "CFOs: The Opportunities and Challenges Ahead", Karachi, 13 March 2007. | Shamshad Akhtar: Pakistan – changing risk management paradigm – perspective of the regulator Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the ACCA Conference “CFOs: The Opportunities and Challenges Ahead”, Karachi, 13 March 2007. * * * A paradigm shift has taken place in the banking sector of Pakistan in recent years. Today, the sector is relatively more robust, market based and highly profitable than it was ever before. The new paradigm has emerged largely as a result of the flexible monetary management, adoption of market oriented banking sector policies, transfer of ownership both in private and foreign hands, clean up and resolution of banks’ loan portfolios, and strengthening of regulatory and supervisory standards. In this session, I will discuss the (i) overall risks Pakistani banks face as a result of the changing economic and banking paradigm, (ii) identify the role bank regulations and supervision play in risk management, (iii) share perspectives on the key risks facing Pakistani banks and briefly touch on the emerging trends, and (iv) highlight central bank and banking industry’s initiatives to strengthen the banks and system-wide risk management. Emerging challenges and risks from changing paradigm Most critical among this is recognition: • First, that Pakistani banks like other emerging economies have benefited from macroeconomic stability and resilience of the economy, there is ample evidence that emerging economies, including Pakistan, are more significantly prone and exposed to shocks than developed countries. • Second, Pakistani banks are today faced with new forms of risks which have altered the nature and type of risk they are exposed to – aside from standard corporate assets whose credit risks is changing with the size and complexities of businesses, banks are now engaging in diverse businesses and sectors and are now extending their exposure to household sector and growth in bank trading books has increased exposure to market risk – a recent phenomena in Pakistan. Concurrently, banks’ overall risk profile is also affected by the complex interdependencies now emerging because of cross ownership of financial institutions and corporate sector. • Third, that enhanced risk exposures can, however, be well managed given that today world is more informed about what drives exogenous and endogenous shocks and how to effectively deal with them through improved measurement, management and mitigation of a wide array of risks i.e. macroeconomic risks, credit risk, liquidity risk, market risks, solvency risks and operational risks. • Fourth, bulk of banks now being under private ownership can no longer count on taxpayer funds to rescue them and recognition that uncompetitive institutions have to be prepared to exit or to fast restructure. Existing regulatory and supervisory framework – principles and approaches As a regulator, SBP has established a comprehensive and well balanced regulatory and supervisory system to inculcate a culture of sound risk management within banks. Simultaneously SBP’s capacities have been enhanced to effectively regulate and supervise banks and assess system wide risks, both on a quarterly and annual basis. Generally, banking regulations have been designed keeping in perspective Pakistan’s economic and political realities, prevailing banking practices, and environment for legal recourse and property registry systems all of which constitute integral elements of the risk management infrastructure. Regulatory framework offers guidance on risk measurement and management and its tools. After being overhauled in 2004, the regulatory framework currently enforced has a good blend of conservatism and prescription while allowing for flexibility and pragmatism to relax exposures when banks have developed effective capacities and systems to mitigate risks. The main elements of regulatory framework are to; (i) Encourage establishment of well capitalized banks – all banks are expected to meet the minimum capital requirements of $100 million by 2009. The requirement for capital has facilitated gradual consolidation and emergence of stronger banks, while allowing banks to take greater risk exposures to the extent that a set of regulations are linked to the equity base of banks. Currently, 8 banks are fully complying with these requirements and others are striving to accelerate compliance, (ii) Encourage banks to contain risk exposures. For instance, both the individual or group exposure is linked to borrowers’ capacity as well as bank’s equity base. Similarly, banks have to contain their trading books through a set of regulations that define the exposure to investment and lending in stock market (Prudential Regulation R-6), (iii) While encouraging sector diversification through a set of development oriented prudential regulations for agriculture, small and medium enterprises and microfinance etc., the regulations are by and large advocating better risk management and controls to help diversify and extend bank’s outreach, (iv) Encourage financial stability through guidelines on corporate governance, anti-money laundering, risk management, internal controls, stress testing, on country risk management, information technology security etc, (v) Encourage financial innovation while keeping in perspective bank’s capacity to manage risks. Keeping in view the role derivatives play in risk management, SBP formulated Financial Derivatives Business Regulation (FDBR 2004). SBP grants Authorized Derivative Dealer (ADD) status to banks that has been assessed to have adequate systems and expertise to conduct derivatives business. Banks which are now allowed to sell derivatives not only to hedge for their customers’ interest rate and foreign exchange risks, but take on for the management of the risks in their own books, and (vi) Enhancement of Disclosure requirements: The SBP in collaboration with the ICAP and the commercial banks has facilitated adoption of International Accounting standards (IAS) by the banks. In 2006, SBP revised the reporting formats for banks to incorporate the significant regulatory developments as well as modifications in the International Financial Reporting Standards (IFRS). With these changes, the quality of disclosure in the Annual Accounts of Pakistani banks has become at par with international best practices. To ensure effective enforcement of regulations, besides day to day oversight, SBP has substantially enhanced its on-site inspection and off-site surveillance capacity. Regular onsite inspections of all financial institution provide an assessment of FIs/banks overall financial condition, evaluate its management and Board performance and check compliance with legal and regulatory requirements. Keeping in view the developments taking place in the financial sector, increase in its size and complexity and introduction of new and innovative financial products, State Bank inspection is also updating its tools and methodologies. We have already realized that going forward specialized skills will be required to assess and evaluate areas like consumer financing, Islamic Banking, treasury, foreign exchange, information technology etc. We have also identified other critical areas for our supervisory focus like Basel II, Anti Money Laundering, internal risk models etc. and capacity building initiatives are being taken in these areas. In line with practices of regulators, SBP has introduced IRAF (Institution Risk Assessment Framework). It offers a composite rating drawing from offsite and onsite feedback, findings of management of banks on board, to establish their rating regarding their compliance with standards, codes and guidelines issued by SBP. IRAF once fully operational will make the supervisory process an all-inclusive and comprehensive exercise which includes information from SBP, Board and Management as well as market vigilance regarding the health of banks. Perspective on key risks facing Pakistani banks Like all other regulators, SBP is encouraging banks to strengthen their risk assessment capability and testing their capacity to withstand shocks under different scenarios. SBP offers its perspective on system wide risks publicly through its Financial Sector Assessment Report and Quarterly Banking Surveillance Reports. The findings of these reports confirm that thus far banks risks are diversified and managed in line with the banking regulations. An analysis of trends in different types of risk would offer better appreciation and perspective on changes in banks’ risk profile: Credit risk: In Pakistani banks, credit operations remain the main source of banks income and have been supported by strong economic activity. Given its size, credit operations are a primary source of risk. Supported by growth in businesses and gradual improvement in internal credit reviews, on balance credit risk have been well managed. The net NPLs to net loan ratio have declined in the last few years and fell to 1.8% by September 2006. In recent years, the macroeconomic environment has been supportive of the growth of banking systems but the growing fiscal imbalance and the external imbalances have enhanced domestic demand pressures. While the vulnerabilities of banking system have been well managed, the shocks arising from external sources can be a cause of concern. Exposure to perceived risks arise from the (i) structural problems facing the real sector whose resolution is critical to maintain the momentum in credit operations, and (ii) high domestic asset prices given high interest rates, equity prices and property prices. Underlying the credit growth is altering risk exposures which need to be well tracked to ensure their effective risk management. There is a broader concern that the growing domestic demand have impact on bank asset quality and the growing exposure of household sector to consumer financing could have their attendant risks. Consumer finance has risen from 2.4% in 2002 to 14.3% by September 2006 and number of borrowers of consumer finance from 0.25 million to 2.6 million, respectively. Thus far credit risks on the banking books associated with some assets has been limited. For instance, the housing finance is barely $1 billion (or 2.3% of total loan outstanding) and mortgage business non-existent. Market risk: Banks market risk exposure largely stems from the interest rate risk as the equity price and exchange rate risks are not substantial given their exposure in balance sheet is limited. Interest rate risk emanates from movements in interest rates, which are determined both by the liquidity available and its response to short term rates and the future expectations of economy, the longer term yield curve. Interest rates in Pakistan have remained volatile in line with demand pressures during the past few years. After the 9/11, initially growth in liquidity resulted in fall in interest rates and by August 2003 the interest rates reached lowest levels and the differential between the interest rates on Rupee and Dollar squeezed. Low interest rates added to the revaluation gains especially for those banks which were holding longer term fixed investment securities and carrying positive duration GAP. Subsequently, interest rates rose with the building up of inflationary pressures. Consequently, banks with significant interest rate exposures had to bear the risks related to their positions. The impact of these trends was manageable as banks were able to hedge their positions in response to the SBP clear monetary policy signals. To evolve better risk management, SBP has allowed derivatives to hedge the open positions of the banks. With the increased knowledge, and realizing the importance of managing the interest rate risks, large banks have established systems and models to better assess and manage interest rate risks. Banks use different quantitative techniques, like VaR models, to assess the risk of loss focusing on tail events. Under the guidance of SBP, they recognize the duration of their assets and liabilities and conduct appropriate sensitivity analysis. With these analytical tools, banks have better understanding of their interest rate risk profile and accordingly better management of such risk exposures. However, banks need to move to more broad based and refined risk management systems so as to capture the right risks at right time. Independently, SBP reviews market risk profile and the mismatches in the assets and liabilities of banks, which generally remain with in the acceptable limits. Liquidity risk: Banks need to be equipped to deal with the changing monetary stance which shapes the overall liquidity trends and the FIs/banks own transactional requirements and repayment of shortterm borrowings. In the modern financial markets, banks have to manage their liquidity through money-market operations which offer a range of options and at any given point has ready providers and buyers of liquidity. In case of temporary liquidity squeeze banks can resort to discount window operation, and in situation where it threatens bank solvency they can resort to the lender of the last resort facility. As highlighted above, from 1999-2003 banks liquidity position was comfortable supported by easy monetary policy. With the growing monetary tightening the central bank has focused on strengthening its capacities for liquidity forecasting and management and conducted effective OMOs to ease or tighten liquidity pressures. In general banks have contained their liquidity risks, but liquidity position of banks has been tightened as evident from rising loans to deposits ratio at 73.2% with some banks reporting above these averages. Liquidity risks can, however, be effectively managed if banks address the fundamental problem of maturity mismatches stemming largely because of bank’s unwillingness to extend their deposit tenor which has limited bank’s capacity to lend long too. Operational risk: Growth in business did stress the individual and system wide financial infrastructure. However, industry is launching initiatives to strengthen its operational capacities by augmenting its systems and processes & adapting information technology solution and outsourcing. Growing wave of mergers and acquisitions leading to conforming business practices have introduced fresh complexity in the operational processes and procedures of the financial institutions. Besides, introduction of new risk management processes and products and hedging strategies, which although reduce credit and market risk but may create additional operational risks, which are on the rising trends. SBP is encouraging banks to adopt best practices to manage their operational risks and has issued guidelines on the areas of Business Continuity Plan, Internal Control, and IT Security. Operational risk was not effectively recognized and captured under the Basel I framework and as such there was no capital charge specifically prescribed for operational risk. Revised Basel Capital Accord (called Basel II), recognizes and defines the operational risks and its dimension and has prescribed capital charge for it to be calculated based on the gross income of the bank. Under Basic Indicator approach (BIA), capital charge for operational risk is a fixed percentage of average positive annual gross income of the bank over the past three years. Whereas, under the standardized approach all the business activities of the banks will be divided into eight business lines: corporate finance, trading & sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. The capital charge for each business line is based on gross income from that line, and ranges from 12% to 18% of the average gross income of last three years Despite increasing attention to operational risk, little systematic information exists on the extent and impact of operational risk as the losses can result from a complex confluence of events, making it difficult to predict or model contingencies. The biggest challenge for Pakistani banks is the availability of relevant and accurate data within the affordable cost to develop robust and solid operational risk measurement systems for quantification of expected and unexpected losses resulting from people, systems, internal process, procedures and external events. Major initiatives underway to strengthen risk management of banking industry Besides being a regulatory tool for capital adequacy, the new Basel II accord encompasses a comprehensive risk management system. The basic philosophy that the capital should be commensurate with the level of risks has a lot of merit. There is a direct incentive to be more discerning in identifying risk differentials among a set of opportunities and going about managing these risks in a prudent manner. Efficient utilization of capital is the prime goal of Pillar I (MCR) of the accord. Once the Basel framework is in place, banks with superior risk management skills would be able to get a competitive advantage over their counterparts. Recognizing this, Pakistan’s roadmap for implementation of Basel II Accord advocates that banks adopt the standardized approach from January 2008 – progress on this front varies from bank to banks. Bank’s ability to move towards Basel II would require them to address a number of challenges. There is, among others, need for; (i) Collective action to encourage corporate sector to become credit rated; as in absence of recognized credit rating of borrowers, banks would end up allocating more capital than warranted and this would render them uncompetitive, (ii) Development of allied and support infrastructure that facilitates the process e.g. the internal control and IT systems within the banks is absolutely imperative if the framework is to succeed, (iii) Presently the Basel II framework requires banks to apply a capital charge of 15% of average positive gross income of last three years for operational risk (under BIA) there is a need to clearly distinguish between a strong versus weak operational risk environment, (iv) Availability of historical data, for the purpose of carrying out quantitative analysis, and (v) Intensive capacity building of industry and SBP. To discuss these and other challenges SBP has set up a working group to first assess the current state of preparedness of the industry on a standard and agreed template for Basel II compliance and identify joint collaborative action to facilitate smooth transition. Developing rating industry and encouraging entry of raters which have been identified under Basel Accord-II would be critical for an effective implementation of Basel II for Pakistani Banks. SBP would have to draw its own understanding and linkages with the raters to ensure it is applying standards for weighing risks effectively across industry. SBP is in the process of developing a “Banking Supervision Risk Assessment Model” (BSRA) which will help SBP to better quantify the credit and market risks of the individual banks in terms of “Value at Risk” and forecast banks’ position under various stress scenarios on a quarterly basis. BSRA model would use information from the Data warehouse (data received through Reporting Chart of Accounts (ROCA)) for market risk and electronic Credit Information Bureau (eCIB) for credit risk. For operational risk, key risk indicators (e.g. frauds, systems breakdown etc) would be identified and captured and processing would be carried out after a sufficient database is maintained. Once fully implemented and live, the risk assessment model will help Banking Supervision Department to strengthen its surveillance system through monitoring and measuring the risk profiles of the individual banks, even under stressed scenarios. The model will also help BSD to understand and monitor the credit and market risk appetite of the individual banks and proactively take corrective measures, if required. Conclusion The changing economic and banking paradigm has increased the complexities and risk facing banks. While the industry has been bracing up to face the changing risk paradigms which have included not only enhanced exposures to corporate sector but now banks are extending their outreach to household sector, SME and microfinance whose exposures need to be better managed through effective risk management. SBP has adopted sound regulations and proactive supervision to ensure effective surveillance of banks and is advising banks to manage their risks prudently. Despite the growth and diversity in businesses and emerging macroeconomic pressures, banking system has shown a degree of resilience. Results from latest stress tests for all Banks for Third Quarter of 2006 while applying different credit and market shocks to calibrate its impact on solvency i.e. the capital adequacy ratio of the banks indicates that after shock CAR of all banks remain above 11%. Like in previous years, credit risk weight remains high and is assigned bulk of the capital, while market risk is confined to largely interest rate risk with equity risk now being an emerging phenomenon. The liquidity shocks do reflect a decline in liquidity coverage ratio of varying order among different institutions – a 5-10% decline in the liquid liabilities would lower liquidity coverage ratio by 3-7%. In the short term, while banks would have to continue effective risk management through better assessment of credit and market risks, but going forward in anticipation of Basel –II Accord, more fundamental changes in approaches and methodologies of both individual categories of risk is required and extending its reach to operational risk which is currently not accounted for. SBP will continue with its close consultations with the banking industry to get aligned with the international regulatory standards and solve the challenges arising out of these standards jointly with the industry in a congenial environment. | state bank of pakistan | 2,007 | 4 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Federation of Pakistan Chambers of Commerce & Industry, Karachi, 30 April 2007. | Shamshad Akhtar: Monetary policy in Pakistan Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Federation of Pakistan Chambers of Commerce & Industry, Karachi, 30 April 2007. * * * Mr. Tanvir Ahmed Sheikh, President FPCCI, Mr. Zubair Tufail, Vice President FPCCI and Mr. Sheikh Amjad Rasheed, Chairman FPCCI Committee on Banking, Credit, & Finance Background Monetary policy management and financial sector stability are two primary roles of State Bank of Pakistan (SBP). Monetary policy and process of its formulation in Pakistan has undergone changes with the evolving economic dynamics within the country and the improved empirical and theoretical understanding of the monetary policy across the world. Monetary policy in Pakistan, in line with SBP Act, has been supportive of the dual objective of promoting economic growth and price stability. It achieves this goal by targeting monetary aggregates (broad money supply growth as an intermediate target and reserve money as an operational target) in accordance with real GDP growth and inflation targets set by the Government. Over the years, while maintaining the broad legal mandate, SBP has improved the quality of monetary formulation and its process quite significantly. This morning, I propose to first outline measures taken by the Government and SBP to strengthen the monetary policy management. Second, I will discuss the rationale and key elements of SBP current monetary policy stance which I believe is helping bring down inflation without stifling credit or economic growth. Finally, I will discuss the impact of SBP’s policy actions, and challenges in its implementation. Changes in monetary policy management SBP shifted its reliance from an administered monetary policy regime governed by ad hoc changes in reserve ratio’s, directed credit and regulated interest rate policies in mid 1990s to a liberal and market oriented monetary policy management. Abolishing sector and bank credit limits, central bank adopted “3-day SBP discount rate” as a major policy instrument to signal easing or tightening of monetary policy which essentially responded to the demand pressures of the economy in line with the growth trends in monetary liabilities and monetary assets – with former capturing the growth in currency and deposit base and latter the growth in domestic credit (including both government borrowings and private sector credit). Generally monetary module of the economy is the least understood area. This is largely because monetary segment of the economy deals with on one hand the changes in stocks and flows of money supply and on the other hand trends in it subsumes and defuses the impact of developments of fiscal and balance of payments accounts. Notwithstanding both sides of the balance sheet of monetary accounts impact price behavior. As highlighted above, broad money supply growth has to be consistent with the targets of growth in real GDP and inflation rate. However, if there are excessive demand pressures either because of high fiscal deficit or because of the excessive foreign inflows money supply grows faster than the growth in productive sectors and generates demand pressures which manifests itself in rise in inflation rate. Despite all contests and debates, inflation is primarily a monetary phenomenon. To keep it under control it is critical that macroeconomic imbalances are kept within the permissible limits. Fiscal profligacy in the past has resulted in Government’s unlimited recourse to low and fixed interest rate financing. While interest rates were kept low to nurture private sector credit growth – this did not traditionally happen as private sector investment remained subdued due to host of structural problems facing the economy. Instead low interest rates nurtured fiscal indiscipline as the Government continued to borrow at cheaper rates to finance expenditures. Recognizing this dilemma, qualitatively monetary policy formulation and its implementation underwent profound changes. In 1997, SBP and its Central Board were empowered to formulate, conduct and implement monetary policy and a Monetary and Fiscal Coordination Board was established to ensure fiscal policy is well coordinated with the monetary policy – specific provision of SBP Act mandates Central Board to impose limits on Government’s central bank borrowing. In 2005, the Fiscal Responsibility and Debt Limitation Act 2005 requires Government to reduce its revenue deficit to zero by 30th June 2008 and maintain it thereafter, and concurrently reduce public debt to sixty percent of GDP by 2013 and below that limit thereafter. Compliance with the two pieces of legislation has been underway and over the period will help in eventually curbing more effectively Government’s recourse to central bank borrowing – which traditionally has complicated monetary policy management. With greater powers to formulate monetary policy, SBP moved to market oriented monetary policy where it relied more on interest rate to serve as a policy fulcrum and developed its capacity to manage financial markets and related activities effectively. Proactive conduct of monetary operations and management of market volatility has helped improve market flows. The Open Market Operation (OMO) process has been institutionalized with better flexibility vis-à-vis tenors and frequency. In 2005, SBP introduced the Money Market Computerized Reporting System (MM-CRS) for banks which helps in assessing the market liquidity. SBP’s treasury operations and gradual improvements in its liquidity management have together helped OMOs and money market development. Current monetary policy stance Public, businesses and market needs to develop understanding that monetary policy does indeed, over the long run, determine the behavior of the price level. While inflation is precipitated by supply shocks, hoarding, official restrictions, import prices, and so on, but these influence price level in a given year. However, it is monetary policy that can prevent an effect on the rate of inflation over a more extended period. That is, following the initial price level shock, an appropriate adjustment of the interest rate (if necessary) can stop a potential second round of repercussions on wages and prices. Specialists use measures of core inflation, which exclude volatile prices, as a way to see through oneoff shocks. Core inflation is very useful to the central bank itself, as a guide to the appropriate setting of its monetary policy stance. Unexpectedly low (high) core inflation usually indicates the need for easing (tightening) in the policy stance. The ultimate objective of a central bank, and the measure of success of its policy, is in terms of overall (i.e. headline) inflation. In this context, the way to deal with price level shocks is to stress their temporary nature with respect to the inflation rate. This involves: ensuring that the effect on inflation is only temporary – this may or may not require a policy action, and realizing that as monetary policy influences the trend of prices with a lag of at least a year and a half, headline inflation should return to its pre-shock rate not within not 1 year but 2 years. Price signals in a market economy operate less effectively when the price level is unstable; in addition, resources are diverted to unproductive speculation and hedging. Thus, countries with unstable price levels – high inflation or deflation – almost always experience weak output and growth. Thus, low inflation is not merely an end in itself, but also a means to good overall economic performance. The main cause of high interest rates is high inflation, through the expected-inflation premium. Conversely, the best prospect for low interest rates is a stable environment of low inflation. In this context, the relatively high interest rates that may be necessary to achieve a desired disinflation represent “short-term pain for long-term gain”. SBP, therefore, has a current focus on anti-inflation policy which will ensure steady growth in the long run. Since April 2005 in response to the headline inflation reaching 11.3%, SBP has been and remains in monetary tightening phase. It has to be recognized that the inflationary pressures build up in 2005 because of the preceding few years of easy monetary policy. While SBP addressed this overhang by raising policy discount rate from 7 to 9% in April 2005, there were renewed demand pressures as fiscal and external account deficits rose in wake of both international oil price increase as well as unforeseen spending demands triggered by the earthquake. To offset additional demand pressures, SBP had to further raise its policy discount rate by 50bp in July 2006 along with 4.5 percentage point upward revision in reserve ratios. In line with the evidence observed for developing countries, impact of monetary tightening on curbing inflation started to be visible after 12-18 months or so. As aggregate demand pressures moderated, CPI fell to 7.9 percent in FY06 (remaining well within the annual target of 8%) and CPI continued to decline to 7.7% in March 2007 with core inflation being still low at 5.4%. However, CPI remains above annual target of 6.5% largely because of a number of factors that disrupted the impact of monetary tightening: (i) food prices remained quite volatile during FY07 due to supply disruptions; (ii) higher fiscal pressures resulted in greater than planned recourse to the central bank borrowing. More specifically, government has borrowed Rs. 180 billion for budgetary support by 14 April 2007 compared with only Rs. 37 billion during the same period last year. During the later part of FY the Government has been retiring part of the central bank borrowing and financing its deficit by external flows or commercial bank borrowings; (iii) heavy borrowing from commercial banks seems to have been crowding out private sector borrowing for long-term investment as banks find it convenient to park their funds in government securities rather than lending; (iv) SBP being mandated to provide higher than projected refinancing for the textile sector – besides its high borrowing to meet working capital requirements through EFS, textile exporters were allowed debt swap and new long term borrowings which ranged around Rs50 billion; and (v) higher than expected foreign inflows are expected to enhance the levels of net foreign assets and result in monetary expansion. Together these factors have resulted in 16.9% YoY growth in reserve money by 14 April (compared to 11.2% last year) which has translated into broad money supply growth of 17.3% by 14 April 07 – higher than the monetary policy statement’s original projection of 13.5%. To avoid adverse impact of monetary tightening on investment demand in the economy and the longrun growth momentum, SBP has ensured proper liquidity management. Not only have the overnight rates been kept close to the discount rate, but the volatility in the short-term interest rates also reduced during H1-FY07. 6-months KIBOR rose by 58 bps to 10.2% during July-April 07 and banks weighted average (marginal) lending rate has increased from 9.9 % in June 2006 to 10.5 % in February 2007. During July-April 14, net credit to private sector grew by Rs266.4 billion (or 12.6 %) against Rs 339.7 billion (or 19.8 %) in the corresponding period of FY06. Despite liquidity in the system, commercial banks are not able to lend because of low demand for private sector’s credit that has borrowed quite heavily in last few years. While there has been growth in working capital, the demand for fixed investment has been subdued. In some cases, corporate sector is further meeting their demand either from retained earnings or foreign borrowings. In some sectors, banks have deliberately slowed down to now assess and develop their own capacities to lend more prudently. The process of mergers and acquisition in a number of banks also impact private sector credit as most “acquired banks” slowed down their business. Trends in key macroeconomic variables indicate that SBP monetary policy stance has proved successful in striking the required balance between curbing the demand side inflationary pressures and supporting the growth momentum. Indications are that the economy continues to grow at a robust pace on account of acceleration in Large-scale Manufacturing (LSM) and agriculture, and the persistently strong performance of services sector. More importantly, core inflation, which had registered a sluggish decline in FY06, has already witnessed a substantial deceleration during the first nine months of FY07. By March 2007, YoY core inflation has come down to as low as 5.4 percent, which is 1.25 percentage points lower than the 6.7 percent level recorded during the corresponding period last year, 0.9 percentage points less than the level observed in June 2006. This comforting decline in core inflation, however, is eclipsed by the persistently high food inflation stemming principally from supply side disturbances. In totality, the average consumer price index (CPI) saw a rise of 8.0 percent during July-March FY07 relative to the annual target of 6.5 percent for FY07. With inflation in Pakistan being relatively higher compared to its competitors and trading partners, the Relative Price Index (RPI) increased by 5.8 percent during first three quarters of FY07. Higher domestic inflation has offset the gains emanating from nominal depreciation and the real exchange rate, measured in terms of the real effective exchange rate (REER) index, appreciated slightly by 2.5 percent during first three quarters of FY07. Conclusion To conclude, so far, the current monetary policy posture appears to be striking the balance of gradually reducing the excess demand pressures from the economy, without prejudice to the highgrowth prospects. In the short-term, SBP will need to maintain its monetary tightening stance and enhance its communication to influence inflation expectations, and effectively communicate that concerns about the adverse effects of higher interest rates on competitiveness and/or growth are ill founded as the real interest rates in Pakistan are low relative to its competitors. However, it is important to recognize that monetary policy alone will not be able to contain the rise in inflationary pressures. The Government will need to continue to alleviate supply-side constraints because of problems of market structure and distribution system. Success in containing inflation further depends on continued effective monetary management which requires minimizing Government’s recourse to central bank borrowing, mitigating the monetary pressures arising from the surge in capital flows ensuring that these are sterilized and keeping refinancing within manageable limits, while complementing these measures with check and vigilance on food prices. Going forward, SBP will be launching preparatory work on inflation targeting. There will be need for introducing supportive legal and regulatory framework which allow for targeting inflation and allow greater operational independence to the central bank, while ensuring that SBP has the desired transparency and communication strategy critical for transition to an eventual adoption of inflation targeting. | state bank of pakistan | 2,007 | 5 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 4th Islamic Financial Services Board Summit, Dubai, 15 May 2007. | Shamshad Akhtar: Islamic finance – emerging challenges of supervision Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 4th Islamic Financial Services Board Summit, Dubai, 15 May 2007. * I. * * Background Diversification and structural transformation in financial sector has been accompanied by increasing integration among different segments of the financial sector. The traditional boundaries between banks and non-bank financial institutions are eroding and we are witnessing the growth of universal banking and/or mergers among different segments of sectors. This trend has its benefits but has associated risks as well. Supervisors face a dual challenge. On one hand, supervisors are promoting financial diversification and consolidation to achieve market development and innovation. On the other hand, supervisors have to position themselves to recognize the new dimensions and types of risks and encourage appropriate risk mitigation. These considerations have triggered world wide debate on how to effectively supervise different segments of financial sector in conglomerate and universal structure. So far these debates had been concentrated around conventional banking but now it is widely gripping the world of Islamic Finance (IF). Stronger inter-dependencies among different segments of IF are emerging largely because Islamic Financial Institutions (IFIs), in principle, have features and inherent characteristics and more compulsion, than conventional banking, to conform to universal banking or to evolve inter-linkages among different market segments. II. Factors driving cross-sector linkages and interdependencies First and foremost, IFIs’ depositors/borrowers desire to conduct financial transactions that are Shariah compliant. It can be assumed that a person preferring to bank with an Islamic bank will also seek to use other faith-based financial services such as Takaful and Islamic mutual funds. This faithdriven feature in itself forces and incentivizes IFIs to offer, along side bank-based services (i.e. deposit and loans), a wide range of financial services. As a result, Islamic banks end up undertaking non-core banking activities such as fund management, capital market operations, securitization, leasing, and housing finance. This has enhanced the degree of integration between various segments of IF. For example: Islamic banks are likely to be strongly integrated with the Shariah capital markets since on credit portfolio side, Islamic banks do not have the same investment avenues as those available to their conventional counterparts. The outcome is that Islamic banks either end up taking large exposure in the capital markets directly or acquire subsidiaries which primarily engage in such businesses. Second differentiating aspect is the nature of contractual arrangements that drive deposits mobilized by conventional banks as compared to Islamic banks. Conventional bank deposits are interest based contracts with guaranteed interest return whereas Islamic banks raise deposit on a profit and loss sharing basis in either a Mudaraba or Musharaka structure. Mudaraba/Musharaka contracts transform the Islamic banks’ deposits into essentially a fund management product (although currently most regulators recognize these as equivalent to conventional deposit contracts) and this impacts the corresponding asset portfolio. There is a need therefore that Islamic banks acquire assets on a PLS basis as well and eventually move beyond fixed return products, like Murabaha and Ijara. This pushes an Islamic bank towards universal banking since in order to manage the portfolio profitability; it needs to invest across sectors in businesses based on Shariah principles, like equity and Sukuks in the capital market and trade contracts like commodity Murabaha, Musharaka, Ijara and Takaful. Thirdly, further development of Islamic banking itself depends on concurrent development of Islamic capital market. For instance, development of Islamic debt market is key to the provision of adequate liquidity support while providing additional investment avenues. Likewise, Takaful development is critical to provide insurance coverage to Islamic banking products, like auto and consumer financing, while strengthening secondary capital and Islamic bond markets by being a major buyer of Islamic instruments. It is the confluence of these factors that have induced regulators to encourage and IFs to promote rapid and deeper financial inter-linkages and integration. III. Supervisory challenges posed by cross-sector developments It is some of these above considerations that have augmented strategic alliances and linkages of various types among IFIs, both within country and cross borders. As such, IFIs are evolving either as part of a global financial concern or as a domestic bank acquiring or establishing subsidiaries and/or the two arms, i.e. Islamic and conventional banks coexist. Moreover, as the conventional parts of financial institutions move towards cross-sector integration, their Islamic counterparts (either as specialized window or as independent entities) will also follow eventually. While it has by now been well established that there are significant benefits of enhanced integration and inter-linkages or conglomeration in IF, such as the economies of scale, operational synergies and effective use of scarce human resource, there are definitely certain risks. 1 In this area, I would like to offer few basic observations. Firstly, it is inevitable that enhanced exposure of Islamic banks into capital markets exposes them to the volatility in associated businesses. Likewise, conglomeration, whether through universal banking or through parent subsidiary model, 2 exposes them to a variety of issues such as contagion risk, regulatory arbitrage, high group exposures, conflict of interest etc. These risks apply equally to both Islamic and conventional modes of finance. However, Islamic banks have thus far not erected firewalls, like conventional banks, to separate legally, financially and managerially their investment and commercial banking activities. Obviously these risks pose a challenge to the supervisors and necessitate that appropriate changes be made in the supervisory regime. Secondly, Shariah compliance issues necessitate taking a more aligned view across IF businesses as user of Islamic products may be oblivious of ideological differences as well as varying perceptions and interpretation of the Shariah advisors or boards and/or by regulators. Since institutions being supervised by one regulatory authority may be offering products of institutions being supervised by a different regulatory body, this could introduce complications and the challenge of ensuring uniform Shariah compliance across financial institutions and products. Thirdly, traditionally different segments have been regulated by their specialized supervisory authorities. These authorities have adopted risk management principles and supervisory stances which are strictly in line with the risk profile of supervised sectors in isolation. With sector integration, supervisors have to coordinate closely in policy formulation and regulation as well as on-site supervision. They have to coordinate creation of necessary firewalls, remove moral hazards and govern the degree of cross segment exposure. This may even call for institutional restructuring through merging various supervisory bodies into a single entity or for closer coordination between supervisors through creation of a third coordinating body. IV. Sector inter-linkages of Pakistan’s Islamic finance system In Pakistan, besides offering trade loans, like Murabaha, Islamic banks are offering equity and quasi equity products, such as Musharaka and diminishing Musharaka, and investment banking activities such as loan syndication, structured finance, etc. The six full fledged Islamic banks with a network of 108 branches and another 58 stand alone Islamic branches of 13 conventional banks have registered phenomenal growth and as of April 2007, the Islamic banking sector constituted 3.3% of total banking assets. 3 In view of the equity based nature of Islamic banking and lack of Shariah compliant financial instruments, central bank has allowed Islamic banks a relatively higher exposure (35% direct and 10% future of their equity) in capital markets compared to conventional banks (20% direct and 10% future). In addition, the State Bank of Pakistan (SBP) has relaxed statutory reserve requirement (SLR) for Islamic banks at 8% versus industry norm of 18%. Financial Sector Regulation: Issues and Gaps, IMF 2004. Universal Banks: First structure is of universal bank, in which all financial operations are conducted within a single corporate entity. The second model is the parent-subsidiary or operating subsidiary model, in which operations are conducted in and regulated as subsidiaries of another financial institution, usually (but not necessarily) a bank. Finally, in a holding company model activities are conducted in legally distinct entities, each with separate management and capital but all owned by a single financial or sometimes (unregulated) non-financial institution. See Annex A for details on product wise share and bank. Furthermore, Islamic banks are allowed to nurture parent-subsidiary/affiliate model whereby Islamic banks are by and large setting up asset management companies, brokerage firms and, now, Takaful businesses. Thus far the supervision of IFIs is bifurcated, with Islamic banks being regulated by SBP and non-bank IFIs, namely, Modarabas, Islamic mutual funds, Takaful companies and securities operations under the regulatory oversight of Securities and Exchange Commission of Pakistan (SECP). Sector specific supervisory approach is also characterized by varying regulatory requirements vis-à-vis operational matters, governance framework and Shariah compliance across the range of IFIs. The differences extend to minimum capital requirements ranging from Rs6 billion for Islamic banks (by the year 2009), Rs500 million for family Takaful operators (by the year 2011), Rs300 million for general Takaful operators (by the year 2011) and Rs30 million for Islamic fund managers to Rs2.5 million for Modaraba management companies. The low capital base of financial institutions, engaged in the business of Takaful or fund management, poses a significant risk to the solvency of financial conglomerates that characterize the Islamic financial markets. In terms of financial reporting, Takaful companies are not required to circulate quarterly accounts among shareholders whereas all other Islamic financial institutions are required to do so in terms of the legal and regulatory framework. The segregated supervisory approach has resulted in carving of legal framework specific to each sector for both conventional banks and IFIs 4 but eventually there is a need for addressing the idiosyncratic nature of IF industry, products and market players. Moreover, with regard to IF, both the regulators are following different approaches towards Shariah compliance in the institutions regulated by them. SBP requires Islamic banks to appoint Shariah advisors according to a prescribed fit and proper criteria and a Shariah Board has been constituted at the level of SBP to deal with issues relating to Shariah interpretation and compliance among Islamic banks. SECP’s approach varies across different segments of IF. A Religious Board, constituted by the government, is responsible for approving the prospectus of each Modaraba containing the types of business to be conducted, management, etc. While the Religious Board has a significant role, there is no requirement for Modarabas or their management companies to appoint Shariah advisers at individual fund level. Islamic mutual funds and Takaful operators, on the other hand, are required to appoint Shariah Council/Boards but no explicit fit and proper criteria has been laid down by SECP in this regard. SECP is also authorized to appoint a Central Shariah Board under the Takaful Rules, 2005, which has not been established as yet. The greatest challenge resulting from different Shariah compliance practices followed by Islamic banks, Modarabas, Takaful companies, etc. is the reputational risk faced by IFIs and misperceptions in the minds of public about Shariah compliance. This issue, therefore, needs to be addressed through coordination amongst the supervisors. Another issue arises from overlapping supervisory jurisdiction. The Banking Company Ordinance allows banks to act as Modaraba management companies for floatation of Modarabas. In terms of Modaraba Companies Ordinance, Modarabas can be formed to conduct any type of business, which is permitted under Shariah, be it trading, manufacturing, airline, financing, leasing, services, etc. and these are regulated by SECP. Due to overlapping regulatory jurisdictions, banks are floating modarabas through separate subsidiaries, 5 resulting in higher administrative, set up and regulatory costs. For sometime (from 1991-1997), these Modarabas were under the regulatory control of SBP, but the powers relating to licensing, winding up, etc. were retained by SECP; consequently the regulatory authority has been reverted to SECP. Again, this highlights the need for cross sector regulation of IFIs. Eventually there is a need to develop mechanisms for oversight of financial sector in an integrated manner. Besides coordination and cooperation among regulators, there is a need for consolidated supervision framework for financial institutions, guidelines for consolidated public financial statements and application of regulatory prudential limits on group wide basis and coordination to examine the intra group linkages with industrial and commercial entities. While conventional and Islamic financial industry would have to adopt similar approaches to integrated supervision, it has to be recognized that Fund management, as used here, refers to management of Islamic mutual funds and Modarabas. A number of banks have formed subsidiaries and floated modarabas like NBP, HBL, ABL, Habib Metropolitan Bank, etc. No Islamic bank has yet floated a Modaraba. the latter is a relatively nascent industry and hence the targets should be modified to match the ground realities. V. Conclusion IFSB’s ten year roadmap has highlighted the cross sector nature of IFIs and the resultant need for supervision to evolve accordingly. It is in recognition of these factors that IFSB has sought to broaden its membership to securities and insurance supervisory authorities as Full Members of IFSB. IFSB’s efforts for developing Islamic regulations as well as accounting, auditing and governance standards will facilitate adoption of unified principles for the development, operation and regulation of Islamic financial services. | state bank of pakistan | 2,007 | 6 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Financial Inclusion Conference, DfID & HM Treasury, London, 19 June 2007. | Shamshad Akhtar: Building inclusive financial system in Pakistan Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Financial Inclusion Conference, DfID & HM Treasury, London, 19 June 2007. * A. * * Introduction Supported by high and sustainable economic growth during 2000-2007 Pakistan has made key inroads: poverty incidence has reduced by 10% down to 24%, per capita income doubled to $925, and there has been steady progress in other Millennium Development Goals (MDGs). Turnaround and transformation in banking sector, supported by privatization and restructuring and market oriented policies, has already shown visible results in broadening, deepening and diversifying financial services in the country. However, the growth of financial sector has, as yet, not penetrated across all segments of population and across different regions. This is not unique to Pakistan as most countries have had to adopt explicit financial policies and affirmative action to redress the inequities and deficiencies of financial system which tend to disproportionately serve businesses and individuals with appropriate net worth backed by assets and collateral or located in prosperous areas. Recognizing this, the central bank of Pakistan has launched a broad based strategy for enhancing access to development finance. In this paper, I propose to discuss the case for a holistic and broad based strategy for financial inclusion in Pakistan to achieve desired scale and sustainability. In doing so, I intend to first outline: (i) Impact of financial sector reforms in deepening access to finance; (ii) Identifying nature and intensity of financial exclusion; and finally (iii) Discuss the key objectives, goals and principles and major elements of financial inclusion strategy – The strategy is anchored on developing financial and socially sustainable mechanism of credit delivery with particular focus on financially excluded population and regions. The central bank of Pakistan (the State Bank of Pakistan (SBP)) has now assumed a coordinating and supportive role with the alliance of Government, private sector and partnership with development assistance to evolve and implement the financial inclusion strategy. B. Impact of financial sector reforms in deepening access to finance Over the last seven years, Pakistan’s banking sector landscape has changed drastically. Principally both ownership and management changed. Financial markets have been fully deregulated. Together these measures resulted in remarkable quantitative and qualitative change. Growth in bank assets, deposits and advances has been unprecedented. Profitability is high, and nonperforming loans are at the lowest etc. Most notable has been • Rise in private sector credit from Rs18 billion in FY00 to over Rs 400 billion in FY06 • SMEs accounted for 17.4% of the total outstanding advances by December 2006 • Consumer credit accounted for 12% of the total outstanding advances by December 2006 from virtually negligible levels • Rise in agriculture credit from under Rs40 billion in FY00 to Rs 168 billion in FY07 • Housing loans rose from negligible levels to Rs70 billion by December 2006 • Microfinance loans increased from about Rs3 billion in 2003 to over Rs. 10 billion by December 2006 • Aggregate number of borrowers has risen from 2.7 million borrowers in 2003 to about 5.5 million by December 2006. Also, now banks are extending their business focus from corporate to household sector. About half of the borrowers have tapped consumer financing which is changing lives of low and middle income households that can now access credit (Table 1). Table 1. Distribution of Sector Lending 31-12-2003 Sectors Corporate SMEs Agriculture Consumer Finance Mortgage Loans Others Microfinance Loans Total Number of Borrowers 17,743 91,663 1,411,508 721,201 NA 135,561 315,000 2,692,676 Amount in Million Rs. 606,500 215,009 104,676 61,437 4,114 169,035 3,150 1,163,922 31-12-2006 Number of Borrowers 25,740 168,233 1,480,214 2,665,423 24,313 122,190 997,778 5,483,891 Amount in Million Rs. 1,269,564 417,873 141,856 276,037 49,134 246,289 10,743 2,411,496 % Growth over Dec 03-Dec 06 Borrowers Amount 1,094 NA: Not Available Source: SBP except microfinance numbers are from Pakistan Microfinance Network C. Nature and intensity of financial exclusion Despite the progress highlighted above, financial penetration in Pakistan is quite low. Pakistan has the highest number of people per bank branch among regional countries except Bangladesh (Table 2). Table 2. Regional Comparison: Bank's Branch Penetration Number of People per Branch Country Bangladesh 22,348 India 15,864 Indonesia 11,845 Malaysia 10,208 Pakistan 20,450 Philippines 12,773 Singapore 10,954 Sri Lanka 14,551 Thailand 13,929 Source: World Bank and SBP calculations Thus far, 37% of the adults have bank accounts; the number of borrowers, at 5.5 million, constitutes only 3.5% of the population; there are only 171 deposit accounts per 1000 people and 30 loan accounts per 1000 people. Agriculture and SME credit reaches only to 1.5 and 0.16 million borrowers 1 , respectively. Furthermore, outreach of documented microfinance sector is 1.13 million as of March 2007. December 2006 Financial exclusion exists in all economies and markets, whether developed or developing. However, the level and degree of financial exclusion is far more in developing and large countries as both population and size of country introduces their own constraints and challenges (Table 3). Table 3. Financial Penetration: Rural vs Urban Rural Urban Total Population Poverty Incidence (as estimated by GOP) 67.0 28.1 33.0 14.9 100.0 23.9 Bank Branches 33.0 67.0 100.0 Total population having bank accounts Adult population (19+ years) having bank accounts * 6.0 14.0 37.0 75.0 17.0 37.0 Deposits (number) Deposits (amount) 25.0 9.9 75.0 90.1 100.0 100.0 Advances (number) Advances (amount) 17.0 7.1 83.0 92.9 100.0 100.0 *: this figure may be overstated due to multiple accounts. Source: SBP and Economic Survey 06-07 In Pakistan financial exclusion manifests itself in different forms: (i) Exclusion because of geographical constraints since a large proportion of population e.g. almost 67% lives in rural areas and there are pockets of population residing in difficult remote and disadvantaged terrain such as barani and arid areas and tribal areas; (ii) Exclusion because of lack of enabling environment at provincial level. For instance, banks find it difficult to intermediate agriculture credit in provinces where there are problems such as lack of suitable land records and weak law and order enforcement. Similarly, these problems hinder other sectors including microfinance institutions to increase their penetration which is highly desirable due to prevalence of high headcount poverty. (iii) Exclusion because of banking behavior and practices either because they are not servicing a large segment of population or they rely on traditional modes of lending which require collateral or documentary requirements or they impose prohibitive transaction costs etc; (iv) Exclusion because of poverty or illiteracy or cultural and language barriers as a result of which population generally lacks awareness and understanding of financial services and products; (v) Exclusion because of lack suitability of products like current accounts, which do not offer an overdraft and an easy route to borrowings; and (vi) Exclusion because of regulatory barriers, such as the money laundering guidelines requiring proof of identification which many poor and vulnerable people find difficult to provide. Financial inclusiveness is critical as 42% of Pakistan’s population is under 15 years of age and about 24% of the population lives below poverty line, both these segments can benefit from economic empowerment. Apart from banks’ loan pricing policy and lack of easy availability, financial institutions are reluctant to venture into new areas as they do not have the capacity to assess the demand and deliver their financial services. The lack of availability of the faith based system of financial services, lack of alternate delivery channels and financial innovation, inadequate database and information on borrowers, and weak enforcement of contract etc. are some of the main stumbling blocks that prevent inclusiveness of financial sector. D. Pakistan – financial inclusive strategy Objectives, goals and principles. Recognizing the overwhelming size and intensity of financial exclusion in Pakistan, SBP in designing the second generation reforms for financial services industry is placing high priority on developing and implementing an effective strategy for financial inclusion. This section offers some perspectives on this strategy. A key objective of the financial inclusion strategy of Pakistan is to support the Government’s target for halving the income poverty headcount by 2015 and to reduce eventually poverty to a single digit. To realize this objective, the Government and the SBP has for sometime been creating conducive policy, legal and regulatory framework across the board, while adopting multiple approaches and modalities to extend its net of financial services to larger segment of population. Keeping these perspectives in mind, Pakistan has adopted a holistic strategy for empowering and enhancing the capacity of poor to contribute and participate in economic growth. On one hand, the Government is focusing on enhancing public investment in education and health and a wide variety of poverty alleviation programs. On the other hand, the central bank has been steering a broad-based policy framework for promoting inclusive financial development. The principle thrust of the approaches and programs designed has been to shift emphasis from directed and subsidized credit to adopting best practices and market based approaches to promoting private sector in financial inclusion. Meanwhile, public expenditure is supporting selective and targeted interventions to stimulate and catalyze action and nurture institutions which leverage public: private partnerships to improve access to financial services for poor. Most prominent e.g. is the support for the Pakistan Poverty Alleviation Fund (PPAF) and the National Rural Support Program and the recent President’s Rozgar Scheme that offers credit to nations young and unemployed. The PPAF is sponsored by the Government of Pakistan and funded by the World Bank and other leading donors. The PPAF follows a model of public private partnership through lending of wholesale funds to civil society organizations committed to community outreach programs for enhancing income and economic welfare of the disadvantaged people. Specifically, the PPAF provides funding for projects that help generate income, improve physical, social infrastructure, and skills of the vulnerable. On February 28, 2007 the PPAF had a resource base of US$ 826.17 million (Rs. 49,560.2 million) 2 . The NRSP is the largest Rural Support Programme in the country in terms of its outreach, staff and development activities. It is a not-for-profit organization with a mandate to alleviate poverty by helping people to harness their potential and undertake development activities in Pakistan. It has presence in all the four Provinces including Azad Jammu and Kashmir. The NRSP, with more than half a million poor households organized into a network of about 29,000 Community Organizations (COs), manages one of the largest micro-credit portfolios in Pakistan, with 282,421 active loans as of March 2007; it holds 25% of the microfinance market. The NRSP provides various financial services to the members of COs in rural areas to help them implement their Micro Investment Plans (MIPs) 3 , including Micro Credit, Micro Insurance and savings products. Pakistan Poverty Alleviation Fund National Rural Support Program and Pakistan Microfinance Network The National Bank of Pakistan, largest nation-wide bank, is offering small loans to unemployed and poor to finance purchase of auto rickshaws, setting up utility stores under franchise of the Utility Corporation, and setting up public call office etc. Interest on these loans is fixed at 12%: 50% of interest charges are to be borne by the Government and the remaining 6% by the borrowers. The Government will pick up first 10% of all losses and share credit risk insurance. External and internal verification of borrowers, references and guarantees are handled by ICIL – a representative firm of Dun and Bradstreet. This scheme is anticipated to deliver over 5 years period about Rs105 billion (US $ 1.74 billion). Since its launch this year, the scheme has delivered Rs2 billion to about 22,136 borrowers 4 . Recognizing Pakistan’s context, and drawing from other country experiences, it has to be acknowledged upfront that financial exclusion can only be tackled effectively: (i) If it is well conceptualized, well grounded and well integrated in the overall financial sector policy framework; (ii) If it is backed by absolute political commitment and cooperative stance of the federal, provincial and local government and relevant sector agencies to create a healthy and conducive environment for financial intermediation at the lower end of population where risks are of different nature; (iii) If financial institution recognize their corporate social responsibility and work towards financial deepening and credit diversification that is key to financial inclusion as well as to managing banks’ health and its systemic risks; (iv) If there is focus on provision of holistic financial services, whereby savings mobilization is perceived critical and integral to establishing the client on a sound footing and clients have collateral free access to financing with adequate provision for risks mitigated through credit enhancement mechanism and insurance; and (v) Facilitating reliable and secure payment between different parties. Major elements of financial inclusion strategy. Drawing from considerations highlighted above, Pakistan’s financial inclusion strategy is broad based and flexible that aims to encourage partnership and social cohesion and mobilization with the objective of empowering and nurturing clients and their businesses. It engulfs all segments of population by offering them holistic and multiple services and products. Anchoring and weaving these objectives, goals and principles, the SBP and the Pakistan Microfinance Network (PMN) have developed a far reaching Microfinance Strategy that is one of the principal driver’s of financial inclusion strategy 5 . In April 2007, the Government has approved this Microfinance Strategy and a time bound Action Plan has been prepared to launch its implementation. Presently, the institutional framework of MF industry includes a set of (i) retail providers such as six MFBs (licensed only recently by central bank), (ii) the national and provincial rural support programs and charitable or specialized NGOs, (iii) the wholesale apex institution, the principal being the PPAF which relies on donor and government financing support to refinance community organization whose number has reached 60,000; and (iv) the NGOs and the cooperatives – later are now mostly closed except for one principal operator, the Punjab Cooperative Bank that has managed to be proactive but it relies on SBP credit lines (quite an unsustainable approach) and provincial government support and has to be eventually restructure to be more financial viable. National Bank of Pakistan. Expanding Microfinance Outreach in Pakistan, www.sbp.org.pk/about/speech/governors/dr.shamshad/2007/MF-PM-17-Apr-07.pdf. Commercial banks have selectively provided liquidity support to few MFIs. In the last six years, MF industry and beneficiaries have grown (Table 4). Currently the network of MF providers is 239 branches servicing about 1.1 million clients with about Rs5.6 billion portfolio. Among MF providers, Khushali Bank alone accounts for 47% of this network. However, MFloan portfolio is higher close to Rs73 billion (as of December 2006) if one adds to MF providers programs all the agriculture, National Bank of Pakistan and other banks’ small and micro lending. Table 4. Growth in Microfinance (numbers in thousand) Year Borrowers Savers 2007 up to March Source: Pakistan Microfinance Network Even though industry has grown and is quite vibrant, its limited scale (both in terms of beneficiaries and region) and impact has recently necessitated stock taking of where we stand and how to transform this sector to meet more aggressively and swiftly country wide requirements. The MF-strategy advocates enhancing scale of MF operations to serve 3 million within 3 years for it to be henceforth extended eventually to 10 million expeditiously. MF ought to provide multiple services and products and sector financing and should include support for the un-banked poor but also those above it. The strategy aims to encourage a change in vision and mission of MF operators from being charitable and social service providers to sustainable financial service providers. To achieve scale, the strategy underscores that all MF business need to position themselves for scalability and sustainability by augmenting their reach and developing alliances with other players, provision of wide ranging financial services and nurturing both financial and social sustainability. In addition, the strategy aims to unleash the potential of existing MF providers, while enhancing competition by allowing entry of new international players, exploiting greater synergies between public: private institutions and retail-wholesale providers, developing framework for piloting credit unions and developing basic infrastructure for enhancing capacities of industry and borrowers as well as developing credit information bureau. The strategy further advocates developing effective synergies between the commercial banks and the Microfinance Banks (MFBs) and between the Microfinance Institutions (MFIs)/Nongovernmental organizations (NGOs). This interdependence and integration is perceived critical to encourage commercial banks to provide the desired liquidity to MF providers – which is absolute necessity until deposit mobilization at MF level generates required surpluses. Alliance between formal institutions and MFIs/NGOs is intended to help them access client and achieve desired degree of social mobilization – not a forte of banks. The strategy recognizes that MF providers alone cannot reach the large proportion of poor and low income so proper synergies and partnership among financial institutions will facilitate swifter extension of financial services to the small and micro borrowers across different sectors. The MF providers would have to reorient the way they do business and provide different products including loans, saving and insurance instruments as well as structure safety net schemes. More specifically, MF providers would need to develop capacities to deliver credit to different sector such as agriculture, housing etc. Furthermore, strategy recognizes that MFIs and MFBs would need to develop commercially viable and financially sustainable operation. This requires appropriate availability and blending of financing: equity support, debt raising mechanisms, leveraging funding through credit enhancement, and exploiting more aggressively resource mobilization from depositors. Furthermore, MFIs need to enjoy flexibility in charging interest rates that fully recover costs – administration and supervision as well as risk perceptions – public acceptability of this is critical as eventually financial services would be priced effectively with enhanced competition. To realize these goals, Government is (i) Introducing level playing field among the MFBs by bringing all MFIs under one legislative and regulatory framework – this requires bringing the Khushali Bank, the largest branch network, established under special ordinance and supported by subsidized funding that distorts level playing field in the industry. (ii) Encouraging MFIs to upgrade themselves to a full-fledged bank by offering a 5 years tax break to MFBs. (iii) Developing special funding/financing arrangements for MFIs which have potential for exploiting scale but cannot do so without resource constraints. MFIs (such as NRSP) are facing difficulty in extending their reach in difficult terrain such as barani and un-irrigated areas and rural areas without effective liquidity to conduct business. To address this issue, central bank is exploring mechanisms to encourage relationships and alliance between the commercial banks and MF providers with the objective of former providing the desired level of liquidity with and without credit guarantees or acquiring MFI to nurture such institutions. At the same time, the NRSP will be transforming itself from MFI to MFB and is working on a strategy to restructure with the objective of achieving scale in its operations. (iv) Facilitating entry of new international players such as BRAC, Shore bank, etc. and encouraging setting up a Build-Own-Trust Model supported by the Grameen Trust. (v) Encouraging restructuring of First Women Bank Ltd. to enhance its role in serving microcredit requirements of women. Restructuring would involve bringing in strategic partner in this bank and encouraging enhancement of its capital to allow it to leverage itself properly for augmenting its outreach. (vi) Enhancement of capacities of PPAF to offer credit enhancement to leverage resources for microfinance industry and supporting other industry-wide initiatives. (vii) PMN further positions itself to serve as a think tank, advocacy group and collate trends and analysis of industry and has played an instrumental role in steering the industry and strategy. Central bank’s special initiatives to enhance outreach and scale SBP’s Annual Branch Licensing and Basic Accounts Policy. SBP has introduced the Annual Branch Licensing Policy with a road map for 2008 and beyond. This 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 branch of any bank exists. Table 5. Proportion of Rural vs Urban Bank Branches % age of Rural % age of Urban Total Branches Branches Branches Foreign Banks Five Big Banks 5,448 Private Banks 1,575 Islamic Banks Specialized Banks Source: SBP The branch licensing policy has had a significant impact on braches of the five large banks with more than 40% branches in the rural areas (Table 5). In contrast, the private banks, despite having a considerable number of total branches are lagging behind in rural branches leaving much to be improved. This could be due to the fact that private banks mostly comprise of smaller banks with less than 100 branches. Similarly, Islamic banks and foreign banks will have to open rural branches once they reach the threshold of 100 branches. In addition, SBP has allowed banks to establish sub branches, booth and service centre of commercial banks in inner regions where it is costly to maintain a full fledged branch. These sub branches can be managed by skeleton staff and can act as an extended arm of the near by branch for performing limited banking functions such as deposits, withdrawals, issuance of demand draft, telegraphic transfer etc. and also facilitate payment of home remittances to their beneficiaries. Since November 2005 all commercial banks operating in Pakistan are required to offer Basic Banking Accounts (BBA) to facilitate and provide basic banking facilities to the low income people in Pakistan. A typical BBA can be opened with a minimum deposit of Rs1000 carrying no fee, no limit of minimum balance and full ATM facility. As of March 2007, about 120,000 BBAs were opened. Hesitation in mobilizing BBAs has been there as the banks complain of high transaction costs associated with these accounts. While BBA is relatively a new product, the current and savings account are almost 47% of total deposit base and remain sticky despite the low returns offered by the bank. Central bank has introduced substantive competition by allowing entry of new and foreign banks and it is likely that this competition will eventually drive interest rates up for small depositors over time and would serve in turn as an incentive to clients to bank more aggressively. Special products offering different schemes for car loans and insurance etc. are already attracting urban small depositor, who were earlier out of the net, to bank. Promotion of Post Office network. SBP and Post Office (PO) are exploring how 12,343 field office network of PO can be used to provide financial services by encouraging alliances between MFBs/MFIs and PO. So far, PO manages over 4 million saving accounts with 70% of such accounts holding savings below Rs10, 000 (or $165). PO is now working with a few MFBs/MFIs to develop viable arrangements for PO to sublet premises to MF providers or to partner with them to launch wide range of financial services. PO recognizes that it would have to rely on MFIs for financial intermediation, though local POs have over the years developed an understanding of local communities that they service. SBP’s Sector Prudential Regulatory Framework catalyzed to service under-served. Dedicated prudential regulations have been developed for specific sectors. In 2001 SBP issued Microfinance Ordinance and supportive Prudential Regulations as well as guidelines to allow setting up of national and regional MFBs and now 6 national level MFBs are licensed. The MF ordinance has been amended last year to ensure that minimum loan size being offered by MF be raised to Rs150,000 to allow providers to service MF business requirement and now MF are allowed to engage in remittances businesses. Banks are allowed to lend to small and medium enterprises clean i.e. without collateral up to Rs3 million and now SBP is considering broadening it to include small enterprises. In parallel, there are several initiatives to extend financial services to small borrowers. These include: SBP’s-SME financing Strategy that advocates promotion of Credit Guarantee Schemes and Venture Capital Funds, establishment of SME training centers and capacity building of banks’ SME Loan Officers, SME Credit Risk Scoring and Competitiveness Benchmarking and Triennial Survey on SMEs to estimate their demand for the financing. In tandem, SBP has introduced Prudential Regulations for Agricultural Financing and Guidelines for Livestock and Fisheries financing; estimated agricultural credit demand for complete value chain from production to export by the farmers/growers; and simplified and standardized loan documents, and offered three years revolving credit scheme with one time documentation and automatic renewal on annual cleanup of principal plus markup for production loans to farmers. SBP has further allowed banks to finance against market/realizable/forced sale value of the agriculture land, urban properties, gold/silver ornaments, etc. and also against two personal sureties (up to Rs.500,000 – US$8,333) in addition to passbook of the land etc. These initiatives have contributed significantly in enhancing formal institutional agricultural credit disbursement for small borrowers. Besides allowing commercial banks and removing caps on house loans and bank based exposure limits for housing finance, the House Building Finance Corporation (HBFC) is being corporatized to deal with the back log and demand for new housing units in Pakistan, estimated at 19.3 million including back log of 6 million low income housing units. HBFC, with support of the Government, has announced to promote low income housing on sound banking principles. Islamic banking, which carries appeal for Shariah compliant clients, is being promoted to cater for underserved sectors such as SMEs, agriculture sector and micro enterprises through Shariah compliant products. Besides six full fledged Islamic Banks and permission to conventional banks to render such services, a full fledged Islamic Microfinance Banks (IMFB) would be encouraged also. The central bank is working with the Government to develop adequate and commercially viable credit enhancement mechanism to support lending to MFIs which have now developed their niche and have potential to enhance their outreach but are constrained because of lack of funding or financing for capacity support. Similarly there is need for credit guarantee mechanisms to support evolution of small businesses. For these areas it is arranging for technical support from international service providers such as Grameen Foundation of USA will help in development of credit enhancement mechanism and establishing a poverty monitoring mechanism to assess the credit delivery to vulnerable population. The central bank is encouraging promotion of insurance products to support micro and small lending. For instance, SBP plans to play a proactive role in development of Islamic micro-insurance products and has already worked with private sector insurance companies to develop non collaterized lending and crop loan insurance products which should help leverage MFBs and other institutions interest in supporting agriculture lending for small borrowers. The central bank has promoted electronic banking which should lay the foundation for country wide connectivity of financial institutions. Already about half of the bank branches are now engaged in electronic fund transfer which is eventually to be supported by the legal coverage provided by the Payment and Electronic Fund Transfer Act, 2007. In parallel, efforts are underway in collaboration with ADB to launch mobile banking. The central bank has already laid out a Policy Paper on Regulatory Framework for Mobile Banking in Pakistan for public comments. Under this, central bank will promote both branchless as well as bank and non-bank focused models of mobile banking. The central bank has restructured itself in September 2006 and established a full fledged Development Finance Group. This is now headed by an Executive Director – who is a important member of the Banking Cluster, with independent sector finance departments which steer and help implementation of policy, legal and regulatory framework for Small and Microfinance businesses, agriculture and rural credit, housing and infrastructure finance and Islamic finance. This Group has been entrusted with the Mission to steer and implement the financial inclusion strategy, launch development programs and analyze and monitor issues and progress in access to development finance in collaboration with the stakeholders and Government agencies. The Banking Services Corporation – a subsidiary of SBP – is now being restructured to engage through Local Advisory Committees to disseminate the financial inclusion architecture at field level and to provide us feedback on problems of development access while raising awareness and understanding of financial solutions offered by various providers and providing feedback on the problems public faces. The central bank with the support of its two principal training institutions i.e. National Institute of Banking and Finance and the Institute of Bankers Pakistan is implementing financial literacy and capacity building for financial institution and public to leverage available financial services while building momentum for them to appreciate that pricing of formal delivery channels while high would be competitive vis-à-vis informal and other lending opportunities they may have. E. Conclusion In conclusion, given the nature and intensity of financial exclusion in Pakistan, we can ill afford to delay sound and quick implementation of the financial inclusion strategy that has been developed by the central bank with support of all stake holders. It is critical to recognize that this broad based strategy aims to unleash the potential of both public and private sector financial intermediaries and agencies and channel them more coherently and systematically to launch an all round aggressive campaign on financial inclusion. The central bank on its part is not in business of directing or supporting itself financial intermediation but is in the business of performing its public role and responsibility leveraging policy, legal and institutional standing and strength to act as a principal agent for motivating, mobilizing and using moral suasion with industry to serve the people. Its role is more to empower the industry and its agents and to empower public through financial literacy to position themselves to access wide range of financial services in a cost effective and efficient manner. Political commitment, the passion and power of MF providers and banks at large will be able to help us reach every household and individual to transform the lives of those currently excluded from financial system. The central bank has entered into a partnership with DfID to coordinate and help implement this financial inclusion package. SBP will work with DfID to establish Financial Inclusion Fund to structure credit enhancement mechanisms and facilities for industry to develop required governance structure, infrastructure/IT to facilitate MF lending and provide business entrepreneurial development support including development of capacities for accounting/financial literary, corporate governance and launching special studies/surveys to help support development of inclusive financial system groups and its impact. Finally, it is important to recognize that providing poor and vulnerable groups access to financially and sustainable development finance is the most effective and respectable way of poverty alleviation. | state bank of pakistan | 2,007 | 8 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Dawn Asia Finance Conference, Karachi, 11 September 2007. | Shamshad Akhtar: Pakistan Islamic banking – past, present and future outlook Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Dawn Asia Finance Conference, Karachi, 11 September 2007. * A. * * Introduction Islamic finance has gripped the world with a strong fervor and passion. Interest in this discipline has proliferated to almost 60 countries, going beyond the Islamic world to the leading global financial centers. For quite sometime, United Kingdom has adopted an open door policy and provided a level playing field to Islamic finance and now Singapore is following its lead. Every day, Islamic finance is breaking new boundaries and new frontiers. Leading Islamic banks have fast spread their network from home base to develop a regional and global reach. Some of the Middle East banks are now entering into African and Central Asian markets and are sizing up Australian financial market. Motivation and renewed interest in Islamic finance industry stems from its strong economic, financial and social considerations, backed by its unique features. Most significant is its appeal to add to financial diversity and innovation being skewed towards (i) asset backed and equity based transactions, which promote entrepreneur friendliness and consideration of project viability; (ii) equitable distribution of risks and rewards among the stakeholders; and (iii) inculcating market discipline and higher ethical standards given its emphasis on nonexploitation and social welfare. In the wake of high Asian domestic savings rates and build up of the region’s foreign exchange reserves as well as oil surpluses of Middle East in the last few years, Islamic finance is now also emerging as a way to wealth management, both of richer nations and high net worth individuals. While the world is now recognizing the significance of Islamic finance industry, in Pakistan, as early as in 1948, Mr. Muhammad Ali Jinnah emphasized the virtues of Islamic principles and in his address at the inauguration of the State Bank of Pakistan (SBP), said: “I shall watch with keenness the work of your Organization in evolving banking practices compatible with Islamic ideas of social and economic life. We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice 1 .” B. Historical context of Pakistan’s Islamic finance Pakistan has a protracted history of Islamic banking with the initial attempt to Islamize banking system in 1980s 2 , leading to sweeping changes in the Banking Companies Ordinance, 1962 (BCO’62) and associated laws and regulations to accommodate noninterest based banking transactions. Some specific developments around this period are noteworthy: i. In 1979, two Government-owned mutual funds in Pakistan, the NIT and ICP, started to eliminate interest from their operations by eschewing investment of their funds in Quaid-e-Azam: Speech at the foundation laying stone of the State Bank of Pakistan, 1st July 1948. Aurangzeb Mehmood, “Islamisation of Economy in Pakistan: Past, Present and Future” Islamic Studies 41:4 (2002). interest bearing securities. Investor scheme of ICP was substituted as from October 1, 1980 by a new scheme based on profit and loss sharing. ii. The state-run House Building Finance Corporation (HBFC) also eliminated interest from its operations from July 1, 1979. iii. In June 1980, legal framework was amended to permit issuance of a new, interestfree instrument of corporate financing called Participation Term Certificate (PTC). iv. A new law, namely, the Modaraba Companies and Modarabas Ordinance, 1980 along with the Modaraba Companies and Modaraba Rules, 1981 was promulgated to introduce modarabas, as a two-tier fund structure, for undertaking Shariah compliant businesses. v. In 1984, the Banking and Financial Services Ordinance, 1984 amended seven laws and Banking Tribunals Ordinance, 1984 provided a new system of recovery of noninterest based modes of financing. vi. From January 1, 1981, separate interest-free counters started operations in all the nationalized commercial banks to mobilize deposits on profit and loss sharing basis. Concurrently, banks were prohibited from specified interest based transactions, which resulted in development of Islamic modes of financing. vii. Finally, SBP issued BCD Circular No. 13 of 1984 that called for elimination of Riba from the banking system and in January 1, 1985 all financing to Federal and Provincial Governments, public sector corporations and public or private joint stock companies was directed to be only through interest-free modes. viii. From July 1, 1985 all commercial banking in Pak Rupees was made interest free. 3 Resultantly, profit and loss sharing (PLS) deposits, as a percentage of total deposits, rose from 9.2% at the end of 1981 to 61.6% by end of 1985. These measures resulted in a country-wide roll out of Islamic banking. However, the premature and sudden conversion of banking system to Islamic system coupled with the lack of preparedness and understanding among financial institutions and public posed difficultly in implementation. The Federal Shariat Court challenged some emerging products and processes and declared them un-Islamic. The Shariat Appellate Bench of the Supreme Court upheld the decision of the Federal Shariat Court and offered guidelines to address the issues involved, setting a timeline for implementation. This decision was later set aside in a review petition filed by the United Bank. C. Current state of industry Some key lessons emerge from Pakistan’s experience of 1980s. Firstly, it is prudent to allow industry to adopt an evolutionary process, rather than adopting a revolutionary approach, in order to nurture acceptability and development of Islamic finance industry. Secondly, flexibility rather than rigidity allows for effective accommodation of changing needs of a dynamic market. Thirdly, the markets and customers must have confidence in Shariah compliance by the Islamic finance industry to ensure sanctity of the system. Lastly, all stakeholders involved, including the regulators and the industry, have to be properly equipped and prepared for the eventual launch of a new system. Valuable experience and lessons learned by the policy makers and the industry helped in the re-launch of Islamic banking in Pakistan in 1990s. In recent years, a notable element of SBP’s financial sector strategy was the introduction of Islamic Banking Policy in December 2001. Under this policy, Islamic banking is being promoted in parallel to the development of Mohsin S. Khan and Abbas Mirakhor: Islamic Banking, Experiences in Islamic Republic of Iran and Pakistan. conventional finance industry in an integrated, gradual and steady manner. SBP has been issuing licenses for Islamic banking to stand alone Islamic banks and Al-Meezan Investment Bank, which had been functioning as an Islamic Investment Bank, became the first Islamic bank of the country upon award of Islamic banking license by SBP. In addition, SBP allows conventional banks to set up Islamic banking subsidiaries or dedicated Islamic banking branches to offer range of financial services. SBP has put into place a comprehensive and robust multi-tiered Shariah compliance mechanism to lend customers and investors confidence in the Islamic banking industry. Shariah compliance mechanism has three main pillars: (i) a Shariah Board at SBP which approves policies and guidelines as well as the fit and proper criteria for Advisors; 4 (ii) Shariah Advisors in all banks to provide guidance to banks and comfort to customers on Islamic financial services; and (iii) a Shariah audit system. SBP has introduced nine model agreements and contracts for major Islamic modes of financing and Shariah audit guidelines for banks, after vetting and approval of the SBP Shariah Board. Work is underway on three more model contracts, namely, Diminishing Musharaka, Istijrar and Wakalah. Shariah compliance inspection of Islamic banks will start this year and will cover a review of the Islamic banks’ arrangements and operations, their services and products, financial statements and accounting records to ensure that all transactions are being carried out in accordance with the injunctions of Shariah. Backed by this elaborate structure, today 6 full fledged Islamic banks (IBs) and 13 conventional banks offer a network of around 170 branches. Total assets of Islamic banks are close to Rs135 billion 5 while Islamic deposits and financings stand at 2.9% and 2.4 % of market share respectively. D. Future strategy and outlook While the number and operations of Islamic banks are fast expanding, this segment of the market is still small relative to the appetite for Islamic finance. Pakistan, in light of its past experience, is launching a gradual and steady approach to Islamic banking. Despite rapid expansion in industry, the share of Islamic banking in the total banking system is a modest 3.2%. Moreover, it only caters for around 23,000 borrowers through around 170 branches relative to the country-wide 5 million borrowers (or 4.8 million excluding microfinance borrowers) tapped through 7,700 branches by conventional banks. Financing and investment levels of Islamic banks barely range around Rs77 billion, which is below 3% of the total banking system’s advances 6 . On the product side, Islamic banks so far offer about 75% of products currently available in conventional banking while clean lending for consumer financing products, like personal loans and credit cards, still pose a challenge. Islamic banks operate exclusively in large cities with some now venturing into secondary cities but they are absent from rural areas where there is great potential for business growth. Global interest in Islamic finance industry and Pakistan’s success in laying basic foundation and core infrastructure of Islamic financial system lends confidence that the country has Further, it has also been specified that a Shariah Advisor shall not hold any executive/non-executive position in any other financial institution, except working as Shariah Advisor of Islamic mutual funds of the same IBI. Needless to mention that, Shariah Advisors of IBIs are also prevented from having any substantial interest in or becoming employees of same types of organizations like Exchange Companies, Corporate Brokerage Houses or Stock Exchange. These provisions in the Fit and Proper Criteria for Shariah Advisors have ensured objectivity in evaluation criteria, minimization of conflict of interest and induction of new lot of Shariah advisors in the market. As on End March 2007 End March 2007 good potential and prospects to further exploit this industry. Going forward, however, it is important that Pakistan adopts a more calibrated and coordinated approach and strategy for the development of Islamic finance industry. In designing this strategy, Pakistan will conform to the standards being promoted by the Islamic Financial Services Board (IFSB) – the sixteen member Council of Governors of Central banks with several associate and affiliate members – whose chairpersonship Pakistan assumes effective January 2008. The goal and objectives of the forward looking strategy should be to offer an alternative avenue of financial intermediation, which is competitive and promotes efficient allocation of resources in an equitable manner. Strategy should aim to supplement conventional banking industry’s efforts to broaden and deepen the process of financial intermediation and financial penetration. Islamic banking can serve as a key vehicle to improve and strength the access to development finance by bringing in financial innovation that can cater adequately to diverse demands of the population as well as corporate sector’s and country’s infrastructure financing requirements, while ensuring that it nurtures faith based system of financing consistent with the Shariah principles. Major elements of this strategy would require both industry and SBP to closely work together on multiple fronts. Some of the key areas of focus include: Aggressive deposit mobilization to augment domestic financial savings of the country. Although late starter, Islamic banks have phenomenal potential to exploit resource mobilization. Substantial savings have still not been channeled into the financial system because of reservations relating to interest based system or return deficiencies of the conventional system. Islamic banks, besides catering to the needs of small depositors through profit and loss sharing basic accounts with no charges, need to tap high net worth investors and companies which are increasingly being driven to the attractive options and returns being offered by more innovative players worldwide. Fast adaptation of these practices by the Islamic finance industry will be helpful in competing more effectively with conventional banks in raising deposits. Resource mobilization is critical for Islamic finance industry to grow effectively and meet the alternative requirements of economy and society. Diversification and innovation of financial structures. This would involve either applying innovative Islamic products on a stand alone basis or applying a combination of Islamic instruments to suit project finance needs. In attempting the latter, it needs to be ensured that vanilla Islamic products such as Murabaha, Ijara and diminishing Musharaka etc. are implemented with their necessary preconditions, consistent with Shariah principles, to promote modes that can be used to finance commercial and project finance activity. This would require greater reliance on equity based financing, given that it is akin to participation and risk sharing consistent with infrastructure financing requirements and Islamic principles. At the same time, it requires financial engineering, flexibility in the evolving Sahriah system and alliance both among domestic and with the bigger global players (such as Standard Chartered, HSBC, UBS, Citibank etc.) to diversify Islamic financial structured products to support project finance in addition to associated real estate, shipping, trade, and aircraft financing. Islamic financing products/structures are now quite common in Middle East and Saudi Arabia and have gained ground in non-Muslim countries too. In most cases it has to be recognized that Islamic financing is incorporated within a multi-sourced project financing offering, along side the conventional project financing structures backed with or without supportive credit enhancement or export credit agencies financing. The Islamic financing element of the project is provided pari passu with the other senior debt. Istisna’s and variant structure of Ijara are frequent products used. If required, there should be standard legal structure for establishing and operating with ease Islamic SPV as the financing vehicle. Islamic finance tranches are known to offer additional benefit of competitive pricing and tenor. There should be harmonization of these alternate and multi-financing legal and regulatory structures and appreciation that conventional project financing documentation could be acceptable to different Shariah Boards/Committees. Pakistan has been exposed to these structures, given its earlier experience with the Hub River project, which in early 1990s incorporated Islamic Tranche of Istisna, and more of such recent deals. In designing such structures there has to be more tolerance among participants to: • integrate Islamic and conventional funds to allow co-financed projects with different players; • accept ownership risks (since in all Islamic transactions, lender is at some stage the owner of financed goods) but with comfort of clarity of legal issues surrounding ownership; • ensure proper tax treatment of the proposed Islamic financing structures, avoiding adverse treatment relative to conventional borrowing, e.g. often profit participating payments are subject to tax while interest payments on loans are tax deductible; • ensure flexibility in selection of assets for Islamic tranche; • understand issues surrounding asset risks; and • provide for payment of insurance and maintenance expenses for Islamic financed assets etc. Extend the outreach of financial services in a holistic manner with focus on underserved regions and poor and vulnerable groups. Islamic banks will be allowed to pursue their plans for branch expansion as long as Islamic banks, like conventional banks, open at least 20% of new bank branches in rural areas. Conventional banks will have the option to seek partial or full conversion to Islamic banks. Microfinance banks are to be allowed to set up special windows or dedicated branches for Islamic Microfinance operations and licenses will be given to dedicated Islamic Microfinance banks. Guidelines have been already issued to promote Islamic Microfinance industry. Similar initiatives will be launched to issue guidelines for promoting SME, Agriculture and Infrastructure financing. Promote financial industry diversification by requiring that, in tandem with Islamic banking, there is adequate development in Islamic capital markets, which so far has lagged behind the banking sector. Enhance understanding and capacities of Islamic Banking Risk Management. Risk magnifies in Islamic banking, considering that banks and customers operate on profit and loss sharing mechanism. Because of this participatory risk relationship, the financial institution may not be exposed to traditional credit risk associated with conventional banking but more to risks associated with assets financed and off-balance sheet risk linked with the transfer of assets and its management as well as any volatility in the values of underlying assets. In structuring new products, there is need for institutions to factor in appropriate risks of real commodities, properties and equipment being financed with proper risk mitigation management and techniques. The strategy has to recognize the risk associated with Islamic banking and as such it has to include appropriate mechanisms and approaches to mitigate these. Promote development of liquidity management instruments to ensure investor confidence while effectively managing Islamic banking system’s systemic risk. Apart from Government’s efforts to launch Shariah compliant SLR securities, SBP will need to launch Shairah compliant Treasury Bills along the lines of other central banks which have a range of short term securities based on sales and purchase contracts that are tradable in the secondary market and launch Sukuk cum Ijarah instrument proposed by the Central bankIslamic Industry Task Force in 2006. Islamic repos would be also need to be structured. To facilitate the issuance of these types of instruments, amendments will be required in SBP Act as well as setting aside of specific assets of public sector by the Government. Once these instruments grow, SBP will align the SLR for Islamic banks at par with the conventional banks’ SLR as the risk associated with Islamic banks are in some senses far greater than in conventional banks given their reliance on equity based diversified products. Some countries have even considered higher SLR for Islamic banks as their inherent risks are often times varying in nature and far steeper. Promote international standards and best practices in Islamic Industry. Aside from standard application of conventional banking regulations and guidelines, Islamic banks will be encouraged to adopt IFSB and AAOIFI (Accounting and Auditing of Islamic Financial Institutions) standards with appropriate tailoring to suit domestic requirements. SBP is an active member of these international bodies and has provided input into the technical design and formulation of these standards. Promote good corporate governance in Islamic banking. Islamic banks must exhibit unique fiduciary responsibilities towards investment account holders, ensure Shariah conformity and select investments that are Shariah compliant (avoiding products/businesses that are haram) as well as implement sound internal risk management. As such, they will be required to follow a distinct corporate governance framework in line with the IFSB’s Guiding Principles on Corporate Governance. Launch joint capacity building efforts for Islamic finance industry. SBP and the industry will promote capacity building for greater understanding of Shariah principles, asset and liability management, and features of product structure. In addition, specialized training will be needed to promote smooth and effective implementation of IFSB and AAOIFI standards. E. Conclusion With its promising prospects and potential, Islamic banks will need to grow at least by 4050% annually to be able to raise its share from 3.5% to about 15% of the total banking system. Given that banking industry as a whole has been growing at a substantively fast pace, the level of effort required for Islamic banks would have to be steeper to claim this share. Given the success of some countries in achieving this share for Islamic banking, it is important that concerted efforts are put in to propel Islamic banking system further and deeper in Pakistan. | state bank of pakistan | 2,007 | 9 |
Closing keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Georgetown University, Washington DC, 18 October 2007. | Shamshad Akhtar: Islamic finance – its sustainability and challenges Closing keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Georgetown University, Washington DC, 18 October 2007. * * * Introduction In the closing session for this event on Islamic Finance, I propose to reflect on the growth and trends in Islamic Finance, its size and dimensions and prospects which are now evolving from regional to global scale and impacting the private capital flows. The renewed interest and hype in Islamic Finance is unprecedented. Since it coincides with commercial interest of Western financial institutions to attract flows generated from oil revenues and other savings, there is a degree of skepticism regarding sustainability of interest and trends in Islamic Finance industry within and outside Muslim jurisdictions? Also there are concerns echoed on whether the industry will persevere the competition from the global financial world nurtured by the conventional system backed by strong legal, policy, regulatory and institutional framework. In my assessment, the Islamic Finance now seems to be a reality and is on its way to be institutionalized, albeit at different levels in different countries, and the Western world is also now selectively and cautiously positioning to invest in this system. There are promising signs that Islamic Finance trends are sustainable. It is entrenched in a well conceptualized Islamic economic system whose mysteries are being unfolded with renewed academic interest in the subject. While undeniably faith driven, the Islamic finance system has great potential to meet the financial gaps and requirements of development and society at large and as such its demand would be robust going beyond religious grounds. Islamic Finance has to be recognized as a parallel system which will augment and be augmented by the deeper knowledge and experience of the conventional financial system. As such, the key challenge going forward to its growth and sustainability would lie in how it interfaces and benefits from complementing and supplementing the conventional system and how it adapts and conforms to the international regulations and supervision adequately refined in line with the technicalities and nuisances of the Islamic financial instruments and their associated risks. Exploiting properly the unique features of Islamic finance with appropriate adaptability, without compromising Shariah principles, will be critical to the growth and promising future of Islamic industry. Touching on some of these debates, I propose to first discuss the trends in Islamic Finance, lay the case for sustainability of Islamic Finance and finally discuss some of the key challenges facing the industry which the Islamic financial community at large is now trying to address. Global and regional growth and trends Spread across 70 countries, Islamic Finance has grown to almost a $ trillion industry. Despite its growth, given its current size and composition it is still a niche market in the overall global financial industry. Prospect for the industry are quite bright given strong demand for financial services from a large segment of about 1.4 billion Muslim populations and need to channel effectively rising foreign savings and high net worth individuals. The growth, level, interest and motivation to promote this industry vary across the globe. The growth in Gulf Cooperation Council has been exceptional with Bahrian emerging as a main centre adopting and implementing Islamic banking regulation, being the first central bank to issue Sukuk and establishing centre for Islamic finance education, etc. Iran and Sudan declared sometime back 100% conversion to Islamic banking. Within South East Asia, Malaysia stands out with $31 billion Islamic banking assets, $1.7 billion Takaful industry and has the largest Islamic private debt market which constitutes 45.5% of its total debt market. 1 Other countries in South East Asia have smaller Islamic financial markets and Singapore has positioned itself to offer strong wealth management potential. Within South Asia, Pakistan stands out for its proactive and systematic stance to evolve Islamic finance industry. In all these countries, assets of Islamic banking have grown faster than the overall banking assets and scope and coverage of financial services has been extended to retail and consumer finance, private equity, structured products, insurance and project finance etc. Distinct from Islamic countries, is the interest of few global financial centers such as London that now provide policy and tax incentives to promote Islamic finance industry to attract funds from high net worth clients. Same motivation seems to have driven global banks such as HSBC, Standard Chartered, Deutsche Bank, Citibank etc. to set up special hubs to structure Islamic finance products. In reality, while current hype in industry may be partially driven by availability of surpluses generated by oil revenues, Islamic banking is emerging as an alternate financing option that coexists alongside the conventional financial industry. Moving from traditional Islamic products, now the industry is offering consumer financing for residential purposes and structuring financing vehicles for supporting infrastructure and housing finance projects etc. Product innovation is emerging with several different types of hybrid Sukuks and other combination of structures which involve different forms of Musharikas with other products. Notwithstanding these developments, increasing share of equity based credit products, such as Murabaha and Ijara, remain the dominant form of Islamic financing across the Islamic financing institution. These trends are expected to persist and the industry is set to grow. Standard & Poor Services Rating Agency estimates that industry has potential to grow to $4 trillion over medium term. 2 As highlighted above, the exceptional growth in Islamic Finance, particularly since 2000, which has coincided with growth in oil revenues, has raised questions whether interest in Islamic Finance is one time phenomena? And what the future prospects and sustainability of the industry are? While motivations and driving factors for this industry vary across the world, this round of wave in Islamic finance industry is there to stay there. What lends one confidence is the large investments by financial industry across main hubs in GCC/Middle East/South East and South Asia, within countries and growing foreign ownership and joint ventures across borders, in infrastructure development in this industry through: (i) issuance of holistic banking licenses or opening of special windows or creation of hubs/dedicated Islamic asset management funds, private equity funds and hedge funds etc. accompanied by Dow Islamic Index to which all such transactions subscribe too are large; (ii) development of Shariah knowledge and understanding and engagement of Shariah advisors and scholars which together are providing required consensus, guidance and legitimacy to Islamic industry, products and structures; and (iii) development of Islamic standard setters such as the Islamic Financial Supervisory Board and Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and International Islamic Financial Market (IIFM) etc. by the central banks as well as a range of Multilateral Development Agencies including the Islamic Bank Malaysia: Leading Islamic Finance – Price Water House Coopers; http://www.pwc.com/extweb/indissue.nsf/docid/1d681d874f24fda7ca25720a00158bfd Standard and Poor: Islamic Finance Outlook 2006, http://www2.standardandpoors.com/spf/pdf/media/Islamic_Brochure_2006.pdf Development. The combined efforts have helped develop and initiate implementation of Islamic prudential regulatory, accounting and auditing frameworks, and inspection and supervision of financial institutions; All these regional and global efforts are serious long term initiatives which are irreversible though maintaining and building momentum on these fronts would be critical to address the questions of sustainability and challenges facing this industry. Sustainability and challenges of Islamic finance Prospects for sustainability of Islamic finance appear promising, but there are associated challenges which need to be concurrently addressed while one exploits and maximizes the opportunities created by this discipline. First, the sustainability of Islamic finance stems from recognition that Islamic economic and financial architecture has a lot of appeal and depth going beyond Muslim countries. While initially conceived to be solely anchored on Riba free interest rate regime, there is now appreciation that advocacy to move to Islamic business and finance structure – whether on religious or social grounds – is not a “slogan” or mere religious pronunciation or condemnation of Riba but is supported by a complete and deep Islamic ideology. When studied carefully, it has its logic and basis in a comprehensive Islamic economic system which deals with allocation of resources, production and exchange of goods and services and distribution of wealth – all too familiar debates in conventional economic textbooks. Second, the confidence in sustainability of Islamic economic system emerges from the better understanding that this economic system is a well conceptualized, consistent and integrated framework. More interestingly, it is accompanied by a rich and an elaborate set of tenets which, among others, recognize the right to property supported by elaborate obligations for stakeholders, principles and rules of conduct, a contract system and institutional framework and procedures for enforcement of rules which all together lay the foundation for Islamic business and financial architecture. It is this substantive Islamic ideological and legal framework, governed by Shariah injunctions and principles that have translated into defining the public and private economic and social affairs that eventually help frame the business and financial relations. The core of these relationships is backed by solid principles of contracts, rights and obligations of parties to the contractual arrangements. Third, the sustainability of this system is reinforced by the business and financial relations that are guided by the logically defined emphasis on the preferred modes of transaction which advocates profit sharing and as such relies on “ex-post” variability rather “than ex ante” fixity in returns and consequently has built in risk sharing as a central element of transactions. Relevance of contracts is at the core of Islamic transactions which define the rules of game for sale and purchase/trade/exchange of goods and services. Financing contracts are than structured around the nature of transaction which could be either in the form of trade financing; asset based financing or different forms of partnerships. Under Islamic finance preference is given to trading of physical assets as well as trading of rights. Fourth, the confidence in sustainability emerges from the framework of enforcement implicit in Islamic system. The main driver of enforcement of contracts and rules-compliance in Islamic system is ideology and faith which is in turn influenced by Islam’s emphasis on establishing an equitable, ethical, just, and fair socio-economic system. It is this feature which shapes up Islamic finance and also distinguishes it from the conventional finance. Although one can argue that sustainability of interest in Islamic Finance is tied solely to the response of Muslim population to their religious values and beliefs, but it has to be recognized that attraction in this discipline is now widely emerging as there is better understanding of Islamic economics and finance and mechanisms are being found to juxtapose the knowledge of conventional economics and financial engineering. Fifth, flexibility and innovation to structure different types of financial products which augur well for Islamic Finance’s sustainability. What distinguishes Islamic finance is its emphasis on trading of goods and services and its advocacy for profit and risk sharing in businesses supported by a variety of partnership arrangements – this is in sharp contrast to loan based financing in conventional banks. By virtue of these characteristics Islamic finance offers prudent financing options being asset backed or equity based; particularly linkage of assets with financing ensures that transaction is less prone to debt crisis and funds are used for their prescribed purpose minimizing defaults resulting from improper use of borrowed funds. Concurrently it offers promising potential for offering alternate avenues for saving and investment for all segments of population. Sixth, market surveys confirm that the potential for retail, housing and project finance 3 and innovation emerging in these markets is significant and augurs well for economic and financial services development. Islamic banks have registered double digit growth in retail markets. Penetration has occurred faster where personal banking solutions have been structured well and where information technology is used to offer online, ATMs and telephone banking services. By and large products are structured on murabaha principles where funds are allocated for particular projects or finance an asset (such as home ownership and automobiles) in which depositor shares in the project rather than bank profits and to structure ijara (leasing) with appropriate asset backing and legal structures. Islamic housing finance for acquisition and other purposes has evolved to be a natural and promising market to cater for huge home financing demand in Muslim countries. This market is gaining momentum following some interesting facilitation/incentives offered by some countries: for instance US has facilitated Islamic lease-to-own relationship by allowing bank to take title to property and in the UK Bank of England abolished double stamp duty on Islamic mortgages, ijarah and murabaha transactions, and rationalized of legal service fees and risk weightage etc. and Australia and Canada allowed adoption of declining balance partnership concepts to facilitate structuring Diminishing Musharaka contract etc. In some jurisdictions momentum for tapping retail market has been accelerated by partial or full conversion of conventional to Islamic banks such as Saudi Arabia – challenges of which cannot be underestimated as it involves converting the loan book to Shariah compliant modes of product. Stand alone Islamic banks have a challenging task of competing with the conventional players who have an edge of longevity and customer loyalty and economies of scale. High level of customer service, offering full product range, introducing a level of transparency in transactions, devising unsecured personal loan products (a wave emerging with adoption of tawarruq product), introducing Shariah compliant credit cards, handling properly the unfunded businesses and improving efficiencies are some of responses to challenge of competition. Large scale business opportunities however lie in exploiting project finance. Successful application and integration of Islamic instruments with the conventional financing has helped in this area while facilitating closure of large and complex multisource financing deals. Project financing, backed by asset and equity and structured using combination of Ijara, Istisna,, Sukuk and Musharika etc. has offered opportunities for risk diversification, avenues for resource mobilization and revenue sharing and performance of services between contractual parties. These deals have illustrated how conventional and Islamic financing can blend and coexist under common legal and regulatory arrangements. Finally, more than conventional finance, Islamic finance emphasizes just and equitable financial system. Among others, Islamic finance offers a financial inclusive option to Muslim Islamic Finance: The Way Ahead – Filed under: East Asia/Pacific, Middle East, Economics, Religion. February 10, 2007. who have excluded themselves from financial services in absence of riba free services. 4 Since a number of Muslim countries suffer from low financial services penetration, bringing in the appeal of Shariah compliant financing mechanism could turn out to be a powerful tool for enhancing access to development finance and empowering the poor and vulnerable groups. It is important to recognize that Islamic finance confines itself to largely socially and development projects and institutions are not permitted to invest in prohibited or socially undesirable investments. Emphasis on ethical issues and rigorous self-regulation in terms of Shariah supervision ensures fair play and justice and offers superior consumer protection model. Furthermore it induces higher financial discipline and places stringent ethical standards for all stakeholders that offers a strong and unique model of governance. Conclusion In conclusion, encouraging developments and trends in Islamic Finance lend confidence that this industry has taken off. However, there are varying motivation and driving factors for the development of this industry ranging from religious fervor to the opportunities that exist in Islamic finance for broadening and deepening the process of financial intermediation which augurs well for financial innovation and engineering, enhancing the financial services penetration in national jurisdictions and for cross border capital flows. While the size of Islamic financial industry is still quite small as a proportion of the total world’s financial assets, the current growth trends and the investments in infrastructure in development of its Islamic Finance networks and its regulatory and supervisory systems, lend confidence that this industry has promising potential. Prospects for this industry appear comforting because of variety of factors – most significant being the strengths of Islamic ideology and economic system which offer a complete framework for the Islamic finance industry. Islamic financial system lays down rules of conduct and contractual arrangements, and offers feasible financing structure which emphasize trade and equity financing that together will help the much needed financial diversification in Islamic countries. Islamic finance also has potential to blend economic and social objectives and address the ethical aspects of financing effectively. As such it is generally more acceptable in populations with moderate to strong inclinations toward managing their financial relationships in line with their beliefs. This can thus help in poverty alleviation through inclusion of a larger proportion of population into the banking system giving them access to credit and mobilizing their savings effectively. The emerging solutions and application to structure Islamic finance innovatively have helped cater for all types of markets and financing requirements ranging from retail to project and home financing to equity funds and products and insurance. Industry effort to benchmark pricing and apply legal, regulatory service standards at par with conventional products and standards has also helped encouraged confidence in the system. Going forward, the sustainability of Islamic Finance would rest in how the international community builds on the momentum achieved thus far. This would require (i) Further deepening the efforts to enhance the legal and regulatory framework of Islamic finance consistent with the international practices. (ii) Continued strive to conform and align the structures and products in line with the Shariah principles would help Muslim population’s motivation to turn to this See “Building an effective Islamic financial system.” Dr. Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Global Islamic Financial Governor’s: Financial Regulators Forum in Islamic Finance, Kuala Lumpur, 27 March 2007. alternative mechanism of financing, while attracting others to product and risk management and mitigation innovation and additional option that this window offers. (iii) Recognizing that Islamic finance has perpetuated and changed the dynamics of cross border private capital flow, this industry has great potential to augment the process of globalization and financial integration, but this requires more cooperation and vigilance on the part of home and host regulators. (iv) Launching aggressive efforts to implement the evolving Islamic financial regulatory and supervisory standards and capturing the different types of risks associated with Islamic finance, while launching consumer protection frameworks. (v) Promoting more financial diversification by encouraging financial innovation and Islamic capital market development. | state bank of pakistan | 2,007 | 11 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Federation of Pakistan Chamber of Commerce and Industry (FPCCI), Karachi, 26 November 2007. | Shamshad Akhtar: Pakistan – economic outlook and perspectives Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Federation of Pakistan Chamber of Commerce and Industry (FPCCI), Karachi, 26 November 2007. * * * Let me start off, by first thanking the Federation of Pakistan Chamber of Commerce and Industry (FPCCI) and its office bearers and other members for inviting me at FPCCI. The economy of Pakistan continues to perform well. This is commendable given the political noise in the country and the growing challenges in international economic and financial markets. 2000 onwards by and large world economy enjoyed a fairly benign economic environment. However it is now certain, more than in the last few weeks that financial and economic vulnerabilities have grown across the world and is likely to impact global outlook. Upfront it has to be acknowledged that despite these adverse developments by all accounts the world thus far has persevered recent shocks quite well given that underlying financial health and macroeconomic fundamentals of both advanced and emerging economies were quite strong. Among the key factor impacting global economy is the financial market turmoil. It originated in U.S Subprime mortgage markets in 2006 but spread with incremental speed from June 2007 into the money markets and transcended boundaries hitting Europe and other economies and resulting in unprecedented liquidity crisis in advanced financial markets as manifested by the rising spreads in credit markets. Financial and economic costs of this episode are still being unfolded but are large. It has already caused US and Europe central banks to inject liquidity and prompted losses of close to $300 billion in US subprime markets (of $1.2 trillion). The losses are bound to further rise as interest rates resets on these transactions hit the borrowers further. Furthermore, profitability of a number of large and strategic commercial banks has been lowered as banks had to write off and provision for the losses on their own balance sheets of sub-prime and other asset backed commercial paper as well as assume loss making off balance sheet transactions, while rescuing structured vehicles and/or troubled affiliates. The financial market turmoil has impacted private equity and debt markets where spreads have risen. The problems of subprime mortgages market are now well acknowledged to drag the housing sector of U.S and its growth. Additional risks which cloud global economic prospects are rise in inflationary pressures given volatile oil markets and rise in commodity prices going beyond precious and industrial metals to foods such as wheat, soybean oil and palm oil that have reached record highs during 2007. Weakening dollar has further amplified the oil price surge. Combined with financial turbulence this is now inducing investors to diversify away from dollar denominated financial assets to commodities – this second round impact carries risks of magnifying the inflationary pressures. With this backdrop, I propose to provide briefly Pakistan’s economic update attempting to lay down some emerging trends for FY08 which require stronger vigilance at economic policy making level and industry and private sector to be more responsive. In general, it has to be underscored that despite domestic and international events, Pakistan economic prospects remain strong. Barring impact of international commodities prices which I will discuss shortly, Pakistan financial markets have remained by and large insulated from the financial market turmoil as it did not have exposure to mortgage or other asset backed securities. The external sector which has thus far been manageable could however see some spill over impact of US slow down if it turns out to be more severe. Notwithstanding this conjecture, some emerging trends could have implications for economic outcome of FY08. On production side, growth is likely to be impacted by setback to two major crops i.e. cotton and rice as they were hit by pest attacks and other problems. Part of the agriculture crop shortfalls could be offset by the higher than expected other crops, for instance sugarcane harvest is likely to touch new high level of 62.3 million tons – up by 13.5% relative to last year. July-October 2007 data for industrial production while preliminary reflects mixed picture. Production growth in construction related industries appear reasonable including cement, wood, paints and varnish units, followed by fertilizer, pharmaceuticals, petroleum refining and few metal and engineering good. In these sectors, Pakistan can reduce rate of import dependency (such as petroleum refining where production capacity is 13.2 million tons relative to consumption which is 18 million tons) through capacity augmentation and even consider exploiting export markets. In contrast to some of these sectors, first quarter results of some industries reflect slower growth. For instance deceleration in cotton yarn and cloth, which has a weight of 20.6% in large scale manufacturing value added, and footwear, automobile, edible oil and vegetable ghee is evident. While demand remained strong, slowdown in manufacturing sector emerged because of combination of reasons including demand for import substitutes (as Government relaxed imports of automobile), slowdown in export demand and increase in raw material prices such as palm oil which recorded 73% growth in value of imports. Both local manufactures and the Government need to take measures to improve competitiveness of domestic goods. Ensuring quality through innovation, skill development and technological up-gradation, reducing costs through scale, diversifying product-line in line with the market demand, and achieving self sufficiency in raw materials etc. are some of the areas where entrepreneurs need to concentrate. Adversities in production sectors is however likely to be offset by the continued buoyant performance of services sector which accounts for over half of value added of GDP. Down turn in inflation, despite its slippage from target, was notable in FY07 relative to trends in preceding couple of years. However, surge in food prices is visible. Consumer price index (CPI) rose to 9.3% in October 2007 on YoY basis mainly due to a jump in food-CPI by 14.7% on YoY basis. Seasonal factors such as Ramazan, higher international food prices, and domestic supply shortages contributed to the pressures on food-CPI. Consequently divergence between headline and core inflation grew; core inflation which came down to almost 5% in May 07 and remained below average inflation forecast of 6.5% has shown signs of picking up. Pressure on core inflation reflect (i) the lingering impact of significant growth in monetary expansion in the last few weeks of FY07 as was predicted in the Monetary Policy Statement of July 2007 and (ii) the second round impact of food prices. As inflationary pressures mount, debates on effectiveness of monetary policy on inflation are triggered afresh. Central bank is undoubtedly able to more directly impact core inflation and evidence in FY06-07 has shown that monetary policy has paid dividends in bringing down core inflation. Higher non-core inflation penetrates economy in different ways (i) it impacts consumer purchasing powers since cutting down essentials is difficult and there is low price elasticity of food and energy, (ii) even if the Government delays the direct pass through of energy prices to consumers, businesses often pass through immediately higher costs of energy on to their consumers, and (iii) with inflationary trends persisting consumers and producers higher inflationary expectations set in trends too. Higher inflation expectations have become self fulfilling as they have impacted wage setting and pricing decisions now. Inflation currently is a global phenomena and driven largely by commodity price trends both in energy and food. Inflationary pressures are likely to persist as international wheat prices are up by 50-60% because of Australian drought, low world stock and continued high demand. Similarly palm oil prices are up by 94% in international markets and soybean by 57% due to low production, rising consumption and its application for feed and energy uses. In the same way, prices of milk and its products have risen by almost 100% in some markets because of reduced EU subsidies, short global supplies and rise in consumption. Inflationary pressures could rise, since fiscal imperatives now demand for Government to pass through the impact of the recent oil prices that reached close to $100 bpl in international markets. The direct effect of the recent oil price rise on headline inflation in the United States is estimated to be around ½ percentage point by the end of the year. But for the tight monetary policy that curbed demand pressures and kept core and headline inflation in check, inflationary trends would have been more significant in Pakistan. However, SBP may find that it has less room for maneuver if the higher fuel costs have second round effects on other prices and wages. Macroeconomic sustainability during the course of inflationary period is critical. July to early November data reveals that money supply is growing at 3.2% (compared to 2.5% in July-Nov FY07), and at 20.1 percent on YoY basis largely because of the pressures of Government borrowing and improvement in net foreign assets (NFA). M2 growth is still manageable given that in the first 5 months, private sector credit demand grew slower than preceding year. Fiscal pressures appear to be strong as the Government despite higher receipts from the National Savings Schemes and the Pakistan Investment Bonds has resorted to central bank borrowing. The Government budgetary borrowings from the banking system during July-10 November 2007 rose by Rs 146 billion compared to Rs101 billion over the corresponding period in 2006. Recent requirements have meant higher recourse to the central bank borrowing which is infusing pressure on core inflation. Abstracting from medium term challenges, the external current account deficit over JulyOctober, 2007 has reflected modest level of contraction over the last year. Trade deficit remained high but did benefit from export pick up (though growth remained below FY04-06 trends) import compression and was financed by the continued growth in remittances by 22%. During July-October 2007, Pakistan recorded a surplus of $3.2 billion in the capital and financial account compared to $2.8 billion last year. Most of the surplus emerged from debt flows as the equity flows were impacted by outflows in SCRA restricting the net inflow to US$ 124.4 million during July-21 to November 2007 and postponement of launching of new privatization. Given the commitments in pipeline, momentum in foreign flows will pick up further in the last quarter supported also by the floatation of global deposit receipts whose timing is now coordinated with the settling of domestic scenario and world financial markets which currently exhibit high spreads. Strong economic activities along with increasing foreign exchange flows have resulted in visible changes in the foreign exchange market in recent years. In FY07, the foreign exchange market grew substantially in both capacity and volumes. Market volumes of foreign exchange transactions grew steadily during the year, and reached US$ 68.5 billion in Q4FY07, compared to US$ 55.4 billion during the same period last year. SBP took a number of initiatives in response to the changing market dynamics. The business hours for the foreign exchange market were extended in January 2007, thus enabling the banks to cater to their customers’ needs more effectively. In addition, the bases for calculating Foreign Exchange Exposure Limit (FEEL) of banks was revised from 10% to 15% of their paid-up capital in March 2007, which increased the overall exposure limit of the commercial banks from US$200 million to approximately US$325million, thus facilitating banks to more effectively manage and price large volume transactions for their customers. The USD/PKR Exchange Rate continued to be market-determined, and any market intervention is always aimed at moderating the rate of change or diluting any excessive volatility in the exchange rate, rather than establishing any level for it. SBP as a policy doesn’t target any specific exchange rate level and the rate is driven by prevailing demand and supply conditions. The stability of the exchange rate, though with healthy two-way volatility, has helped bring more confidence to the international investors to attract long-term investment into the economy as well as to our local corporate to amicably price their goods & services. On the current FY’08 YTD basis, PKR showed marginal weakness against the USD with a point-topoint nominal depreciation of about 1.28% as compared to depreciation of 0.25% and 0.97% in the last two fiscal years. The PKR was amongst the few currencies of the region, which depicted a marginal depreciation, compared to number of other regional currencies such as Indian Rupee, Thai Baht, Malaysian Ringitt, and Chinese Yuan gained significant strength against USD during the period. Hence in relation to the regional currencies PKR weakened significantly which brought price competitiveness to our exporters. CURRENCY PKR INR BDT LKR MYR CNY THB PAKISTAN INDIA B' DESH S' LANKA MALAYSIA CHINA THAILAND % ∆ FY 08 -1.28% 2.58% 0.73% 0.88% 2.78% 2.81% 1.58% % ∆ Since June 06 -0.82% 14.62% -0.18% -7.85% 8.96% 6.31% 16.77% % ∆ FY 07 -0.25% 11.54% -1.28% -7.20% 6.05% 4.75% 17.06% 1 Up to Nov 26, 2007 * -ve % shows depreciation against USD, +ve show appreciation against USD To continue providing stimulus, SBP has facilitated banks liquidity management by regular and effective auction and open market operations. The rise in discount rate in July 2007 helped sterilization of foreign inflows that in June 2007 alone shot to Rs 214 billion and added 5 percentage point to monetary expansion. Weekly weighted average overnight rate remained within the interest rate band on two percentage points over July-November 2007 and below the discount rate. In the first few months, the demand for credit was low but because of a variety of factors including seasonality and timing of crop procurement, wait and see attitude for new investments, and banks positioning themselves to develop their systems in wake of growing defaults in selected sectors particularly consumer financing and agriculture where lending did grow exceptionally. However credit for private sector is gaining momentum, as it has started to pick up since the last week of September 2007. First, there is substantial room for banks to lend as creditdeposit ratio is around 60-65% and liquidity position of banks is eased by OMOs as and when required. Second, private sector IPPs are now maturing for drawdown of credit. Third, banks that had slowed down because of merger and acquisition activity such as Standard Chartered Bank and ABN Amoro are likely to regain their credit growth activity with more vigour. Fourth, companies which met their demand from external borrowings are likely to revert to domestic markets given the widening of spreads overseas. Finally, banks are now provisioning for loan losses which remain manageable. With these developments private sector credit is expected to gain momentum. Growing liquidity and competition forced banks to lend close to and in some instances below KIBOR and overall there was softening of lending rates. Resultantly, the benchmark KIBOR has also shown rationalization and 6-month KIBOR has registered a decrease of 61bp on a Y-o-Y basis and is currently around 10.0%, despite the increase in Discount Rate by 50bp. Banks have also been responsive on deposit side to the central bank calls. In November, Pakistan Banking Association announced a consensus view of the industry to raise deposit rates for saving accounts to minimum of 4% and also prior to that there have been series of announcement of new products for investors holding certain balances with commercial banks. These measures along with the zero CRR for long dated deposits and moral suasion of central banks has resulted in growth in share of time deposits and rise in weighted deposit rates by 181 bps on fresh deposits / 157 bps on outstanding deposits, relative to December 2005. SBP has further been facilitating both the export and long term refinancing. The outstanding funds provided by the State Bank and banks to Exporters at 7.5% reached Rs132 billion as on 3-11-2007 – which is higher than last year’s trends. SBP has honoured applications for around Rs 6.8 billion LTFEOP contracted prior to July 2007. At the same time, it announced the implementation of 3% interest rate subsidy for spinning sector and continued to pay R&D support expeditiously which has now reached Rs25 billion on a cumulative basis since its introduction and SBP disposed off almost 270,000 cases of it. The scheme for Long Term Financing Facility will be operationalized in January 2008 as soon as the details of its workings have been well understood by the commercial banks. This is a broad based facility which will make available long term credit for fabric, garments, made up, towels , rice processing, leather & leather garments, sports goods, carpet & wool, surgical instruments in the core categories, and fisheries, poultry & meat, engineering goods etc in the developmental categories of industrial sectors and is expected to finance both domestic and imported plant and machinery equipment for all exporters reporting exports of Rs 300 million annually or fifty percent of their production capacity whichever is lower. In order to facilitate matters banks are now allowed to make advance payments upto 100% of fob or cfr value of goods against firm registered contracts and LCs. Exporters are allowed issuance of bill of lading on document acceptance and document payment basis and also can retain 10% of export proceeds in the foreign currency accounts. In conclusion, our economic assessment and support for industry should help provide for clear direction of economic trends and expectation, while positioning industry to plan its futuristic investment in accordance with market incentives. | state bank of pakistan | 2,007 | 11 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 14th: World Islamic Banking Conference, Bahrain, 9-10 December 2007. | Shamshad Akhtar: Islamic finance – growth, competitiveness and sustainability Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 14th: World Islamic Banking Conference, Bahrain, 9-10 December 2007. * * * 1. Islamic finance has received overwhelming response from across the world as one discovers its ideological and practical richness and relevance. Growth in Islamic finance industry has however triggered a number of debates regarding the challenges this industry faces. These debates essentially revolve around whether Islamic finance is progressing well and is it there to stay? Is Islamic finance going to be a niche market or does it have global appeal? What are key drivers for enhancing the efficiency and competitiveness of Islamic finance industry which would in turn help broaden its appeal and in turn enhance its sustainability? In my brief remarks I will touch on these debates. 2. Despite transitory challenges – typical of a new and emerging industry, my view is that prospects for growth of Islamic finance are promising but rests on building an effective system for Islamic finance. 1 Growing interest has led to rising investments in Islamic finance and resulted in phenomenal growth in Islamic finance businesses. Interest in this discipline has already extended beyond Muslim and Islamic countries to non-Muslim population and jurisdictions and non-Islamic financial institutions. The avoidance of forbidden investments (“haram” products) and interest rates and speculative structures prohibited in Islamic jurisprudence and Islamic finance’s emphasis on just and equitable financial system offers distinct appeal for Muslims to be attracted to this option. Appeal of Shariah compliant financing mechanism is also likely to be a powerful tool for enhancing access to development finance and empowering the poor and vulnerable groups, particularly if Islamic banks extend their reach in rural areas which are currently not effectively served by conventional system. 3. Irrespective of religious appeal and affiliations, consumers would be eventually attracted to Islamic finance if it positions itself to offer an efficient and competitive alternate avenue of financial intermediation which caters to all segments of population and economy and services retail and personal banking and project finance. This can happen only if key messages and principles of Islamic finance are flexibly, constructively and innovatively interpreted, its conceptual framework further developed, nurtured and translated effectively into practical applications, and work is launched to better develop interface and linkages between Islamic and conventional finance and unleash the synergies to advantage of global financial development. Drivers for enhancing efficiency and competitiveness 4. Few key drivers for enhancing efficiency and competitiveness of Islamic Finance include: (i) Financial engineering and innovation. (ii) Global financial centers and their regulators support for Islamic finance industry. (iii) Standard governance and prudential regulation and supervisory guidance which require tweaking regulations to properly identify and assign proper weights for new “Building an effective Islamic financial system.” Dr. Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Global Islamic Financial Governor’s: Financial Regulators Forum in Islamic Finance, Kuala Lumpur, 27 March 2007. and different types of risks associated with the special and unique characteristic of Islamic finance business. (iv) Development and adoption of simple and standard and cost effective legal frameworks for contracts associated with the new and hybrid products. (v) Flexible and practical application and enforcement of Shariah principles and injunctions and its acceptability by public. 5. Taking up these items, first it has to be emphasized that financial engineering and innovation is one of the most potent tools of Islamic finance and will be the key driver to attracting global economic and financial player’s interest which will be critical for competitiveness and sustainability of Islamic finance. Increasingly Scholars, academics and practitioners have worked with global banks to offer wide range of wholesale, retail and trade financing banking solutions. For instance: (i) Vanilla Sukuks are now being compliment by range of hybrid Sukuks: Sukuk –Ijara, Sukuk-Musharaka, Sukuk-Moharba and so and so forth – as per IMF recent study there are today over twenty odd different variants of Sukuk. (ii) Islamic derivative market now offers Islamic equivalent of interest rate swap/option called profit rate swap/option and Islamic cross currency and FX swap and options. This is appreciable development given that Shariah compliant transaction has to fulfill existence of underlying real assets and generally it does not approve of uncertainty (jahala) and speculation or undue risk taking (Gharar). (iii) Private equity has already structural compatibility with Islamic financing, although it has to be deployed for Shariah eligible uses. (iv) Personal banking solutions are now being floated saving and investment account and information technology is used to offer online, ATMs and telephone banking services. (v) By and large products are structured on murabaha principles where funds are allocated for particular projects or finance an asset (such as home ownership and automobiles) in which depositor shares in the project rather than bank profits and to structure ijara (leasing) with appropriate asset backing and legal structures. (vi) In some cases there is move into bancassurance through establishment of associated Takaful institution and appending insurance sweetener is also a wave, though slow to take off. 6. There is scope for deepening financial engineering and innovation and exploiting its edge to promote equity based financing or structure hybrid debt: equity instruments. This will allow Islamic banks to offer richer and multiple options to customer, while allowing banks opportunities for proper fund mobilization and asset diversification. It will allow avenues for proper diversification and integration of financial services and pooling of risks through blending of Islamic and conventional financing to epitomize risk sharing between stakeholders and align rewards to be consistent with the risks. 7. Second driving factor would be global financial centers and their regulators support for Islamic finance industry. Currently wave of interest in Islamic finance is fascinating and has helped attract global banks in Asia and Europe to use their skills to augment the application of Islamic finance principles. As expected the approach and level of enthusiasm and pro-activism has varied in Western world. I would like to highlight the emerging approach of United Kingdom which has set on course a conducive and practical approach for development of Islamic finance which I would advocate other developed jurisdictions can pursue. U.K aims to strike a balance whereby FSA’s recent paper 2 highlighted that it has adopted “no obstacle and no favors” policy for Islamic finance. Recognizing its secular framework, U.K has been upfront, practical and candid requiring financial institutions to find mechanisms for conforming to FSA basic regulatory framework, while being open to be accommodative in interpretation of its rules and regulations. To conform to FSA requirements, Islamic financial institutions have to ensure structures evolved are in compliance with FSA requirements. Meanwhile, U.K provides the necessary flexibility and the required relief to its regulation on case to case basis. Equally supportive has been U.K rationalization of multiple taxes applicable in purchase and sale of properties to facilitate Sukuks and Islamic mortgages. 8. Third critical driver of Islamic finance is the efforts being launched by central banks to reach understanding on banking regulation and supervision. Broad understanding has now evolved that financial institution have to conform to standard financial regulation and supervision requirements applicable to conventional banks. There has been steady progress to improvise and modify regulatory framework to recognize the safeguards required for risks associated with Islamic banking solution and the required capital treatment for special and unique characteristics of Islamic finance business. The differences in the assets and liability structure in Islamic finance and the complexities associated with different Islamic products, however, tend to alter the risk perception associated with this financial system. 9. As such, work of IFSB and industry continues to be critical to evolve better understanding of different risks and how to cushion for such risks. Ensuring harmonization and consistent adoption, application and implementation of these evolving standards for Islamic finance and products will be a challenge but absolutely required to avoid regulatory arbitrage by industry and certain Islamic jurisdictions. Potential for such distortions will be inevitable as Islamic prudential regulatory and capital adequacy standards require more guidance and awareness. Furthermore, in line with the spirit of Bank International Settlement subscribed regulatory standards, IFSB standards are also for voluntary, rather than compulsory compliance. While this would result in differences in timing of adoption of such standards by Islamic industry, it is expected that with growing awareness market and investors will be factoring in differences in compliance in their choice of institutions. 10. Fourth critical driver of Islamic finance would be development and adoption of simple and standard legal frameworks. Contracts are at the core of Islamic transactions which define the rules for sale and purchase/trade/exchange of goods and services. Contracts are structured around the nature of transaction which could be either in the form of trade financing; asset based financing or different forms of partnerships. Under Islamic finance preference is given to trading of physical assets as well as trading of rights and with the growing hybrid products the demands for legal documentation has multiplied and is adding to the cost of transaction. Certainty of contract is another important element under Islamic contract law. The body of Islamic Contract Law while rich and supportive of participant’s right in transaction is onerous, complex and prone to different interpretations and rulings. Equally challenging are questions of enforceability of terms and conditions and lack of ability of courts to arbitrate litigation in case of dispute on contracts. 11. Fifth, it has to be recognized that Islamic finance is in its evolutionary stage and its sustainability would depend critically on regulators work with Islamic Scholars to reach flexible and shared, if not unified, understandings on principle elements at international level, despite differences in faiths and disciplines. There are number of faiths and disciplines across Muslim jurisdictions (for e.g. Syria and Pakistan are Financial Services Authority: Islamic Finance in the UK: Regulation and Challenges. Micheal Ainley, Ali. Mashayekhi, Robert Hicks, Arshadur Rahman and Ali Ravalia. November 2007. predominantly Hanafi school, Bahrain, Dubai and Abu Dhabi pursues Maliki school, Saudi Arabia and Qatar relies on Hanbali school). Rather than pursue harmonized views, each faith developing its own applications adds to the cost of transaction, introduces doubts on viability of Islamic finance given the split opinions, and confuses the public that basically relies on Scholars endorsement of products and business. These differences along with different interpretations of Shariah Scholars at the Boards or as advisors within the banks, if significant, further carry the risk of Sharia arbitrage which carries complications for regulators. Reaching consensus and shared/harmonized guidance among Scholars of different beliefs and faiths and evolving more unified institutional mechanism for adoption of common Shariah standards and ensuring proper enforcement through effective internal controls for their compliance would let the industry grow and compete on level playing field. Flexible and simpler interpretation of the basic tenets at the level of Scholars would enhance public acceptability. 12. Finally, keeping these macro considerations aside, Islamic banks being late starters do face a real challenge of competing with a well established conventional industry. Furthermore, full-fledged Islamic banks as per their licensing requirements have to confine themselves to Islamic businesses and products, while conventional banks with Islamic windows have inherent advantage as they can compete more aggressively offering both conventional and Islamic businesses. Different approaches to licensing are debated to have implications for competitiveness of industry whereby there is an argument put forward that in interest of fostering healthier competitions banks should be allowed to choose what they offer without imposition of licensing policy constraints. 3 To propel Islamic industry allowing dedicated Islamic banks is a well accepted course as long as regulators do not shield or provide preferential treatment to these institutions but creates a level playing field in regulatory and supervisory oversight. Next stage of development 13. Competitiveness of Islamic finance in future would depend on how Government and regulators perceive and nurture future development of Islamic finance and address the issues highlighted above and develop institutional, regulatory and supervisory frameworks and their effective enforcement. In the next stage of Islamic finance development, there is need for more substantive work on Islamic finance in the areas of: (i) Standardization of contracts and documentation which would reduce transaction costs and risks of litigation. (ii) Development of dispute resolution mechanism for Sharia compliance matters as regulators will not be in a position to resolve these. (iii) Proper implementation of evolving guidance of regulatory standards for special features of Islamic without comprising international standards to which both Islamic and conventional banks are to be subject too. (iv) Development of more interfaces between regulators – so far there seems to have been more systematic alliance between central banks to coordinate standard setting and its compliance. There is however need for better coordination between bank and non bank regulators and also for later to launch more initiatives to nurture nonbank Islamic sector. The McKinsey Qaurterly: Rethinking Regulation for Islamic Banking. Nasr-Eddine Benaissa, Xavier Jopart, and Ozgur Tanrikulu. 2007. | state bank of pakistan | 2,007 | 12 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the World Economic Forum, Davos, 24 January 2008. | Shamshad Akhtar: Inclusiveness, growth and gender equity Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the World Economic Forum, Davos, 24 January 2008. * * * 1. Growing theoretical and empirical evidence across the world has now confirmed that “policy-inclusiveness” is a prerequisite for benefits of economic growth and development to trickle down smoothly and speedily to the marginalized and vulnerable segment of population. Global and regional efforts launched over the last decade or so have paid off. World has made decent inroads in reducing level of poverty and financial exclusion, tracking and monitoring global and regional poverty and its dimensions and developing better understanding of the nexus and transmission mechanism of inclusiveness, growth and gender equity. 2. In my remarks I propose to lay out the size and dimension of the exclusion with focus on women and make the point that gender inequalities exacerbate exclusion of large segment and level of exclusion aggravates gender inequity itself. 3. To address “exclusion” there is need to nurture policy inclusiveness, ensuring robust campaign of financial inclusion to broaden access to finance, while launching supportive development strategies and programs that enhance the viability and sustainability of the financial services provided to the vulnerable groups. Size and dimension of exclusion 4. With better global monitoring mechanisms it is now well established that “women are poorer and disadvantaged relative to men”, as: • Nearly 70% 1 of the one billion of world’s poor living on less than $1 a day are women and half a billion live in Asia. This number goes up to 1.4 billion if one applies $2 a day definition for poverty; • Women make up 65% of the world’s illiterate 2 ; and • Women get paid less and hold less than 6% of senior management positions 3 etc. 5. Feminization of poverty is overwhelming and perennial gender inequality results in “inequality trap” which ends up reproducing other types of inequalities. This statement of the World Bank’s Global Monitoring Report, 2007 captures well the qualitative dimension, complexity and enormity of problem and the associated challenges of tackling gender inequalities which have trapped women in poverty. 6. Notwithstanding, significant reduction in poverty incidence in recent years, albeit at different pace across the world, is impressive. Population growth and economic cyclical factors however add annually to the ranks of poor. In Asia, poverty incidence fell from 27% in 1990 to 20% by 2006 accompanied by improvements in attainment of MDGs. Pace of poverty reduction has been steeper in East Asia relative to South Asia 4 with former lifting The estimate of poor women is based on UNDP Human Development Report 1995 which stated, "poverty has a woman's face – of 1.3 billion people in poverty 70%are women." This ratio of poor women is most widely quoted even presently. Global Call for Action “Stand up & speak out: 70% poor are women” 2007. Ibid. The World Bank, Global Monitoring Report, 2007. around 630 million people from extreme poverty in under a quarter of a century. This has lowered the region’s share in the total poverty from 58% in 1981 to just 9% in 2004. In South Asia poverty fell from 52% in 1981 to 32% in 2004, but absolute numbers of poor remain large. Several factors have contributed to improvements in these indicators ranging from higher economic growth and liberalization to concrete affirmative and targeted anti-poverty programs. Nexus between inclusiveness, growth and gender equity 7. There is now a broad consensus emerging in development literature that women being a large proportion of population and labor force, if appropriately nurtured, through development and finance inclusive policies would have more distinct impact on economic growth and reduce poverty. 8. Recent evidence of few key reports including the World Bank’s Global Monitoring Report, 2007 and Access for All, 2007 and the World Economic Forum, Gender Report, 2007 brings out with greater clarity and distinctly the nexus between inclusiveness, growth and poverty reduction. • First, evidence confirms that there is a positive correlation between country’s gender gap ranking and their per capita income as well as competitiveness ranking. Consequently, it is found that countries with low per capita incomes and ranking inadvertently have high gender gaps. • Second, impact of growth on poverty on women’s uplift varies depending on the level of incomes of countries as well as the quality of economic growth and its transmission mechanism which in turn, among others, influences income distribution. The Global Monitoring Report, 2007 found that in 19 low income countries, 1 percent of GDP growth was associated with a 1.3 percent fall in the rate of extreme poverty and a 0.9 percent fall in the $2-a-day poverty rate. However, for middle-income countries the impact of GDP per capita growth on poverty is less and in some countries average poverty did not decline despite increase in economic growth. • Third, although faster economic development and poverty reduction spurs gender equality the relationship is marred by issues of simultaneity and difficulties in comprehending the causality of relationship. On one hand economic growth and poverty reduction initiatives help to improve sex-specific Human Development Indices and augment gender empowerment. On the other hand, efforts to promote gender equality by way of education and enhanced women’s participation in labor force, credit etc. results in higher contribution of this segment of population to economic growth and poverty reduction. Recent studies using cross-country regressions found that female education has a larger impact on growth than male education. Furthermore, evidence indicates that the direct and indirect effects of gender inequality in educational attainment accounted for 38 percent of the 2.5 percentage point gap in growth rates between South Asia and East Asia. 9. It is now well established that proper delivery of microfinance to women helps reduce poverty and social indicators, while promoting economic growth. Women’s empowerment through proper access to credit further facilitates attainment of a set of MDGs and gender equality through: (i) poverty reduction, (ii) universal primary education, (iii) reduction in under 5 mortality, (iv) improved maternal health, and (v) lowering of HIV/AIDS incidence. 10. While these relationship and linkages have been found to exist, the twist and turns in causality and simultaneity, the social beliefs and practices and complexities of delivery of service have deterred achieving effective results for gender balance. A prerequisite for attainment of gender equality and its sustainability it is important to provide women equal access to “opportunities” backed by proper rights, voice and access to human and productive resources with the objective of augmenting their economic empowerment. Financial and development inclusive policies 11. Global microfinance campaign and initiatives have helped in extending the finance to poor. This has played a significant role in changing lives of poor through economic empowerment. In Asia, the number of microfinance beneficiaries has now reached 113 million 74% of which are poorest and 65% women. Including families of the beneficiary clients, the overall impact of microfinance is close to 465 million 5 . Number of microfinance beneficiary in Asia is the largest constituting 85% of the total recorded microfinance clients world-wide. 12. Microfinance link with gender equity is now evolving in a number of countries. For instance: In Bangladesh Grameen Bank and ASA report that 97% and 78% of its total 12 million clients, respectively are women. In Mexico, 98% of the 765,362 clients of Banco Compartamos’s are women. In Indonesia, Bank Rakyat Indonesia reports 50% of its client are women. This ratio is 70% in Afghanistan and 50% in Pakistan. Most microfinance institutions (MFIs)/Microfinance banks (MFBs) report a high return on equity and assets and recovery rate is by and large over 90%. 13. Global and regional challenges of reducing poverty and MDGs are daunting but attainable provided there is more accelerated, aggressive, brutal and frontal attack through well coordinated and cohesive economic and social policies as dealing with “poverty” is complex given its dimensions and multiple causative factors. 14. Recognizing this dilemma, the evolution of financial inclusion that aims to broaden and deepen access to development finance for all, of which microfinance is a subset, is timely. Ultimately it is a well functioning and efficient financial market which can deal more holistically with provision of financial services to the economy and population. However, emphasis on building financial inclusive system is an integral and core pillar of financial sector reforms. This has emerged in direct recognition that growth and development of finance does not alone address question of “access.” 15. Direct intervention to build financially inclusive system is critical as one recognizes fully (i) financial markets failures and imperfections such as information asymmetries, lack of sensitivity to gender and redistributive dimensions of resources and wealth and high transaction costs etc.; (ii) high price and non-price barriers such as lack of credit history and collateral and connection; and (iii) other constraints such as lack of literacy and entrepreneurial skills, etc. 16. Over the years, there has been substantive development in the architecture and thinking on financial inclusion. While there is no “one-size fits all” strategy or approach but it is important to recognize few core or necessary conditions aside from host of other sufficient conditions that are needed to maximize the benefits derived from a well designed financial inclusion strategy. At the outset, it is critical to understand the size and dimension of financial exclusion. 17. Drawing from this broad framework, State Bank of Pakistan (SBP) has launched a Financial Inclusion Program with the assistance of DFID. As a precursor to this Program, SBP has already formulated a microfinance strategy which aims to enhance the outreach of microfinance industry to 3 million by 2001 though efforts are underway to fast track this and to reach 10 million in next few years. In conjunction with this, SBP is working with the industry to enhance outreach by proper exploitation of the avenues available for promoting State of the Microcredit Summit Campaign Report 2007. credit for Small and Medium Enterprises and agriculture and rural finance. While financial penetration ratio is quite low in Pakistan, the growth in outreach has improved: for instance: (i) number of microfinance beneficiaries have tripled to 1.5 million over the last two years, (ii) number of agriculture borrowers increased to 2 million by the end of this fiscal year, with agriculture credit rising from just over Rs50 billion in FY03 to almost Rs200 billion in FY07; and (iii) number of small and medium enterprise borrowers rose from 91,663 in Dec 2003 to nearly 190,000 in Dec 2007. 18. Through this forum, I would like to invite other stakeholders including Standard Chartered Bank (SCB) to join us and DFID – together to further augment the financial inclusion program. Pakistan has laid sound financial sector legal, policy, regulatory and supervisory framework and has now an elaborate banking and microfinance industry infrastructure which, if effectively, nurtured and exploited can pave way for better results in extending outreach. | state bank of pakistan | 2,008 | 3 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the JP Morgan - Pakistan Corporate Access Forum, Dubai, 5 March 2008. | Shamshad Akhtar: Pakistan – economic sustainability Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the JP Morgan – Pakistan Corporate Access Forum, Dubai, 5 March 2008. * * * Pakistan has withstood series of endogenous events, including political uncertainty as a lead up to election, and the unprecedented exogenous shocks that have ranged from financial markets turmoil to climbing global commodity prices. On domestic political front, with elections now over the country is well on its way to a smooth transition gearing for a fully democratic system. Leading parties’ efforts to cement a coalition augurs well for confidence building; smooth functioning of legislature and their inbuilt accountability, while ensuring representation of public voice in steering the formulation and implementation of the future economic agenda. Ruling and opposition parties will need to rise above personal agenda to ensure sustainability of democracy. After a period of benign global economic environment, world economic outlook since August 2007 has been adversely impacted by subprime mortgage meltdown and its ripple effects on financial markets. Advanced countries are facing slowdown in economic activity. To mitigate the ensuing recessionary pressures, easing of monetary policy by the United States are to compound the already high inflationary pressures emerging from the exceptional rise in the global commodity prices, in particular of products such as oil, gold and wheat. Thus far Pakistan, like other Asian economies, remained immune to these shocks. Economic and financial markets remained calm in Pakistan as they had limited exposure to the US subprime market and other related products. With financial market turmoil deepening, the slowdown in economic growth and consequent reduced demand of advanced countries triggered greater uncertainty and induced vulnerabilities in international equity markets. These developments have begun to cast shadow, impacting emerging economies equity markets softening their growth prospects, albeit they remain set to grow strongly and. Pakistan, like other emerging markets, faces a key question regarding sustainability of its economic achievements. Abstracting from political debates, there is widespread confidence that Pakistan has achieved a significant economic turnaround. While short terms challenges and stresses have magnified, I propose to provide perspectives that the turnaround achieved is sustainable provided it is urgently backed by a well designed macroeconomic stabilization package and deeper structural reforms. In my presentation I make the case that Pakistan has strong economic growth potential given the country’s inherent dynamics. Second, restoring macroeconomic sustainability, despite disruption in FY08 trends, has to be on top of economic agenda and is feasible given scope for domestic resource mobilization and improved debt management. Third, there is need to deepen investment incentives and climate have to improve. Finally, Pakistan is and has to build momentum to diversify agriculture, industry as well as export base, and develop infrastructure. Implementation of this agenda will augur well for country’s long term economic growth prospects while offering wide range of investment opportunities that make Pakistan an attractive destination. Economic performance and potential Pakistan average economic growth rate was 6.3% for fiscal years (FY) FY03-07: during these 5 years economic growth was above 7% in two years and 9% in FY04-05 confirming rise in trend growth rate and capturing well the real economic potential. In productive sectors growth has been broad-based but accompanied by underlying structural shifts. Services sector has been the most buoyant and constitute over 53% of the overall GDP, with agricultural sector’s share declining from 25.9% in FY00 to 20.9% in FY07 and industrial sector’s contribution rising from 23% to 27% over this period. Rising domestic consumption demand has been the main driver of growth; accompanying rise, albeit somewhat slow, in investment rate. After averaging around 18.6% over the FY0306, investment rate grew to 23% in FY07 – reflecting a 4.4% percentage point growth in investment/GDP ratio in one year. This was expected to be boosted further by significant growth in public investment in FY08, though given fiscal exigencies a part of this may not be realized. Pakistan’s rich and large landscape offers a sizeable domestic market that is likely to double, reaching a population base of 230 million by 2030. Being at the crossroads of South Asia, Central Asia and West Asia with close proximity, both by air and sea, to the Gulf region makes Pakistan a promising regional hub and market for nurturing intra and inter-regional trade and investment. Recognizing these considerations, Multinational Corporations several years back set up businesses here. As confidence in Pakistan’s economy grew, there has been a significant growth in foreign capital inflows, cumulatively estimated to be around $13.5 billion (including global deposit receipts flows) over the last five years. The telecom sector, the major recipient of foreign investment close to $4.6 billion, is under private ownership and management; among other achievement the number of mobile subscribers is now over 80 million. Similarly, close to half of banking assets are now under foreign ownership as close to $2.7 billion foreign equity was injected in the sector and oil and gas sector has attracted $1.4 billion. Pakistan is now a well tested destination for foreigners. Corporate and banking companies’ returns have been high and investors, be domestic or foreign, are being well compensated for whatever risk premium they attach to Pakistan. Restore macroeconomic stability; despite the disruption caused by 2007 events Economic growth of Pakistan has benefited from macroeconomic stability. Containing macroeconomic imbalances helped generate (i) external current account surpluses in two of the preceding five fiscal years while (ii) fiscal deficit was below 4% in three of the five preceding fiscal years supported by surplus or zero primary balances (reflecting an effort to balance current revenues with current expenditures). Pakistan however now faces renewed economic vulnerabilities. Among others, compulsion to subsidize food, oil products and power & gas tariffs by preventing full pass through of international price hikes and to raise public investment to address infrastructural and skills gaps, essential to maintain growth path, have together disrupted progress in fiscal containment. Corrective policy actions, taken in the last few weeks, including rise in petroleum products, electricity and gas prices and cuts in development expenditures will at best ease marginally fiscal strains. Notwithstanding, the growing aggregate demand pressures in face of rising per capita income, six-fold increase in remittance, set to reach $6.5 billion for FY08, and exceptional rise in private credit, high import growth of petroleum products and capital, intermediate and raw material goods have compounded these vulnerabilities. Underlying demand pressure and threefold increase in import oil bill coupled with slow down in export growth has also widened external current account deficit. Keeping strong vigilance on the economy, the central bank took a lead in containing the aggregate demand pressures. Incrementally, monetary policy was tightened through three rounds of raising the SBP policy rate (by 300bp) since April 2005 to 10.5%, raising the reserve ratio, and improving liquidity management through open market operations. Monetary policy in Pakistan has benefited from the independence and strong accountability of the central bank as well as from the central bank’s conscious efforts to ensure transparency in public communications of monetary policy stance and perspective on the economy. Monetary policy has managed to keep inflationary pressures in check by managing to lower core inflation; slippages in inflation target were inevitable given the uptrend in the global commodity prices as well as structural complexities and inefficiencies of wholesale and retail markets. Global and domestic cyclical events will undoubtedly pose frequent challenges for small and open economies, like Pakistan. Recognizing this, the new Government will need to strengthen the Medium-Term Macroeconomic Stabilization Program and front load it, while accelerating the implementation of structural reforms to realign deficits to sustainable levels. Keeping this in perspective, the Government’s broader economy strategy for the next few years will need to include: i. Increasing domestic resource mobilization to raise revenue/GDP ratio by at least 5 percentage points of GDP. This is possible given the scope for enlargement of tax base: the existing tax regime collects almost 68% of taxes from manufacturing and corporate sector, while agriculture and services sectors (aside from banks) are exempt and segments of economy are outside tax net; ii. Nation-wide campaign to raise saving levels through continued efforts to raising awareness and deepening financial markets; iii. Restricting large proportion of new resource mobilization for public investment, while prioritizing the recurrent expenditures through a major overhauling of the Government machinery; iv. Restoring the momentum of privatization of state-owned enterprises, which has been one of the most successful in Asia. The Government has sold off cumulatively almost $7 billion of assets over FY00-FY08 and there are around 61 state entities in the pipeline; v. Providing more autonomy to public sector organizations, with effective leadership and management, to improve their operational and financial efficiencies accompanied by a program to strengthen their balance sheets which should allow them to graduate from budgetary allocations to seeking funding from the market; and vi. Raising private investment/GDP from 23% to at least 28% which involves significant tapping additional resources both from domestic and international financial markets. Although this is an ambitious macroeconomic framework, but launching and adhering to it is attainable and critical. To position itself, Pakistan plans to further enhance its policy framework and tap its economic potential by mobilizing additional foreign capital that is likely to be attracted as the country offers lucrative investment opportunities across all sectors. Deepening of liberal incentive and investment regime will help economic sustainability Broad based deregulation and liberalization of investment and pricing regime, Pakistan attracted cumulatively $13.5 billion investment across all strategic sectors. This has been facilitated by easing entry of domestic private sector and foreign equity with flexibility to fully own businesses. Long standing liberal and partial capital account convertibility allows individuals, firms or companies to freely undertake all international transactions through the interbank market. Aside from allowing 100% foreign equity, there are no bars on repatriation of capital, profits, royalty etc. Exchange rate stability has been supported by prudent exchange rate management. Recapitalization and restructuring/privatization and induction of professional management, banking sector has been the most dynamic sector. Liberal entry requirements and huge market potential given the current low financial penetration ratio have encouraged entry of global players. Foreign investors are allowed to hold up to 49% of the foreign equity in the banking sector, while banks with global Tier-1 capital is US$ 5 billion or more or institutions from the regional cooperation organizations (ECO) can hold up to 100% foreign equity in a banking institution in Pakistan. Companies acquired have to over the years be incorporated as wholly owned subsidiary or opening a branch in Pakistan. Even in those cases where foreign equity up to 49% is permissible, a higher percentage of foreign equity ownership is allowed by SBP on a case-to-case basis depending on the strength of the incoming institution. Companies have further benefited from access to private credit which grew at an average rate of 25.5% for FY03-07. This growth has been supported by structural changes in banking sector which is largely private sector run. Over the last five years, profitability of banking sector has surged reaching $1.70 billion in 2007, return on equity growing to 20.0% by Sept 07 and net NPLs ratio reducing to 2.3%. Capital market has benefited from the growth in stock market capitalization from $7.51 billion to $65.9 billion by the end-2007 and rise in P/E ratios have attracted foreign portfolio investment. To promote competition and efficiency corporate tax rate has been lowered and trade has been liberalized. Average tariffs are 7.6% and tariffs on import of plant, machinery & equipment for industrial sector has been reduced to 5% and for agriculture sector to zero percent while 50% Initial Depreciation Allowance is allowed. Nontariff barriers have been removed. Pakistan has Free Trade Agreements with the People’s Republic of China, Sri Lanka, Malaysia, Iran and Mauritius; negotiations are underway with Singapore and the Gulf Cooperation Council to be concluded in 2008, and preferential trade arrangements are also underway with Afghanistan, Bosnia, Bangladesh, Canada, Russian Federation, Serbia, Syria, Switzerland, Laos, Thailand, Indonesia etc. Future prospects for economic sustainability depends on building momentum of structural reforms – I will however dwell on the most strategic elements here. Agriculture and food self sufficiency With global commodity prices on the rise and alternate uses of corn and other products as bio-fuels in vogue, enhancement of crop productivity and area under cultivation will be critical for stabilizing food prices and curbing recourse to imports that have induced fresh external vulnerabilities. Given also the country’s rich and diverse landscape, Pakistan has good potential to serve the GCC and Middle East at large and exploit export potential of its agrobased sector. Renewed efforts will need to be launched by the Government to improve yields of major crops by intensifying research and extension, application of right type of seed and other inputs and mechanization. Comparative advantage in agriculture gives an edge in the development of agro-based industry, value-addition chains and processing and packaging of products and offer huge potential for growth and investment. Besides increasing value-addition, the Government has promoted private sector involvement; except for setting procurement price for wheat – to maintain strategic reserves – market-based pricing mechanism prevails for all agriculture produce. Efforts are underway for transmission of pricing signals to farmers (e.g. through introduction of a commodity futures market), development of crop insurance (particularly to encourage the raising of new cash crops such as oilseeds) and improvement in transportation and storage infrastructure. The proximity to the rich Middle East states, which are widely dependent on import of vegetable products, provides a strong market for agriculture-based products. The ancillary requirements to boost agricultural products exports also require massive investment in mass storage and transportation activities. Industrial and export growth and diversification Manufacturing sector has been growing at 8.4% and its share rose from 14.7% in FY00 to 19.1% by FY07. To realize its growth targets, industrial sector’s share in GDP has to rise to 30% and must be export led. The corner stone of industrial growth and diversification strategy is to set in place programs to: • Move up the value added chain in all key industries by developing capacities, skills and attracting strategic partnerships and technology; • Exploitation of mineral and other strategic resources of the economy; • Modernization, enhancement and design innovation in the textile industry. Scale enhancement could be achieved through foreign investment and joint venture/merger and acquisition. This would enable the textile industry, currently accounting for one-fourth of Pakistan’s output and 69% of exports, to withstand aggressive regional competition; and • Developing backward and forward linkages of large scale industry with small and medium industry that will help in improving productivity and competitiveness. Export growth has been quite impressive, more than doubling to $18 billion over FY01-07. Export Plan for 2006-2013 1 envisages a rise in export/GDP ratio from around 13% to 15% to generate almost $40-45 billion of export revenues. The principal thrust of this strategy will be to promote export diversification to reduce industry and exports vulnerability to textile sector. Substantial exploration is underway to exploit Pakistan’s potential to promote: • Agriculture exports efforts are underway to promote growth of minor crops and noncrop sector particularly dairy sector where Pakistan is now the world’s fifth largest producer. Aside from developing innovative guidelines for credit flows to the sector, efforts are underway to improve agriculture marketing, grading and quality; establishment of agriculture export processing zones with public-private partnership; encouragement of livestock development through cross breeding, artificial insemination and embryo transfer technology. Also, there is scope for expanding inland fish farms and developing in public: private partnership fish harbors etc. • Pakistan, being the fourth largest cotton producer in the world after China, India and US, has strong raw material and experience-edge in textiles. To augment capacities, industry invested $5.5 billion over the FY99-FY05. There is further scope for a three to fourfold increase in spindle and looms capacity and to diversify product (knitwear, bed ware and ready-made garments) and market base and improve quality and design. • In view of the relocation of industry and changing production and subcontracting networks/hubs and alliances as newly industrialized economies move out of labor intensive industries, Pakistan has an opportunity to serve as an alternate production center for electronic, electrical, and engineering industry. • Pakistan has made some inroads into the medium and high-end technology products such as electronic goods and this area could be explored further. • Mineral is another sector where Pakistan has large potential given its copper, high quality granite and marble and gem reserves. • Finally, information technology (IT) and other services sectors which constitute 55% of GDP have a role to play in enhancing exports and can be nurtured by promoting venture capital and private equity funds and enhancing the skill base of population in this area. Government of Pakistan, Planning Commission: Export Plan – Pakistan Inc. 2007. Infrastructure To enhance the competitiveness of Pakistan’s industry and exports, it is however critical to bridge infrastructure gaps. The Government has developed a broad based strategy and short, medium and long term plan for energy sector. Pakistan has good domestic reserves of oil, gas and other fuels and hydro potential. The investment requirements and opportunities arising from a well designed and integrated energy security plan that offers an Asian Energy Corridor are enormous. Potential within this corridor exists for mega projects that involve development, sharing and trading of energy resources between the largest producers of oil and gas in the Central Asian Republic and Middle East to the deficit countries including China, India and Pakistan. To ensure energy security and sustainability, Pakistan’s energy plan recognizes the growth in domestic demand for energy that has to be catered by exploitation and development of balanced energy mix with maximum reliance on indigenous and environment-friendly resources, besides tapping the regional resources. Recognizing this, Pakistan plans to i. Optimize energy mix between hydel: thermal from existing levels of 28:72 to 39:61 in the years ahead by exploiting all key sites with substantial hydel generation potential – this program will help in fuel substitution and energy efficiency resulting in savings of oil imports; ii. Enhance exploration and development of gas reserves. Gas supplies are to be supplemented by exploiting cross border energy transaction through Iran-PakistanIndia pipeline, Turkmenistan and Qatar-Pakistan pipelines and import possibility of LNG; iii. Unleash coal potential given the large measured reserves estimated to 3,300 million tons with substantially large inferred reserves. Major deposits are in Sindh province in Thar though other pockets also are showing promising signs; and iv. Exploit renewable energy resources. Investment requirements for key infrastructure programs were estimated to be in the range of $39 billion for 2005-2010. Over the long term, investment requirements will be staggering as, by some estimates, the aggregate power generation requirements alone will be around 143,310 MW during 2005-2030. Since 1994, generation has been largely in private sector and WAPDA – the largest utility company of Pakistan – has been unbundled by spinning off the regional distribution companies which are to be privatized. Given fiscal constraints, Pakistan has scope for limited public investments so bulk of the new development projects is to be available for private investment. The Private Power Infrastructure Board has floated 45 projects of 12 GW in pipeline, involving cost of close to $11 billion. Independent Power Producers (IPP) are generating 6005 MW, with remaining 13,083 MW MW generated by WAPDA and KESC. IPP have made significant progress (excluding Hubco outside Power Sector Policy framework) though 66% of the total capital requirements were met from official debt sources. Drawing from the lesson learnt of past power sector policy, the 2002 Power Sector Policy set prices based on cost structure of the project as determined by the regulator. Pricing policy allow pass through of items such as the fuel price, interest rate and exchange rate. Pakistan needs $1 billion per year for new dams and related infrastructure, and $5 billion per year for transport infrastructure etc. In road sector, the Medium Term Development Program includes plans to improve 14000 km of existing road and construct 7000 km of new road. Pakistan has managed to promote public-private partnership for a highway project on BOT basis for Lahore-Faisalabad 4 lane divided express way on 25 year concession agreement. The National Trade Corridor is one of the strategic integrated projects that aims to develop trade route from ports in south of Pakistan to northwest towards Afghanistan and Central Asian Republics and will carry 500 million tons of freight up the north-south route and another 50 million tons of international freight. Aside from expansion of two ports in Karachi city, commissioning of Gawadar port, awarded to Port of Singapore for management and operation. Located at the mouth of the Persian Gulf and outside the Straits of Hormuz, this port will serve as a regional hub for energy transportation. The Government has now developed a policy and legal framework for the Public Private Partnership (PPP) which will be supported by the Infrastructure Project Financing Facility (financed by the Government and Multilateral Development Banks). A Project Development Fund will help identify, prepare and procure PPP projects to support economically viable projects, mobilize private capital resources and float the corporate and infrastructure bonds. To support delivery of basic services, public funding will complement and replace user fee to the extent feasible to facilitate viability gap funding along with a supportive risk management framework. Improving productivity Pakistan is structuring a number of initiatives to allow for enhancement in total factor productivity growth which has been key driver of East Asian economic growth. Besides encouraging higher enrollment accompanied by improvement in standards in each of the education tier, investments are being made to (i) enhance vocational and technical education which thus far only caters for requirements of one percent of 15-23 years age cohort; (ii) open six foreign sponsored Universities to augment supply and quality of higher education in the country; and (iii) enhance SME and industry entrepreneurial skills. Supplementary efforts are underway to develop strong integrated linkages between technology and R&D needs of industrial sector and science and technical education. Conclusion Pakistan has great potential, both in terms of its natural and human resource, and has developed fairly good forward looking development agenda and plans. A major breakthrough in industrial and export diversification depends, among others, critically on reinvigorating agriculture sector and ensuring adequate availability of infrastructure to meet the growing economic requirements. Given huge domestic demand and high returns in virtually every sector, there has been a strong interest in Pakistan’s economy as illustrated by the strong foreign investment that has come from both GCC and West. The region given its diversity and richness of resources – with Gulf countries accounting for large proportion of world’s oil and gas proven reserves and now holding sizeable world foreign exchange reserves – along with Pakistan’s large agriculture and growing industrial base, domestic market, skilled labor force which, if effectively, exploited offers opportunities for deepening collaboration and cooperation for mutual advantage. The new Government given its strong political backing has the opportunity to restore macroeconomic stability disrupted in last couple of years which should help restore investor confidence and allow country to attract non-debt creating flows critical for development of industry and infrastructure sectors and to ease the balance of payments situation. | state bank of pakistan | 2,008 | 3 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the IBP Convocation, Lahore, 13 March 2008. | Shamshad Akhtar: Corporate governance for banks Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the IBP Convocation, Lahore, 13 March 2008. * * * This morning I propose to share with you my thoughts on the topical issue of “Corporate Governance for Banks”. Corporate governance revolves around the basic principles of fairness, transparency and accountability. Contrary to the perception of many, good governance is not a new phenomenon – the concept of well governed companies has been there ever since formal businesses took over the barter trading system. “Corporate Governance” received fresh impetus and widespread recognition during the 1990s with launching of the Cadbury Report in the UK and prognosis of East Asian Crisis of the late 1990s and a series of corporate scandals in West including the Enron Scandals. Together the loss of investor confidence and economy generated by the corporate failures brought to forefront the significance of corporate governance. Global and regional debates and initiatives have helped promote greater fairness, transparency and accountability, though there remains scope for still better understanding of its dimensions and effective implementation. Corporate governance is critical to improving economic efficiency and growth. It serves as a deterrent to mismanagement and infuses discipline in the decision making process of boards of directors. Adherence to the principles of good corporate governance serves to foster investor confidence and attract domestic as well as foreign investors. Companies operating on the principles of good corporate governance are able to attract investment. A study conducted by McKinsey quarterly indicated that investors would be willing to pay as much as 30 percent more for shares in companies having effective corporate governance. A number of surveys of investors in Europe and the US support the same findings and show that investors eventually reduce their investments in a company that practices poor governance. Why corporate governance matters for banks? The need for corporate governance in Pakistan is unmistakable. The country has steadily responded to the corporate governance challenges and progress in the banking sector is particularly impressive. Before we consider the corporate governance reforms for banks and the outstanding agenda, let us first explore why corporate governance matters for the banking system! Most importantly, the financial system in Pakistan continues to be predominantly bankbased, with bank assets to GDP ratio of 58.8 percent for 2007. Good corporate governance for banks, therefore, becomes critical in ensuring solvency and stability of the financial system as effectively governed banks are more efficient and prudent in directing their resources. Secondly, banks are highly-leveraged: they lend money borrowed from depositors and must therefore be accountable to these depositors. The corporate governance framework should, therefore, ensure aligning the interests of the management with equity and debt holders. The corporate governance of banks is intricately tied to the corporate governance of firms with former enforcing discipline through proper due diligence of conduct of corporate and their financial, while proper governance at corporate level help in safeguarding bank’s interests. Thirdly, ownership and group structure of banks in Pakistan is highly varied. The banking sector comprises of foreign-controlled, family-owned and some state-owned banks, with each type of ownership structure posing its peculiar governance challenges. Moreover, some banks operate as part of industrial/commercial groups while a large number of them have exposure to the non-bank financial sector through ownership and control. In such a scenario, transparency and fairness in banks’ lending and investment decisions, particularly those concerning group companies, becomes a crucial requirement. Finally, banks need to adopt good governance practices and customer service standards in order to build public confidence in credibility of their operations. Banks operate in a highly vulnerable environment where bonafide or perceived impression of malpractices in a bank’s dealings could trigger a run on its deposits. Role of SBP SBP has been on the forefront in promoting good corporate governance in the country. Primarily as the regulator and supervisor of banks and DFIs, SBP has a crucial role in steering corporate governance reforms in the banking sector. In this regard, SBP has implemented a comprehensive corporate governance regime for banks, which is driven by a robust legal and regulatory framework, risk-based supervision and over-arching banking sector reforms, notably, privatization, liberalization and consolidation of banks. The major thrust of legal and regulatory requirements is to strengthen the functioning of the Boards of directors of banks. In setting out the responsibilities of the Board, SBP requires directors to focus on policy making and general direction, oversight and supervision of the business of the bank. The directors are expected to meet frequently, set up Board committees for audit, risk management, recruitment and compensation, and attend training programs to help them discharge their role as a director. In a recent move, SBP has separated the positions of chairman and CEO of banks and made it mandatory on banks to appoint on the Board at least 25% independent directors and not more than two executive directors. SBP has also strengthened the fit and proper criteria and approves appointment of directors and CEO of banks in line with the criteria. Banks must also follow the fit and proper criteria in appointing key executives although such appointments do not require SBP approval. Recognizing the centrality of proper risk management in corporate governance framework, SBP has issued guidelines on risk management, internal controls, IT security and business continuity planning. Detailed instructions are available in the policy framework for banks. Risk management framework is laid out in the regulatory requirements that check banks’ exposure to group companies and other related parties, restrict exposure to single borrower, borrowing group or sector, as well as limit banks’ investments in equity market. Key requirements in this regard are: (i) Shareholding by a bank/DFI in other companies has been restricted to 30 percent of the other company’s paid up capital or 30 percent of the paid up capital and reserves of the acquiring bank/DFI, whichever is lower. (Section 23 (2) of BCO) (ii) Banks/DFIs have been restricted from taking unsecured exposures on their directors, major shareholders, CEO, their families and firms or companies in which such persons have interest. In case a secured exposure is to be taken, it shall require prior approval of the Board of directors, excluding the director concerned, and the facility shall be extended by the bank at prevailing terms and conditions, on an arm’s length basis. (iii) Standard limits at 30 percent and 50 percent (including 20 percent and 35 percent for fund based exposure) of bank’s/DFIs’ equity apply on single and group exposures, respectively. Furthermore, contingent liabilities of a bank/DFI should not exceed 10 times its equity. Likewise, clean lending to single persons is limited to Rs. 0.5 million while aggregate exposure against all clean facilities should not exceed the equity of any bank/DFI. SBP has also specified that banks’/DFIs’ exposure to a company cannot exceed 10 times of borrowing entity’s equity and the borrower’s current ratio cannot be lower than 1:1. (iv) Banks/DFIs should not invest in shares of any company/scrip in excess of 5 percent of their equity. Banks/DFIs will require prior approval from SBP in order to purchase shares of a company in excess of 5 percent of their paid-up capital or 10 percent of the capital of the investee company, whichever is lower. Furthermore, aggregate investments of banks in shares should not exceed 20 percent of their equity. Any shares acquired in excess of 5% limit due to underwriting commitments must be off loaded within a period of three months. (v) Banks/DFIs may also take exposure in future contracts to the extent of 10 percent of their equity on aggregate basis. In this connection, the 10 percent exposure limit for future contracts will include both positions taken in futures buying and selling. To strengthen further risk management framework, SBP like other countries is steering the implementation of Basel-II in a phased manner. Initially banks are required to adopt the Standardized Approach for credit risk and the Basic Indicator/ Standardized Approach for operational risk from 1st January 2008. Subsequently, once they have improved their in house systems, they would have the option to switch over to more advanced approaches from 1st January 2010 subject to the adequacy of capacities and capabilities and its due diligence by SBP. As a further step to strengthen governance of banks, they are required to undergo credit rating annually. The rating must be announced publicly and disclosed in the financial statements of the bank. SBP also requires banks to appoint auditors from a panel of pre-approved auditors maintained by it. The objective is to ensure credibility of audited financial statements of banks. In the area of monitoring and supervision, SBP has implemented a comprehensive framework, which is underpinned by regular on-site inspections of banks and DFIs under the regulatory ambit of SBP. Banks are inspected in accordance with a pre-approved annual inspection plan, following the CAMELS-S 1 approach. SBP has also developed a comprehensive surveillance mechanism – the Institutional Risk Assessment Framework (IRAF) – to capture the host of risks facing individual banks based on the information gathered from on-site inspections, off-site supervision, market intelligence and selfassessment by banks. The objective is to obtain a composite rating for each bank for effective and proactive supervision by SBP. Finally, SBP is endeavoring to further strengthen its own governance processes in consultation with its Board of directors. An adequate and appropriate governance framework is crucial for the optimal functioning of any enterprise, but more so for a central bank because of its objectives of maintaining price stability and ensuring financial stability along with its crucial contribution to the overall economic policy framework. Furthermore, a vibrant and effective regulator is able to carry forward the corporate governance reform process more rigorously. SBP is fully cognizant of the need to implement good governance practices in its own functioning and has empowered its Board of directors to provide oversight and direction of affairs and business of SBP. In order to modernize SBP’s operational strategies and strengthen its governance, the organization has been successfully restructured in 2006, followed by adoption of market-driven compensation packages for its employees in 2007. The focus of the SBP management has been on improving risk management and internal CAMELS-S covers capital adequacy, asset quality, management, earnings, liquidity and sensitivity in addition to systems and controls of banks. controls systems within the organization as well as enhancing transparency in its communications on policy and financial sector issues. SBP is also working towards developing adequate policy framework for consumer protection and has set up a Consumer Protection Department to safeguard consumer interests. Impact of corporate governance reforms Pursuant to multiple reforms initiated for the purpose, there has been a visible improvement in the corporate governance practices of banks. The fundamental change is in the effectiveness of the board. The implementation of Fit and Proper criteria has ensured that board members are well equipped to carry out their responsibilities. The criteria is also a measure to exclude unscrupulous individuals from the highly responsible position of a board member, In terms of performance, the Boards of directors now meet more frequently, focusing largely on strategic objectives and management oversight. The scope of the Board’s policy making function has enhanced to cover a broad range of areas, such as systems and control, risk management, human resources, credit, investments, etc. Professional management is appointed to carry on the banks’ operations. Furthermore, internal control system has been strengthened in banks through setting up of audit committees and internal audit functions. Compliance officers are now appointed to manage banks’ compliance to the policy framework and laws and regulations, including the AML requirements. The frequency of financial reporting has improved through circulation of quarterly accounts. Financial reporting standards are at par with international best practices while credibility of financial information has received a boost through rotation of auditors after every five years. Enhanced disclosure has positive implications which go beyond just accounting statements of the banking entity. It is a mechanism for the market to assess the quality of assets, and earnings, and expose any hidden risk, for example those arising from associates, subsidiaries, related parties lending etc. These improvements have been reflected in international assessments of corporate governance framework in Pakistan. The ROSC-CG assessment of Pakistan in June 2005 acknowledges that “Reform to improve corporate governance has been significant, including the introduction of a Code of Corporate Governance and increased vigilance by regulators.” The ROSC-CG assessment further notes that “The SBP has also been instrumental in improving corporate governance in the banking system, by requiring banks and DFIs to adopt the Code, and by assessing compliance with other relevant aspects of prudential regulation specifically applicable to banks/DFIs.” Similarly the World Bank’s 2007 report on Doing Business in South Asia recognizes that “Pakistan provides relatively strong protections for minority shareholders against the misuse of corporate assets”. It ranks 19th worldwide on protecting investors. Outstanding corporate governance reform agenda While considerable progress has been achieved in enhancing corporate governance practices of banks, SBP is geared towards filling in the remaining gaps. In this regard, foremost is the need to develop a suitable cadre of professional directors who are knowledgeable of banks’ affairs as well as independent of their management and majority shareholders. Allied to this is the need to clarify and strengthen directors’ fiduciary duties to act in the interests of the bank and all of its stakeholders. It is also essential for banks to provide sufficient time and information to directors to prepare for Board meetings, structure Board meetings so as to allow ample time for discussion and establish appropriate criteria for assessing and improving performance of directors, including independent directors. To raise awareness on these and related aspects, SBP is working towards issuing comprehensive corporate governance guidelines for banks. As earlier discussed, Pakistan’s corporate and financial sectors present corporate governance issues peculiar to complex ownership and group structures. By conducting operations through a complex network of subsidiaries, controlling shareholders often acquire control of operations and/or cash flows disproportionate to their equity stake in individual companies. The key issues that arise as a result include: (i) inequitable treatment of stakeholders; (ii) dominance of controlling shareholder-directors over Board proceedings; (iii) lack of independence of the Board from the management; and (iv) channeling of bank resources to the benefit of group concerns. In order to address such corporate governance issues, there is a need for group supervision by the regulators. As regard the banking supervision, SBP is working towards introduction of consolidated supervision whereby it will not be monitoring banks as a stand-alone entity but rather as part of the entire banking group. This will help to evaluate the strength of the entire group and to mitigate risks arising from group companies. A significant component of consolidated supervision will be review of group structures and detailed examination of related party transactions. I would also like to share with you that SBP has recently launched a survey of banks to assess their corporate governance practices. The survey will help to identify areas for reform in the regulatory framework as well as its implementation by banks. The survey results will be a key input in further improving the corporate governance framework for banks. Conclusion Good corporate governance is essential in establishing an attractive investment climate characterized by competitive companies and efficient financial markets. It is imperative that Pakistan’s banking sector develops and implements good governance practices, in order to provide impetus to economic growth. In the realm of a rapidly globalizing world – characterized by liberalization of markets, relatively free-er trade, sophistication of financial products and instruments, and growing awareness among consumers – Pakistan is ripe with lucrative opportunities for foreign and local investors alike. I would also like to mention that no amount of regulatory intervention can fully institutionalize corporate governance unless Boards and senior management of banks appreciate the value addition of corporate governance to their productivity and competitiveness. In this context, banks should strive to build a reputation for honest and fair dealing while interacting with their internal as well as external stakeholders. Ethics, transparency and the competition for reputation, which are the cornerstone of good corporate governance, would invariably be the distinguishing features of banks that emerge ahead in an increasingly competitive market. | state bank of pakistan | 2,008 | 3 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Golden Jubilee of the Pakistan Institute of Development Economic, Islamabad, 11 March 2008. | Shamshad Akhtar: Policy tradeoffs and structural issues Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Golden Jubilee of the Pakistan Institute of Development Economic, Islamabad, 11 March 2008. * * * Resilience of Pakistan’s economy in the face of unforeseen global and multiple domestic shocks has been a subject of debate – proponents of outgoing Government arguing that it has strengthened, while opponents criticize the state of the economy. In these circumstances, I propose to provide a neutral, unbiased and economic reasoning for why and where we stand today? I encourage Pakistan Institute of Development Economics (PIDE) to further investigate and provide a professional economic perspective on the economy with the objective of feeding properly into policy advice. In providing my perspectives, I propose to highlight the emerging challenges posed by the weak global economic scenario, its consequent impact on the domestic economy which was already under strain, and then discuss the policy options and solutions, especially the structural changes that are required to put Pakistan on the road to sustainable economic recovery. Pakistan entered the 21st century after displaying an average economic performance in the 1990s on numerous fronts. In deference to the historical pattern of growth path and associated business cycles, the economy gained momentum. From 2000 onwards: foreign exchange reserves grew, the debt-to-GDP ratio fell, and inflation, in particular core inflation, decelerated. Dynamism of financial sector, benefiting from the change of ownership and management and strong regulation and supervision, helped revive real economy and exploited untapped economic potential. Financial sector assets rose to $180 billion (125% of total GDP) as banks’ were capitalized and the stock market remained buoyant. Corporate and banking sector profitability attracted cumulatively foreign direct investment of $11.9 billion, remittances at $22.4, and net portfolio flows were $5.0 billion. Since late 2004 domestic vulnerabilities reemerged and mounted as the fiscal and external current account deficits rose above 4% of GDP and induced inflationary pressures. Risks to macroeconomic stability just after few years of robust growth and stability are not surprising. A quick review of Pakistan’s economic history reveals that episodes of strong economic growth in the 1960s and then in 1980s were both followed by the slowdown in growth and weaknesses in macroeconomic indicators. Why is Pakistan vulnerable to these cyclical downturns? Why cannot the country have sustainable economic performance? The oscillating growth performance over the years is largely because of inherent domestic structural rigidities which have yet to be effectively tackled to ensure macroeconomic stability and the desired growth path. Proper diagnosis and effective resolution of issues and implementation of broad ranging structural reforms is critical to skirt such bouts of slowdown in growth and instability. Aside from the broader development debates, what is unusual currently is that Pakistan’s economy is simultaneously faced with twin shocks, global and domestic. The global shocks are represented by international financial market turmoil and the unprecedented increase in global commodity prices, while rising fiscal and external current account imbalances characterize the domestic shocks. In the backdrop of (relative) slowdown in foreign exchange inflows in FY2008, these shocks have resulted in pressure on the exchange rate and foreign exchange reserves, heavy government borrowings from the central bank, and a rise in domestic inflation. Combined, both international and domestic events have complicated short term economic management disrupting monetary management which had succeeded in bringing the core inflation down to 5.2% by May 2007 – below the peak levels of 8.3% in October 2005 and brought to surface more starkly the vulnerabilities economy faces. Like most economic phenomenon, these international shocks and domestic deficits are interrelated and entail stringent tradeoffs when it comes to devising and implementing a well-coordinated, timely, and enduring policy response. Unless immediately addressed, the present economic vulnerabilities emerging in Pakistan’s economy risks reversal of the high growth trajectory and even disruption of the gains achieved. Below, I attempt to give the basic reasons for the (re)emergence of these shocks and deficits, highlight the complexities, and suggest some sustainable solutions. The global scene Worldwide central bankers, economic policy makers and businesses are overwhelmed as global economy slides in tailspin. Financial market turmoil caused by subprime debacle has sparked numerous debates regarding the origins of this event, effects of its aftermath, both in terms of contagion and policy responses across the globe. Risks of spread of contagion associated with US and UK’s credit crisis and liquidity crunch have compounded as the financial and economic losses magnify and thwart global financial stability and economic growth prospects. Combined with record-high international commodity prices (in particular oil and food prices) global inflationary risks have intensified. Emerging markets like Pakistan, which were thus far insulated mainly due to low exposure to the subprime paper, are likely to be impacted by the second round effects of the financial market turmoil which are now visible by way of sluggish world economic growth as US downturn is setting in. To mitigate these risk, US has launched a unprecedented package involving: easing liquidity through special funding windows, cutting policy rate, in five rounds, to 225 bps and providing US$200 billion fiscal package. This package, while warranted, is fairly controversial because of the associated moral hazard and inflationary consequences of rate cuts and easing of liquidity. Since the appropriate size of the stimulus cannot be calibrated with any precision, the aggressive stimulus by way of a monetary accommodation is likely to compound the global inflationary pressures which were already rising in wake of (i) supply constraints magnified due to world wide shortages of strategic products (such as wheat) and oil substitution efforts that diverted use of corn as a bio-fuel and (ii) growing demand pressures with rising world income. Fuelling the international commodity prices has also been the fall in US dollar which has driven investors to chase gold and oil markets. In a globally integrated world the costs of re-anchoring inflation expectations are likely to be punitive. No wonder, other central banks, with the exception of few such as Federal Reserve and Bank of England, have either further tightened their monetary policy or kept on hold to existing levels of tightening. Developing understanding of the origins of the financial crisis and adequacy of its policy responses is critical. Analysts have largely identified collapsing US sub-prime mortgage market as the key cause for financial market turmoil. However, the sub-prime mortgage debacle appears more of a symptom rather than a cause of this evolving credit crisis. Underlying causative factors is the sustained decline in inflation and inflation volatility and the associated notable decline in nominal and real interest rates in most developed and developing economies. This resulted in complacency and central banks’ adopted accommodative monetary policy for longer period that induced excessive liquidity. Combined with regulatory and supervisory gaps in oversight of off-balance sheet and nonbank transactions, this provided opportunities for overleveraging without appropriate risk management frameworks. Arguably, these developments increased appetite for and under pricing of risk (although the pricing of risk was (and is) becoming increasing difficult in the face of fast-paced financial innovations), elevated asset prices, increased capital flows across borders in search of better yields (reflecting global macro imbalances), “carry trade” and currency misalignments. Although, monetary conditions had begun to tighten, the sub-prime mortgage crisis caused liquidity squeeze that resulted in loss of confidence and panic among investors and lenders (and now central banks) as they could not offload the complex risky assets and structured financial products. Since banks turned to rescue and bought off chunks of these papers, with low mark-to market valuations these resulted in losses to a number of financial institutions and write offs required capital injections. This fortunately was possible given the growth in sovereign funds which are waiting for acquisition and other deals. Could it be possible that by accommodating the oil and food prices and (attempting) to revive the economy, US is setting the stage for another round of easy monetary policy and liquidity situation. In my opinion, the key issue for central banks is to differentiate between need for short-term liquidity to rescue troubled financial entities and need for adoption of a credible monetary policy stance which aims to calibrate liquidity management in a way that it does not aggravate inflationary risks which in turn would trigger further complication and protract the global economic recovery. While lowering interest rates, central banks have to weigh inflationary risks against the risk of recession and financial instability. In bailing financial entities, the central banks have to be concerned with “moral hazard” associated with such policy response as it often encourage more risky endeavors by salvaging institutions whose sole purpose of existence is risk taking and profit making. Not only is Pakistan facing different sets of complex challenges, but the emerging global economic scenario itself underscores that country does not mimic the policy response of advanced economies. Advanced countries that are selectively lowering interest rates are those that have enjoyed low inflation for sometime but are now facing steeper risks of downturn. As such, there trade off for growth supportive policies relative to inflation is understandable as risks associated with US slowdown would threaten global economic outlook and financial vulnerabilities. Pakistan on the other hand has relatively stable financial system, but mounting aggregate demand pressures are now visible in rising inflation and rising inflationary expectations. Tightening of monetary stance and flexible exchange rate management are the two key central bank policy responses. These however will have more distinct impact if the Government reverts to fiscal prudence and efforts to this count are visible through recent reduction in oil and other subsidies. Turning to the domestic front Structural Reforms: An Assessment. To understand the economic complexities at hand it is important to trace briefly Pakistan’s economic growth trajectory and experience of structural reforms. Over the last three decades, economic growth has stumbled: While growing around 6-7% in late-1970s-1980s and growth faltered over 1988-2001 to 4.4%. From 2000, efforts launched have resurrected growth to an average of 6.3% over the last few years. The growth path was disrupted frequently by the inability of the government to adhere to prudent macroeconomic management and to consistently implement structural reforms. There is evidence, corroborated by the IMF Independent Evaluation Office 1 that Pakistan’s macroeconomic framework and structural reforms suffered because of the lack of ownership of economic agenda and excessive focus on macroeconomic stabilization without supportive real sector as well as institutional and structural reforms. This resulted in slippages in conditionalities and/or weak implementation of the reforms at best as releasing disbursement to meet economy’s financial crunch outweighed compliance with structural reforms. Problems with design and sequencing of structural reforms resulted in suboptimal outcomes of policies adopted. Few striking examples would illustrate this. Macroeconomic stability has often been disrupted as fiscal slippages were a norm given spending was not aligned to resource envelop that has been for years constrained by narrow tax base. These trends IMF (2002), “Evaluation of Prolonged Use of IMF Resources”, Chapter 9: Pakistan, Independent Evaluation Office, Washington D.C. made fiscal-monetary coordination difficult. Continued recourse of deficit financing from central bank and other domestic financing sources has prevented containment of inflationary pressures, while constraining private sector credit demands. In real sector, industrialization has suffered because of excessive emphasis on import substitution and the incentive regime carried anti-export bias; consequently Pakistan suffers vulnerabilities stemming from lack of industry and export diversification. Nevertheless, structural reforms, adopted since 1990s have been refined in the recent decade. Among others, notable are following steps: Openness of the economy. Deregulation, price liberalization and lowering of tariffs, 2 and the government’s increased willingness to cede greater role to the private sectors in the economy has improved the incentive regime. Greater fiscal space. Broadening of sales tax base, lowering of tax rates and improvements in tax administration together helped in raising the tax revenue; offsetting the losses stemming from tariff liberalization. Tightening of fiscal deficit over FY2002-2005, decline in debt 3 and lower debt servicing (partly through the restructuring of external debt and partly through improved debt management) allowed space for raising development expenditures. Sustaining growth in development expenditures is becoming a challenging as tax base is limited by exemptions and a significant proportion of taxable bodies/incomes remained outside the tax net. Privatization and deregulation. Government’s success in extricating itself from the provision of goods and services in a number of areas by sale off of public companies has helped generate proceeds. This has helped temporary alleviate fiscal needs and would also reduced state enterprises recourse to budget. Privatization has already helped improved accessibility and efficiency particularly in banking, telecommunications, and airline industries as well as the mass media (radio, television, etc.). Improving demographics. Albeit slow, Pakistan has managed to reduce its population growth rate. Large population offers strong domestic market and human resource for industry, but it does pose challenges and tradeoffs. Feeding population when crop productivity and yields are low, meeting their social services obligation and growing demands overstretch infrastructure and natural resource base. Besides harnessing better population potential, emphasis on slowing population growth is likely to generate significant gains in coming decades. Governance and institutions. Over the last 10 years, institutional reforms have helped establish regulators and NADRA (that has helped reduce transaction costs through issuance of IDs etc.), unbundled power sector, building capacities for public: private partnership in infrastructure development etc. According to the World Bank’s Report on Doing Business 2008, Pakistan ranked at 76th position out of 178 countries in terms of ease in doing business and placed at 11th position amongst Asian economies. Supported by these reforms and capital inflows, Pakistan’s investment rate, which has hovered around 18%, has now risen by almost 5 percentage points to 23% in FY07. Encouragingly, public investment has also risen from 3.9% of GDP in FY03 to 5.2% of GDP by FY07. Enhanced resource mobilization would be key to maintaining momentum for growth in public investment. The average tariff rate has declined from 56% in 1994 to around 7.6% by 2007. The decline in the tariff led to a significant increase in trade volumes (correspondingly the trade to GDP ratio has risen from 25 percent in FY00 to 33 percent in FY07). In time, the fiscal reforms led to a sustained reduction in the debt to GDP burden (92.9 as % of GDP in FY00 to 57.7% by FY07). Current challenges. Pakistan is at a critical cross road. On one hand, there are achievements to be recounted. The country’s smooth, though protracted, transition to democracy and the preceding few years’ economic performance that managed to excite foreign interest in Pakistan lends us confidence that Pakistan has strong economic potential and can attract global capital. On the other hand, there remain key economic risks and challenges that the country faces. Unless addressed holistically these could threaten economic prospects; a luxury Pakistan can ill-afford given the geopolitical context and the emerging global challenges. Re-emergence of twin deficits has complicated monetary management. Borrowings from SBP induce expansion in reserve money and Government’s high recourse to banking system potentially crowds out private sector credit. These complications introduce volatility in overnight and other interest rates weaken the monetary policy transmission mechanism and hurts investment potential. Growing demand for goods and services, both from domestic sources and from abroad has helped domestic industry, but has also enhanced import reliance. Over FY03-07, import growth (including oil) averaged 24.7% outpacing export growth (13.4%) leading to a widening external current account deficit. During this period, capital inflows funded fully the external current account deficit and the residual helped in building foreign exchange reserves (growing by $5.6 billion over FY03-07). Even if oil prices fall and foreign inflows are restored, sustainability of external account will remain under stress as export growth may be impacted by the global slowdown. Containing both the external and the fiscal account imbalances is one of the challenges for the government. Solutions, strategy and structural reforms: future agenda. So what is the solution in this situation? The answer is to conduct counter-cyclical policies to curb demand pressures by dealing with the root cause of deficits; the sustainable and enduring solution is not only how to finance these deficits but more importantly how to introduce structural changes to reduce these deficit in a sustainable manner, while reflecting on approaches to meet the country’s development requirements. To resolve macroeconomic imbalances on a sustainable basis and meet the growing development requirements, there is need to as high priority focus on enhancing national saving rate, which is a basic ingredient to increase the productive capacity (possible only through well sequenced structural reforms) of the economy to match rising demand. Saving rate has now been historically low and a combination of policies including a country wide campaign through incentives can help encourage savings. This among others requires to maintain high and stable real interest rate, which given the current high inflationary environment is only possible with high nominal interest rates. In turn, a higher production level in the economy will encourage more savings. The challenge in this context is to remain vigilant about controlling consumption through counter cyclical policies. Recognizing the need to bring the twin deficits within sustainable levels and to increase national savings, the new Government will need to strengthen the Medium-Term Macroeconomic Stabilization Program and front load it, while accelerating the implementation of structural reforms. These steps will be crucial to re-invigorate growth and strengthen economic resilience. Keeping this in perspective, the Government’s broader economic strategy for the next few years will need to include: i. Increasing domestic resource mobilization to raise revenue/GDP ratio by at least 5 percentage points of GDP. This is possible given the scope for enlargement of tax base, removal of exemptions and further strengthening of tax administration. The existing tax regime collects almost 68% of taxes from manufacturing and corporate sector, while agriculture and services sectors (aside from banks) are exempt and some segments of the economy are outside the tax net. ii. Restricting large proportion of new resource mobilized for public investment, while prioritizing the recurrent expenditures through a major overhauling of the Government machinery. iii. Restoring the momentum of privatization of state-owned enterprises, which has been one of the most successful in Asia. The Government has sold off cumulatively almost $7 billion of assets over FY2000-FY2008 and there are around 61 state entities in the pipeline. iv. Providing more autonomy to public sector organizations, with effective leadership and management, to improve their operational and financial efficiencies accompanied by a program to strengthen their balance sheets which should allow them to graduate from budgetary allocations to seeking funding from the market. v. And raising private investment/GDP from 23% to at least 28% which involves significant tapping of additional resources both from domestic and international financial markets. To address the structural weaknesses that are inhibiting Pakistan’s long term growth there is need for: (i) Exploiting agriculture sector, a key driver for economy, to regain food self sufficiency. Conserving agriculture land and dealing with land holding and entitlement issues so that area under cultivation can be expanded, removing infrastructural bottlenecks (such as inconsistent water availability) and promoting right technology as well as research and development, and strengthening wholesale and retail markets will help improve food availability at a time when global food scenario is worrisome. Greater food production will help cater for rising demand both within Pakistan due to the growing population and its prosperity and outside particularly in the Middle Eastern bloc, India and China. (ii) Development of a diversified industrial sector is now urgent to cater for both domestic and external demand. Private sector has to be provided the right incentive and environment for promoting the required diversification. For promoting industry, there is need to broaden and deepen private equity and debt markets – this will help diversify financial sector too which is exclusively dependent on the banking system that carries its own attendant risks. Closely held companies should be encouraged to move more and more to capital markets and to examine opportunities for mergers and acquisition and to attract foreign investment to achieve scale and efficiencies. (iii) Instead of focusing on ad hoc subsidies that reach largely the profitable industry, it is best to design incentives to focus on ensuring adequate supply of infrastructure. All new funding, be it taxes or proceeds mobilized from the privatization of infrastructure should henceforth be kept in a separate account and this funding should be exclusively dedicated for developing infrastructure in dedicated industrial sites. For modernization of the industry, SBP and the Government is already focusing on provision of right incentives for import of plant and machinery. These measures will help industrial the sector’s ability to compete effectively and achieve an organic and natural growth. Scope for exports is significant only if the industry achieves scale, value addition, diversity, and develops information technology and outsourced businesses from the West. (iv) Foreign investment would receive a further impetus if the legal system is overhauled to ensure elimination of cumbersome procedures, effective enforcement of property rights and business contracts and availability of timely justice. In conclusion, Pakistan has an opportunity to draw lessons from past. Among others listed above, a key lesson is need for effective implementation of reform agenda, though there is a case for launching second generation reforms to strengthen the governance of country and institutions which matter in implementation, but cannot be achieved without further institutional reforms. Commitment in addressing the issues and focusing on reforms can go a long way in creating an environment that is conducive to productive economic activity, business friendly environment, and social cohesion. | state bank of pakistan | 2,008 | 3 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Expanding Access to Finance USAID and SHOREBANK INTERNATIONAL WHAM Project 2005-08, Islamabad, 28 March 2008. | Shamshad Akhtar: Financial inclusion Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Expanding Access to Finance USAID and SHOREBANK INTERNATIONAL WHAM Project 2005-08, Islamabad, 28 March 2008. * * * 1. Asia is home to nearly 650 million of poor (defined as 1 dollar a day 1 ) representing 65% world poor. Population growth and economic cyclical factors however add annually to the ranks of poor. Notwithstanding there has been a reduction in poverty incidence in Asia from 27% in 1990 to 20% by 2006, though East Asia managed to achieve steeper and swifter reduction in poverty relative to South Asia. 2 East Asia lifted around 630 million people from extreme poverty in under a quarter of a century and the region’s share in total poverty declined from 58% in 1981 to just 9% in 2004. In South Asia poverty fell from 52% in 1981 to 32% in 2004, but absolute number of poor has been high close to 470 million. Along with poverty reduction, there has been a gradual move to attainment of Millennium Development Goals (MDGs). 2. Several factors have contributed to improvements in these indicators ranging from higher economic growth and liberalization to concrete affirmative and targeted anti-poverty programs. Among these, Global microfinance campaign and domestic initiatives helped in changing lives of poor and extended them finance that contributed to their economic empowerment. In Asia, the number of microfinance beneficiaries has now reached 113 million: 74% of who were poor and 65% women. Including families of the beneficiary clients, microfinance services reached close to 465 million across the world – almost 85% of these are Asian clients. Dealing with “poverty” is complex given its dimensions and multiple causative factors. Global and regional challenges of reducing poverty and MDGs are daunting but attainable provided there is accelerated, aggressive, brutal and frontal attack through well coordinated and cohesive economic and social policies. 3. Recognizing this dilemma, the evolution of financial inclusion that aims to broaden and deepen access to development finance for all, of which microfinance is a subset, is timely. Ultimately it is a well functioning and efficient financial market which can deal holistically with provision of financial services to the economy and population. Building financial inclusive system is, however, an integral and core pillar of financial sector reforms. As growth and development of finance alone does not address question of “access.” Direct intervention to build financially inclusive system is critical as one recognizes fully (i) financial markets failures and imperfections such as information asymmetries, lack of sensitivity to gender and redistributive dimensions of resources and wealth and high transaction costs etc.; (ii) high price and non-price barriers such as lack of credit history and collateral and connection; and (iii) other constraints such as lack of literacy and entrepreneurial skills, etc. 4. Over the years, there has been substantive development in the architecture and thinking on financial inclusion. While there is no “one-size fits all” financial inclusion strategy or approach but it is important to recognize few core or necessary and sufficient conditions that are needed to maximize the benefits derived from such strategy. 5. At the outset, it is critical to understand the size and dimension of financial exclusion. Despite complexities of estimation, a recent study 3 concluded that average level of financial An alternative definition of poverty ($2 a day) gives an estimate of 2 billion poor in Asia. However, for monitoring progress of MDGs, World Bank uses the $1/day definition as it reflects extreme poverty. The World Bank, Global Monitoring Report, 2007. Beck, Thorsten, Asli Demirgç-Kunt, and Maria Soledad Martinez Peria (2007) "Reaching Out: Access to and Use of Banking Services across Countries." Journal of Financial Economics 85 (1). exclusion, as measured by the percentage of the adult population with access to an account with a financial intermediary, in poor developing countries is as high as the level of financial inclusion in advanced industrialized countries where it is rare not to have at least some access to basic financial services in remote parts. In developing countries, level of financial exclusion is steepest in Sub-Saharan Africa (a reflection of extreme poverty and difficult economic condition). Situation in Asia, present a mixed picture. South Asia (average access rate being 31 percent) lags behind in expanding financial access relative to South East Asia (average access rate being 47 percent). Advanced transition economies of Central Europe have progressed well in rebuilding access. There has been relatively little progress made in Central and South America despite a relatively robust economic base, particularly among larger countries. 6. To design strategy and policies, there is further need to understand what the reasons for exclusion are? Is it voluntary or pure denial of services and what the barriers of access to finance are? General evidence does suggest that in developing countries financial penetration is quite low because of (i) geographical exclusion since physically banks coverage of population is low (18,000 persons per bank branch in South Asia and 12,000 in South East Asia), the limited reach in rural areas where larger proportion of population resides, (ii) cash based economy given issues surrounding disclosure, identification, and taxation etc., (iii) low financial literacy, and (iv) lack of collateral and credit history of micro borrowers and micro-entrepreneurs. 7. Conceptually, financial inclusion should focus on • Provision of full range of financial services i.e. going beyond credit to deposit and payment services; • Meet requirements of individuals ranging from consumption to basic education, health and other services, • Cater to the requirements of small and new firms, and • Markets excluded by gender or remoteness 8. Evidence confirms that degree of financial inclusiveness is high where there is high degree of competition in the financial system that encourages financial institutions to go beyond the saturated and right in the corner markets to the excluded and far flung markets and offers appropriate products to clients with different requirements. 9. Commercialization of microfinance business has a massive impact on enhancing scale of outreach. For instance, in Latin America, the Non-Governmental Organizations (NGOs) opted to transform themselves into licensed financial institutions, together with specially licensed financial institutions that they were able to provide almost 45% of the microfinance services. 10. Donor support can be useful provided it paves the way for commercialization and private sector involvement in microfinance, either alone or as part of private-public sector consortiums, by brokering new banking relationships, by offering incentives for the entry of commercial institutions, by taking equity positions in MFIs, by providing credit enhancement on capital market transactions and by promoting international investment funds. 11. Financial inclusion based on private sector involvement and solutions for extending reach to poor yields better and sustainable results. In the UK, South Africa and other Commonwealth countries, private sector with supportive government environment, played an instrumental role in promoting financial inclusion. Government or donor sponsored subsidized or directed lending programs have now proven to limit growth and encourage dependency since they induce price distortions that deter effective competition. 12. Subsidies can work for microfinance borrowers and institutions in certain circumstances. For example, subsidies may be necessary during the start-up stage of an MFI, but they are best used to cover operating costs and to build MFI systems and staff capacity. It can take some years for an MFI to reach the scale and efficiency needed to cover its costs from interest income. During this period donors can support to build the capital base of efficient MFIs, enabling them to grow more quickly, increase their leverage, and serve larger numbers of clients on a sustainable basis. Subsidies may well be used to correct market failures; such as, to increase efficiency, transparency in financial reporting, and supporting industry infrastructure. 13. Within South Asia, Pakistan is actively pursuing a broad based financial inclusion strategy in conformity with the best practices through a public-private partnership model. In order to speed-up the process of financial inclusion, the State Bank of Pakistan has developed an ambitious plan to scale up outreach of microfinance services to 3.0 million users by the end of 2010, scale number of small agriculture borrowers to 2.0 million and SME borrowers 300,000 by 2010. The DFID, and other donors, will be providing substantial financial and technical support to Pakistan’s financial inclusion programs. 14. Based on experience and research, critical conditions for financial sustainability of financial inclusion programs are: (i) Economies of scale: Given direct relationship between profitability and scale of operations, larger banks/MFIs are able to evolve business models and growth strategies to reach out to poor clients on a sustainable basis. Such institutions have inherent ability to spread fixed cost over more transactions, promote multiple sales points, adopt innovation and technology which together offer ease and efficiency in service delivery. These factors enhance ability of firms to expand and compete to stay in power. (ii) Proper Funding Mechanism: Sustainability requires that MFIs largely rely on deposit mobilization to finance their businesses. In initial stages of development however MFIs end up developing alliances with the commercial financial institutions. These arrangements offer opportunities for foreign and/or local currency funds. Setting aside moral hazard of generating protracted dependency, foreign exchange risks in absence of the natural hedge raises the end pricing to clients that inadvertently results in dampening demand or magnifies probability of defaults. It is usually easier for MFIs to successfully borrow from a bank than to sell a bond which involves disclosure of information to produce adequate confidence in the borrower. However, profitable MFI have successfully issued bonds sparking interest in financial markets such as Compartamos bond issue in Mexico. Alternatively, a number of instruments and relationships can enhance the ability of MFIs to access financial markets. For example, use of guarantee funds and other guarantee mechanisms can correct “market failure,” such as inaccurate market evaluation of risk, as a means of bolstering access of MFIs to capital markets. Proper structuring of guarantee schemes, however, require minimizing misperceived risks in lending without undermining the risk management of the lending institutions. (iii) Transformation of NGOs into MFIs: NGOs need to be encouraged to restructure into themselves into legally established companies, licensed preferably by central bank, so that they can operate under effective and transparent ownership with adequate capital base. Backing such MFIs by supportive prudential regulatory framework helps in proper leveraging funding, while providing comfort to depositors and borrowers. To encourage transformation of NGOs into MFI, Pakistan in June 2007 allowed a five year income tax holiday to such institutions and now few large NGOs (such as Kashf Foundation and the National Rural Support Program) are in process of structuring their transformation. (iv) Strategic Alliances of MFIs with financial markets: Developing strategic alliances and other partnerships are increasingly becoming the ways in which MFIs can engage with a wide variety of financial market participants. As these arrangements capitalize on the comparative advantages of vastly different institutions, they can take many different forms. Where MFI cannot achieve organic growth they have two options: (i) these include “strategic alliances,” mergers and acquisitions, joint ventures and contractual arrangements, or (ii) alliance with commercial banks to set up and launch MF operations. (v) Developing supportive infrastructure for nurturing financially healthy MFIs/MFBs: It is critical that countries work towards developing proper rating agencies and credit information bureaus to assess risks associated with microfinance operations and their clients. (vi) Greater diversification and sales volume: The economics of retail financial services drives managers to evolve a set of standardized products and services to expand the volume of sales and lower average costs. (vii) Governance of financial institutions: Proper governance of banks/MFIs is essential to safeguard stakeholder interest in particular depositor funds. The functions of a board of directors and senior management with regard to setting policies, implementing policies and monitoring compliance are key elements in the control function of a financial institution. In addition, governing bodies play a critical role in establishing the values and “culture” of an institution, including its ability to make sound technical decisions on products and pricing, manage risk, innovate, adapt, change and grow. (viii) Role of small, locally-oriented financial service providers: The importance of small organizations should not be minimized; they are often the most significant, if not the only, financial service providers in many communities. Small financial service providers can be expected to penetrate their markets, seeking alliances with others and through networks to offer a greater range of products and services. 15. Though financial sustainability is essential for massive and swift expansion of services, to maximize client-level benefits it is essential to ensure social sustainability of financial inclusion programs. While intertwined with financial sustainability, social sustainability demands that: (i) Effective community and social mobilization is critical to success of financial inclusion strategy. It involves using participatory process to raise awareness, mobilize and involve local leadership, institutions and communities to organize for collective action for common goals and objectives to reach poor, women and the disadvantaged. Community Investment Fund (CIF) provides a useful tool to reach the poorest decile of population. The experience of successful CIFs demonstrate that savings-based and Self Help Groups (SHG) based CIFs are some of the most successful models for achieving better social outcomes on sustainable basis. Externally funded CIFs have lower odds of success as they have to swim against the stream of natural incentives of group members. It is prudent for external funders to provide support services to CIF instead of injecting loan capital. (ii) Targeted support programs. Most pertinent in this context would be the Community and Rural Support programs which catalyze employment opportunities. Whether they are by way of subsidized lending program MFIs (or those who support them) should be able to report on how (or whether) the stated goals they have promised (i.e., improved earnings, reduced vulnerability, increased empowerment, etc.) are being realized. (iii) Properly structured credit enhancements: Design credit enhancement in a way that MFIs use of the facility is subject to fulfilling social sustainability criteria to yield better social outcomes. (iv) Social performance demands keeping a close watch on the financial bottom line through better retention of clients and reduction of costs, quality of services, improvements in client lives through proper economic empowerment which could be through business opportunities, education, health, or agricultural extension, with additional appropriate funding. 16. In a nutshell, evidence suggests that poverty reduction strategies are successful if countries adopt inclusive policies. Building inclusive financial systems that are both financially and socially sustainable is a fundamental requirement of any poverty reduction strategy. | state bank of pakistan | 2,008 | 4 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Harvard Law School, Cambridge, 20 April 2008. | Shamshad Akhtar: Islamic finance: authenticity and innovation – a regulator’s perspective Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at Harvard Law School, Cambridge, 20 April 2008. * A. * * Introduction It’s a privilege to be addressing the floor of Harvard Law School that is now well recognized for its contribution to Islamic Law. Along with others, I have benefited from the rich debate among Shariah scholars, academics, researchers and industry specialists on the topic of “Islamic Finance: its authenticity and innovation.” I would like to offer a regulator’s perspective regarding debate on “authenticity and innovation” of Islamic Finance (IF). Impetus to Islamic Finance (IF) comes from not only its strong appeal and demand both from Muslims and now from Western world but from recognition and reality that IF is indeed an alternate and viable financing mechanism. If appropriately nurtured, it has potential to broaden and deepen financial markets. This is critical for financial markets that suffer from (a) low level of financial penetration – level of financial exclusion in developing markets is as high as level of financial inclusion in developed markets; (b) high dependence on bank and debt based systems; and (c) small and illiquid capital markets. IF’s authenticity lies in its inherent characteristics to enrich and supplement conventional finance by offering options and solutions to address these gaps in financial system, while effectively and efficiently allocating capital and allowing opportunities to optimize firm’s capital structure. Triggered by growing knowledge and research undertaken by Shariah scholars and academics, IF is now being nurtured more by the industry experts and the practitioners as they recognize the benefit of exploiting synergies between IF and conventional finance. While IF offers its own ideology, approaches and modalities, legal and contractual structures and risk management perspectives, conventional finance has steered the global financial markets for ages backed by the well tested policy, legal and regulatory prescriptions, tools and structures etc. It is inevitable that this has resulted in juxtaposition and transposition of the two disciplines to foster innovation and benefit the two fields of finance mutually, while prompting cross border flows and offering new perspectives on financial stability. Provided developing interface and synergies between IF and conventional finance is acceptable to scholars, the debate on authenticity is simplified. In carrying forward this strand of thought, I propose to: (i) Make the case that IF is by design authentic as it offers new ethical and equitable perspectives to world of finance, while allowing flexibility to nurture businesses based on partnership and profit and loss sharing (PLS) mechanism based on a fair and just contractual frameworks. Application of these IF-guidelines and principles to well tested tools of conventional finance itself ought to be treated as innovation. (ii) Highlight that IF engineering and re-engineering has facilitated proliferation of Islamic products which include a range of (a) standalone products that have been tweaked to ensure conformity and convergence of returns with conventional finance, (b) hybrid Islamic products structured by blending two to three Islamic products that suit the financing requirements of businesses, and (c) equity based funds, products and indices, and insurance. (iii) Finally, it has to be recognized that though pace of financial innovation is occurring in IF, there is scope for unleashing its potential further which in turn would also facilitate financial stability. In this context, I propose to offer few selective perspectives which underscore need for enhancing the legal, regulatory and supervisory frameworks for IF to allow for greater diversification both on asset and liabilities side supported by proper governance standards for PLS modalities including adequate safeguards for investment account holders. Greater appreciation and understanding of risk frameworks and development of capacities would facilitate adaption of complex Islamic products and would help in enhancing depth and breadth of IF. B. IF features and its interface with conventional finance Distinguishing features of IF. At one level it is now well established that IF is quite different from conventional finance simply because former is based on Quranic and Shariah injunctions and principles. Islam prohibits exploitative transactions such as (riba), or transactions involving uncertainty (gharar) or speculative behavior (maisir) or trading of debts. In conjunction, IF advocates “material finality” that underscores backing of financial transaction with real economic activity/transactions. The combination of these prohibitions and IF’s emphasis on backing transaction with real economic activity are the two key ideological differences IF has with the conventional finance. Also, IF encourages financial relationship between financiers and entrepreneurs (borrowers) where lender and borrowers share investment risks in businesses and assets. Under these arrangements, returns are not fixed but commensurate with the identifiable rights and obligations of stakeholders. These transactions are well anchored on an elaborate contractual framework which drives its application and content from IF. The ideological underpinnings of Islamic economics and its supportive contractual framework, along with wide range of financial and business transaction options permissible under IF, allows a rich array of approaches, options and modalities for IF. IF and conventional finance interface. At another level, to properly nurture IF it is inevitable that IF relies on conceptual framework of conventional finance and its tools. The interface and linkages between Islamic and conventional finance will help promote development of IF, though this process needs to be delicately managed. While IF converges and conforms to basic principles of finance, to ensure its acceptability and originality this should be achieved without compromising its ideological and spiritual distinction and uniqueness which is critical to public confidence in the system. Concurrently, there is need to recognize that the comparative advantage of IF is rooted in the risk sharing features of IF modalities. C. Financial re-engineering and innovation Generally, IF industry has witnessed explosion and proliferation of Islamic products offering close to full-menu of conventional finance industry options and instruments. Today, industry offers standalone or hybrid Islamic products, offers capital markets options for fund management, insurance products via takaful, and meets requirements for sovereign, corporate and retail sector. To ensure competitiveness and customer acceptability, replication and aligning of returns on Islamic products with conventional products has generated concerns regarding dilution and excessive concentration of banks on one or two products. Practically, the Islamic industry currently is bank-based. Product diversification, albeit slow, is emerging but returns are engineered to ensure conformity and convergence with conventional industry. Re-engineering and engineering in IF can be grouped as follows: (i) Islamic synthetic products. Adopting reverse engineering, a number of Islamic products have been designed as conventional product equivalents. 1 Three core Zamir Iqbal and Abbas Mirakhor: “An Introduction to Islamic Finance: Theory and Practice.” 2006. structures are most popular: (i) Murabahah synthetic (debt based) products that are backed by sale-repurchase agreements or back to back agreement of a borrower held asset or lender’s purchase, (ii) Al-ijarah leasing (asset backed) provide financing; and (iii) equity based profit sharing contracts Musharakah or Mudarabah or crop sharing (Muazarah). (ii) Re-engineering of Islamic synthetic products. Drawing from the core products identified above, re-engineering has been possible in some cases such as the reverse Murabahah, diminishing Musharakah to provide housing finance, Sukuk and its variants along with Musharakah Term Finance Certificates (MTFCs) which is a form of Sukuk. MTFCs have greater appeal since these are issued against the strength of issuer’s balance sheet rather than specific assets of the corporate and are close to PLS framework. (iii) Hybrid Islamic products. Supported by advancements in Islamic securitization, there has been acceptance of Islamic Investment Certificates, i.e. Sukuk bonds that are Shariah compliant and tradable asset backed securities. Industry has floated different types of Sukuk with AAOIFI recognizing about 14 different types of Sukuks. Most Sukuks are sponsored by sovereigns, both in domestic and international markets, backed by approved Government assets. Although Ijara (asset based) Sukuk 2 are the most popular, other hybrid-Sukuk’s backed by synthetic loans, salelease backs or head-lease/sublease ijarah and profit sharing structure are now emerging to be quite popular. Underlying pool of assets for some Sukuk comprise of Istisna’ and Murabahah receivables as well as Ijarah. 3 Another example is the convertible Sukuk – whether pure Ijara or hybrid it can have an embedded option allowing them to be converted into another asset form depending on specified conditions. (iv) Islamic mortgages. These are fast gaining ground and are being structured as: (a) the Ijarah (lease) contract along the lines of conventional mortgage; (ii) equity partnership (diminishing Musharakah), where the mortgagee (lender) and mortgagor (borrower) jointly share ownership, which over a period of time is transferred to the mortgagor, who buys shares in interest of ownership by contributing each month toward buying out the mortgagee’s share in the property and return to the lender is generated out of the fair rental value of the property; (iii) Murabahah (sales transaction), is practiced in the United Kingdom, where the property transfer tax (stamp duty) discriminates against the Ijarah – or Musharakahh-based mortgage; and (iv) cooperative societies, where members buy equity (Musharakahh) membership and help each other to purchase property from the pool of the society’s funds. In parallel to these developments, IF has progressed on capital market development. Few significant development on this front are: (i) Islamic benchmark has evolved to provide an alternate to LIBOR by introducing Islamic sovereign paper. Some initiatives include (a) Sudan Government Investment Certificates based on pool of Ijara, Salam, and Murabahah instruments to raise long term financing, one year maturity Government Musharakah Certificates based on equity partnerships; (b) Bay al-dayn (debt trading) Government Investment Issues (GII) by Malaysia; and (c) Baharian al-salam Sukuks whereby Government agrees to sell forward to Islamic banks a commodity (typically aluminium) against spot payment. Islamic banks in turn designate the Government their agent to sell the Ijara Sukuk are financial obligations, issued by lessor, and backed primarily by cash flows from lease receivables from a credit lessee. Arsalan Tariq: “Managing Financial Risks of Sukuk Structures.” commodity to a third party on delivery and the price of sale determines the price of the Sukuk. (ii) Islamic investment indices. Equity benchmark indices are designed to track the performance of leading publicly trading companies who are involved in activities consistent with Islamic Shariah law. Examples of this are Dow Jones and FTSE Islamic indices which focus on limited range of companies excluding companies which are involved in products/businesses not permissible under Islam. (iii) Islamic equity funds include Shariah-compliant equity and hedge funds, commodity, leasing and trade related funds. Barring equity funds, other funds are low risk. In the case of leasing, the fund is a securitized pool of lease contracts dealing with collateralized assets generating a steady stream of cash flow. Similarly, commodity funds have a short-term exposure in markets that are efficient and have developed forward markets, thus reducing the level of risk. In contrast, equity funds are similar to conventional mutual funds and are exposed to a higher degree of risks. Such funds are designed to ensure that equity stocks included in the fund are not only well diversified but also fully compliant with the Shariah’s guidelines. (iv) Development of derivatives and its equivalents. There is a debate on whether IF allows setting price at a future date with some scholars arguing it is not permissible and others with flexible interpretation that forward trades are permissible in Islam, if structured to provide specific quantity, time, weight and date. Devising solutions which are acceptable to all players are further complicated by difficulties in structuring contractual obligations, methods of eliminating risk inherent in the derivatives contract i.e. counterparty and operational risks, and lack of benchmark data. Despite these impediments, few Islamic OTC financial derivatives on the lines of the conventional ones have been structured. For example: Standard Chartered and Bank Muamalat Malaysia structured Islamic Cross Currency Swap (US$ 10 million) and Citigroup floated a 5-year US$ 230 million Currency Profit Rate Swap, while work is underway to float Forward Rate Agreement (equivalent of conventional FRA), Profit Rate Swap (equivalent of interest rate swap) etc. D. Way forward for Islamic financial innovation Industry’s effort to engineer and re-engineer financial innovation has been impressive, but authenticity demands that industry continues its efforts to innovate. To facilitate this, there is need for IF industry and regulators to now consider a change in mind set accompanied by enhancement of the legal, regulatory and supervisory infrastructure backed by proper governance framework to allow banks to transact in equity based transactions. Traditionally, banks main business has been debt financing and regulators have been conservative in allowing bank’s to indulge in equity products or nonbanking businesses. However, consolidation and conglomeration has pushed the financial industry to universal banking and other structures to retail better different products. Among others, this has resulted in scale and efficiency of financial institutions and required regulator’s to change their regulatory frameworks and supervisory approaches. Given this, in this section I offer some selective perspectives which should allow IF to move and compete in tandem with conventional finance. Consistent with IF provisions, one concrete way forward is to focus efforts to develop right framework and applications for PLS-Shariah compliance products. Currently, equity investment share in IF ranges from 0% to 24% of the Islamic bank’s books. PLS modalities, such as mudaraba and musharaka, being driven by equity partnership arrangements offer interesting options for innovation but weaknesses in policy, regulatory and legal have impeded growth of such options. Some of the constraints to its effective application 4 include (i) equity holders and entrepreneur’s aversion to risk given the uncertainties with return on businesses in PLS arrangements; (ii) absence in most countries of proper property rights which could protect PLS contracts in case of litigation; and (iii) PLS does not lend itself for short term financing and equity transactions underlying it are taxed more than interest income. Nevertheless, promoting PLS modality would help move financial system from being bank centric to market based and thereby facilitate system-wide financial and risk diversification. Workable solutions to reducing principal-agent problems and built in supportive screening and monitoring of projects upfront would go a long way to promote efficiency in capital allocation as it links returns with actual project. Promoting more equity based products would also tackle the mis-match of assets and liabilities which has aggravated since IF has relied excessively on short-term, low-profit and fixed-income assets. Moreover, risk-sharing edge of IF products can be neutralized when Islamic banks pay investment account holders benchmark return regardless of the performance and profitability of business venture. To fully comprehend complexities and dimensions of proper risk and reward sharing mechanism there is need to enhance understanding of management and mitigation of the specific and multiple risks associated with certain types of Islamic products. This requires a mindset change of both Islamic banking industry and regulators whose primary focus has been debt-based financial intermediation. At the same time, it requires development of financial legal and regulatory infrastructure which will help manage principal agententrepreneur relationships, while catering for investment account holders concerns. While augmenting regulatory framework to facilitate IF-innovation, there is need for development of the IF supervisory framework. Currently, the process of thinking of IF supervision varies. By and large, Islamic banks are supervised using the same methodology and approaches adopted for conventional bank. Suitable modifications are needed to delve into oversight of Shariah compliance, a task daunted by the lack of Shariah expertise in regulators and differences in fiqh. A review of Shariah compliance will help facilitate innovation and enhance transparency and disclosure in Islamic banks. Another important area where work is underway but needs to be accelerated is to develop proper understanding of prudential regulations and Shariah inspection and supervision of Islamic banks. Guidance on prudential regulatory framework should incorporate appropriate amendment and refinements to the Basle or other best practices with the objective of providing effective treatment of risks associated with the Islamic products and balance sheets. An important contribution is the introduction of profit equalization reserve fund which is created for the PLS modalities to provide a cushion for the associated risks of businesses, while safeguarding the investment account holders interests. Islamic banks have to incorporate interests of depositors who are considered creditors and first claimants on the banks’ assets and the interest of investment account holders has to be aligned with the Islamic banks’ owners. Accompanying this is the Shariah corporate governance framework which protects the interest of the investor and customer by underscoring need for compliance and ethics as well as maintaining high degree of transparency and disclosures. Before delving into the mechanics of Shariah supervisory framework, it is pertinent to highlight the key challenges faced by Islamic banks with respect to Shariah governance. These challenges are inter-linked and mutually reinforcing and range from: • Reputational risk arising from lack of or uncertainty on Shariah compliance; Humayon Dar and John R. Presley: Lack of Profit Loss Sharing in Islamic Banking: Management and Control Imbalances, 2001. • Demarcation and responsibility and accountability between Board, Management and Shariah Advisor; • Investment policies – compliance with Shariah prohibitions; • Investors’ protection; • Disclosure and transparency of Shariah rulings; • Harmonization of Shariah rulings and offerings; and • Vigilance and Oversight of the supervisor to cater for above factors. Currently, in absence of well conceptualized framework, Shariah compliance standards and their oversight varies across jurisdictions: • In Iran, Council of Ministers and Regulations under the Usury Free Banking Act, 1983 serve as the Shariah Board and set guidelines for the IF industry; • In Malaysia, under Central Bank Act, 1958, Shariah Advisory Council has sole responsibility for IF and court of arbitrator refers disputed cases to this council for their position/advice; • In Indonesia, the National Shariah Board is responsible for Shariah rulings on Islamic products, with IFIs required to establish a Shariah Division in the institutions and NSB approves the Shariah Supervisory Board to oversee the division; • In Pakistan, three tier model of Shariah framework is put in place. This includes Shariah Advisory Board that provides advise and guidance on prudential regulations, guidelines, modes of financing, and model agreements for Islamic industry, but the central bank issues instructions though in case of differences in perspectives on Shariah matters the advisory boards notified by central bank is final; Shariah Advisor, meeting central bank fit and proper criteria, approve products and give guidance on legal and tax matters etc.; and a mechanism for Shariah Audit System which inspects the Shariah compliance of all bank operations. Shariah Advisory Board has Shariah scholars but also industry representatives. • Bahrain, Sudan and Syria have adopted Shariah standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and some others use them as guidelines. Both the prudential regulation and Shariah inspection and supervision are integral elements of the check and balances to ensure products and transactions meet the test of authenticity and compliance with Shariah. While these systems may not be in place right away but development and implementation of this regulatory and supervisory infrastructure requires build up of capacities both at institution and regulators level and will pave way for building confidence in Islamic system. E. Conclusion In conclusion, from a regulator’s perspective development of IF in tandem with conventional finance will help broaden and deepen financial markets which will help not only meet diverse requirements but will also infuse financial stability. The evolution and path pursued by IF industry has triggered debates regarding the authenticity and innovation. What is critical to recognize is that IF by design has to be authentic and brings in additionality both in terms of superior corporate governance framework as good ethical practices are embedded in IF, and risk sharing structures which along with product diversity that the system offers lend itself to innovation. Product proliferation and approaches to security markets, development of Islamic exchange and fund management will help nurture financial diversification from bank based to market centric system. Proper application of PLS system will help provide greater opportunities for innovation provided it is backed by the right corporate governance architecture. On their part regulators have provided the industry free play. Cooperation among regulators has helped to develop core and supportive IF infrastructure which better weaves in the unique features and nuisance of the IF. Development of Islamic prudential regulatory and supervisory framework, which subscribes to Basel standards for conventional banking, will pave the way for development of IF, while tweaking the regulations to accommodate special risk characteristics of the IF. Institutional framework and evolving approaches for supervision systems will help build confidence among investor and customers. It is my belief that proper practical application of IF has the potential of taking global finance to new frontiers and heights. | state bank of pakistan | 2,008 | 4 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at a roundtable discussion at receiving the 'Best Central Bank Governor of the Year 2008 for Asia', arranged by The Banker, Karachi, 30 April 2008. | Shamshad Akhtar: Pakistan – selected perspective on economic challenges and outlook Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at a roundtable discussion at receiving the “Best Central Bank Governor of the Year 2008 for Asia”, arranged by The Banker, Karachi, 30 April 2008. * * * Irrespective of changes on political front, economic liberalization and reforms have helped Pakistan emerge as an open and liberal economy. Foreign investment enjoys equal treatment with domestic players and often assigned preferential treatment to ensure swift entry. As a result of these policies Pakistan has managed to attract a number of global players and significant investment offering a stable and fertile return environment. To quote few success stories, though not an exhaustive list by any means, today over half of the banking assets are with global banks but interestingly they operate as local subsidiaries. Telecom operators are now managing virtually bulk of the mobile businesses and growth of mobile subscribers has risen substantially. Pakistan has managed to unbundle its power sector, privatized its electric company operating in the port and industrial city of Karachi. Incentive regime has been made conducive for energy operators and both generation and distribution sectors have been offered to the private sector. Free entry in manufacturing sector now for quite some time has helped multinationals to operate freely. The process of economic liberalization has been facilitated by the smooth privatization of public enterprises that has been a key agenda of all the three to four successive governments. This will continue to unleash the potential of companies under good management with new investments to yield better results. Economic potential of the country can be judged based on fairly good trends observed in all critical economic variables ranging from real GDP growth that averaged above 7 percent over last few years to the narrowing of macroeconomic imbalances. Most of all given opportunities and high risk premium on all businesses, in recent years, Pakistan did attract substantial foreign inflows – foreign direct investment cumulatively was around $ 11.9 billion and portfolio flows averaged annually $ 1.04 billion. Today, Pakistan has to be judged in the context of the challenging political and international economic environment it operates in. Despite growing political challenges as the election drew closer, FY07 ended with realization of most critical economic targets. Real GDP growth turned out to be reasonable and slippages in fiscal and external current deficit were manageable. Outstanding was the flow of FDI which reached over $ 5.14 billion, portfolio flows were $ 2.3 and remittances which reached $5.5 billion. These flows combined with Pakistan’s decision to float sovereign bond issues and GDRs for some companies helped to build the reserves significantly that reached record highs of $16.4 billion. Building up of reserves was a decision taken in anticipation of the emerging difficult domestic and external environment. It turns out that this served well in preserving the exceptional shocks Pakistan faced in 2007. The severity of the shocks Pakistan has faced in recent months has been complicated by the multi-dimensional nature of these shocks. Economy has had to deal with series of adverse events on the domestic front for instance, episodes of terrorism, which hit political leaders and businesses, and protracted the political transition process. Consequently, this to some extent resulted in postponement of investment decisions (though these are expected to come on line with the new Government now in place). At the same time there has been pressure on spending, among others stemming from the need to build up security and conduct election. While grappling with domestic shocks, Pakistan, like other developing countries, is dealing with the impact of unprecedented hike in global commodity prices which have induced fresh vulnerabilities in the balance of payments and fiscal deficit segments of the economy. These complications could magnify vulnerabilities since the after affects of financial market turmoil is still unfolding even though the present slow down in advanced economies is already impacting demand for Asian exports including Pakistani exports. A few important development challenges Pakistan faces today are: (i) Restoring macroeconomic stability both by taking some short term measures and launching work to develop a coherent macroeconomic framework for the medium term. Immediately after coming into power, the Government has taken some concrete actions to reduce the bulge in fiscal deficit; admittedly more will have to follow. The actions range from pass through of the price increase of strategic products like wheat and oil products and Government’s belt tightening through reduction in recurrent expenditures and postponement of non-priority development expenditures. (ii) Reducing inflationary pressures, while a challenge, as Government allows more and more pass-through of the global commodity prices, is warranted given that it has been rising continuously and have crossed double digits. In this context, improving availability of products, using utility stores to provide goods at proper prices and ensuring proper availability through appropriate involvement of provincial and district administration are some of the measures being taken. Alongside, the Government has improved the pricing for procurement of wheat to incentivize farmers not to be distracted by other options. Similarly on rice, efforts are underway to ensure adequate availability of domestic supplies without disrupting the private sector initiatives to export. Proper availability of commercial financing for key products and curbs on hoarding through borrowings is being controlled through central bank measures. (iii) On its part the central bank has benefited from its continued pursuance of monetary tightening which had yielded visible results in May 2007 when core inflation fell much below the FY07 target of 6.5%. However this trend has been now disrupted by an unabated rise in Government borrowings from the central bank which has magnified risks for inflation. Some short term measures are being contemplated to lower these borrowings to ensure that the end year results show less SBP borrowings by Federal Government. The impact of the high borrowings has however permeated and penetrated in inflation and it will take stronger measures to unwind it and results will emerge with lag. (iv) On its part central bank has continued pursuance of a managed floating exchange rate regime. SBP has been quite transparent in its exchange rate management and has underscored the mechanics on how the exchange rate is determined. Since the central bank does not target a specific level, the exchange rate is market determined reflecting the demand and supply dynamics. To avoid spikes and excessive volatility on a day to day basis, central bank has been supporting upto 100% of oil payments between November 04 to the third quarter of 07 but has since only supported 80% of the oil payments with 20% being handled by private sector. Beyond this, the interventions are minimal. In recent days, the central bank has enhanced its vigilance in markets given the broadening of band between inter-bank and kerb rate and this has been narrowed with improved liquidity in kerb markets and other measures. All market participants have been advised that speculators and others who violate market ethics will be dealt with appropriate actions. Exchange rate of Pakistan has enjoyed a high degree of stability as evident from the foreign inflows and will continue to do so. SBP will take strict measures to combat any excessive build up of speculative tendencies among banks and exchange companies as warranted. (v) Reserve build up will be a continued priority of this new Government and central bank. The reserve build up achieved during FY07 was a conscious decision to ensure that Pakistan has adequate reserves to provide cushion for any eventuality as it entered into a political transition period. Reserves have served well the purpose of acting as a buffer and cushion when there was some slow down in FDI inflows which are now waiting to enter into the country. The stress on reserves however was more than expected because of two elements: • International oil prices have risen beyond expectations and are perhaps still volatile and the recent announcement of President of OECD that it may hit $ 200 per barrel is discomforting for oil importing countries. This is clearly a shock the world was not prepared to bear and/or address but international efforts and coordination are required to address this problem and on its part Pakistan will have to move to a new plateau of energy conservation and launch fast track efforts for substituting oil imports with domestic sources of energy – an option available to us with gas, coal and hydro resources available on the doorstep of Pakistan; and • Food imports which had to be lined up to build our strategic reserves and meet an unusual decrease in domestic supplies as Pakistan consumption levels have risen in the wake of higher incomes and remittances flow. Here again Pakistan is blessed with abundant agricultural potential and efforts to unleash this and raise yields are critical to bring the country back to self sufficiency given the population size. To wrap up my remarks let me state that in any political transition process one has to further recognize that there is need for the new Government to also comprehend the multiple dimensional challenges it faces. In this case the nature and type of political transition is different from normal election events. Coming in office the new Government has been fast to incrementally recognize issues at hand and now various agencies are gearing up to develop appropriate policy stance to tackle both short and medium term challenges. Central bank on its part continues to support the new Government and is working towards nurturing more effective demand management environment, while encouraging greater fiscal-monetary coordination. | state bank of pakistan | 2,008 | 5 |
Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Institute of Bankers Pakistan (IBP) Convocation, Karachi, 23 February 2008. | Shamshad Akhtar: Pakistan – financial stability Address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Institute of Bankers Pakistan (IBP) Convocation, Karachi, 23 February 2008. * * * 1. Recent and recurrent episodes of financial crisis have magnified the significance of financial stability and its dimensions. Every crisis – be it economic, currency, banking or, more recently, liquidity – has resulted in huge financial and banking losses and adverse economic consequences that transcend beyond national boundaries. Learning from the crisis, globally, there has been incremental understanding and build up of knowledge of what disrupts and promotes financial stability. New approaches and methodologies have evolved to assess different dimensions of the risks facing different segments of financial markets and their implications. I. Financial stability: approach and dimension 2. Mishkin in 1991 1 defined financial stability to ensure and promote, in a lasting way and without major disruptions, an efficient allocation of savings to investment opportunities. Generally, maintenance of financial stability depends on effective financial regulation, which aims to provide right incentives for prudential conduct and risk behavior by financial institutions. Primary objective of financial stability policies and assessment should be to provide early warning signals for crisis prevention as distinct from crisis mitigation. Stability of financial system benefits and promotes (i) smooth and efficient financial intermediation processes that allocate savings to profitable investment opportunities; (ii) balanced development of different segments of financial system; and (iii) proper transmission of monetary policy, whose effective conduct and implementation in turn facilitates price stability. 3. Price stability and financial stability tend to mutually reinforce each other in the long run. High inflation creates financial instability since it generates misperceptions and creates problems in predicting real returns. It can also worsen the asymmetry of information available to lenders and borrowers. A business cycle boom accompanied with high inflation is traditionally considered as the typical environment in which real over-investment and asset price bubbles blossom. Excess liquidity provided by the central bank is one of the main factors responsible for the development of inappropriately lax lending standards. Credit growth, which is excessive in view of realistic return expectations, is often the foundation for financial instability. Hence, monetary policy focused on price stability plays an important role in ensuring stable financial markets. 4. Keeping in view these considerations, most countries have developed elaborate frameworks designed to measure, monitor and safeguard financial stability. It is prudent to assess macroeconomic and financial sector vulnerabilities and to judge the implications of these two so that appropriate corrective actions and policies may be put into place to prevent a crisis. A number of advanced countries have adopted sophisticated models to conduct macroeconomic and financial sector surveillance. However, other developing countries, given the data limitations and size of financial sector, have adopted simpler frameworks for assessment of financial stability. 5. In assessing macroeconomic vulnerabilities it is standard to examine the sustainability of the fiscal and external accounts – any drift in these two principal modules of the economy creates monetary complications and can generate instability in both domestic and foreign Mishkin, F. (1991): “Anatomy of financial crisis,” NBER Working Paper, No. 3934. exchange markets. Depending on the intensity of disruptions, there may be implications for the financial sector, often resulting in repricing of assets and affecting the growth of private sector including banking business. 6. To comprehensively assess the financial sector vulnerabilities, there is a need to assess the risks associated with (a) financial institutions relying on a range of financial soundness indicators that help assess credit, liquidity, market, exchange rate, operational and reputational risks etc.; (b) financial markets that may face counterparty risks, contagion or asset price misalignments; and (c) financial infrastructure risks ranging from legal and regulatory risks to the clearance, payments and settlement system. 7. While assessing the key risks and vulnerabilities in the economic and financial system, it is critical to adopt analytical approaches to: (i) identify, assess and measure the source of risks and track the channels through which they may propagate and ultimately affect the financial system; (ii) developing an understanding of financial stability transmission mechanism; and (iii) aggregate the risks and properly stress test the impact of potential shocks on different institutions and markets. II. Pakistan Financial Stability Review 8. State Bank of Pakistan (SBP), the central bank and primary regulator of financial sector, is responsible for conducting financial stability review given its dual mandate of monetary policy and financial regulation and supervision. SBP has a hand on the pulse of economy and as such is able to decipher monetary transmission mechanism and its impact on the economy and the financial sector. At the same time, vigilance on banking sector helps SBP to understand the financial transmission mechanism which assists in the formulation of overall policy stance for both monetary and banking sector. 9. SBP has been conducting financial stability analysis for the last 5 years or so. However, the framework for financial stability is still evolving. Starting in 2004, SBP conducted an annual Financial Sector Assessment Program dovetailed with quarterly and annual Banking Surveillance Reports. Integrating these reports, in 2007, SBP launched its first comprehensive Financial Stability Review (FSR) that offers a rich assessment of risks and vulnerabilities of financial sector and macroeconomic challenges. 10. Among other components, the main component of FSR is the assessment of banking sector as it constitutes the largest segment of financial system. Banking sector has managed to grow substantially and its stability can be assessed in a number of ways: (i) Solvency of banking system is safeguarded if the banks’ capital offers necessary cushion to absorb unexpected losses. Rising profitability coupled with SBP’s policy to strengthen the capital of banks has contributed to rise in the risk based capital adequacy of banking system to 13.6% by September 2007 (relative to 8.8% in 2001). Quality of capital has also improved (with the rise in risk weighted assets to Tier 1 capital) and the share of risk based capital now constitutes close to 80% of core capital. (ii) Profitability: Performance of banks has been good converting the commercial banks’ losses, registered until early 2000, to positive: return on assets is now 2% and return on equity 20%. Although, net interest margins have increased from 59% in CY03 to 70.5% in September 2007 and cost to income ratio, an important ratio to measure operating efficiency, has improved from 62.4% to 42.3% from CY01 to September 2007, there is substantial scope to enhance efficiency in financial intermediation process. Structural change in ownership structure, with private sector now holding almost 79% of total banking assets, has augured well to enhance profitability of banking sector while ensuring professionalism in the management of banks. Growing foreign ownership and acquisitions have paved way for strengthening the capital base of banks and is helping to enhance competition. In addition, in line with the empirical evidence in other countries, it is expected that entry and growth of foreign banks will contribute to higher average loan growth, better risk management practices, greater provisioning and loan loss absorption capacity. (iii) Asset quality has benefited from loan restructuring and write offs, stronger regulations, prudent lending and growth in advances. Non-performing loans (NPLs) to gross loans fell from 17% in CY03 to 7.7% by September 2007 and net NPLs from 7% to 2.3% over this period. Concurrently, provisions to NPLs ratio improved from 64% to 72%. Bank’s capacity to absorb losses has grown as net NPLs to capital ratio declined from over 150.5% in CY01 to merely 11.4% in September 2007. Furthermore growth and sector diversification of loan portfolio has helped to reduce the risk of overexposure. (iv) Market risk has different dimensions as banks are engaged in a variety of businesses that expose them to interest rate, foreign exchange and equity market risks etc. The principal market risk facing banks is interest rate risk. The duration of assets and liabilities offers an accurate indicator of interest rate risk. With banks primarily raising short term deposits and lending for longer maturity the asset-liability mismatches are significant, though banks are being encouraged to raise long tenor deposits through exemption of cash reserve requirements. (v) Liquidity risk: Liquidity management is a key banking function and it helps banks withstand shocks and losses. Liquidity risk, as measured by liquid assets to total assets and other indicators, has remained stable over the last 5 years albeit a modest decline recently along with decline in liquid asset to deposit ratio while advance to deposit ratio rose modestly. 11. While these indicators allow us to gauge the soundness on selective basis, the Financial Soundness Index (FSI) indicator offers a more holistic measure. FSI is calculated as an aggregate index assigning 0.25 weights to four key financial soundness indicators including capital adequacy, asset quality, profitability and liquidity. This index was negative for a number of years but since CY02 it has been positive and has consistently improved. 12. Another major aspect of effective surveillance is checking the resilience of the banking system to various shocks through stress testing exercise. SBP performs stress testing through a set of exceptional, but plausible, assumptions using simple sensitivity analysis. The shocks cover different risk factors namely interest rate, forced sale value of collateral, NPLs, stock prices and foreign exchange rate in addition to liquidity, credit and market shocks. The stress testing exercise allows SBP to gauge the possible adverse impact on the banking system and provides basis for taking future regulatory measures. In principle, fortifying capital base has lent greater resilience to the banking system against the adverse shocks. As of September 2007, capital of all banks can fairly absorb the impact of a shock of 10% in increase in total NPLs. None of the groups would experience a fall in its CAR to below 8%. In consumer finance category, however, a rise in NPL-to-loan ratio to 10% (which is at 4.4% as of 30 Sep 2007) of total consumer loans can have adverse impact on some banks. Individually, four banks holding a share of 11% in the assets of the banking system would experience a decline in their CAR to below 8% under this sensitivity test. The impact of interest rate, exchange rate and equity price shocks can also be well absorbed by the healthy capital base of banks. III. Key policy drivers of financial stability 13. Financial stability in Pakistan has benefited from structural transformation of banking sector and wide ranging policy initiatives of the central bank. In particular, Pakistan’s prudential regulatory regime has been crafted to promote and preserve financial sector stability. Regulatory framework encourages (i) financial sector growth, diversification, and innovation; (ii) healthy competition and risk taking to ensure a sustainable and aggressive income stream; (iii) opportunities for enhancing the franchise value of banks; (iv) prudent behavior and effective risk management to discourage infection of loan portfolio; and (v) safeguarding social obligations and consumer interests. 14. Promoting sound banking practices, SBP has implemented exhaustive guidelines for corporate governance and on risk management, business continuity plan, internal controls and stress testing. In 2007, SBP has been stringent in overseeing the Management and Board conduct and their conformity to fit and proper criterion. Furthermore, two major sets of new regulations were introduced under which banks were required to induct independent Board members and adopt umbrella risk management guidelines. A survey is currently underway to assess corporate governance practices of banks. 15. Financial stability has been further fostered by the strengthening of banks’ system-wide capital base to Rs 372 billion. Process of consolidation has been catalyzed by 30 odd mergers and acquisition (both domestic and foreign-led), moratorium on licensing of conventional banks and rise in minimum capital requirements for banks and DFIs. To streamline capital with risks, banks have initiated implementation of the standardized approach, as prescribed under Basel II regulations. Over the period, this is expected to augment the economies of scale and improve efficiency as competition and innovation grows. 16. Enhanced push from SBP for delivery of development finance will help diversify the credit portfolio and will alter risk profile as there is relatively low correlation of the inherent risk factors among different sectors. 17. Financial stability will further benefit from SBP’s operationalization of the Real-Time Gross Settlement System (RTGS) named PRISM (Pakistan Real Time Inter-bank Settlement Mechanism) in June 2008 which will allow shift from traditional paper-based, end-of-the-day settlement system to electronic payment system for large value, low volume inter-bank fund transfers and settlements. 18. Money market stability has improved with SBP’s efforts to develop an effective market determined yield curve for government securities which sets the stage for development of the corporate debt market. Moreover, derivatives market, which is an important pillar for effective risk management, though still in its infancy, has taken off. Presently there are five banks which have been given the status of Authorized Derivative Dealers by SBP. The derivatives market is being regulated under SBP’s Financial Derivatives Business Regulation and covers interest rate swaps and forward rate agreements, in Pak Rupee and other currencies (after SBP approval). IV. Risks to financial stability 19. The financial sector of Pakistan has experienced an extraordinary growth in recent years. Financial assets have grown to $180 billion and are now equivalent to 125% of GDP (compared to 95% of GDP at end-1997) reflecting strong growth in banking sector assets and stock market capitalization. The substantial growth in financial sector brings with it associated risks. Results for banking sector surveillance, as highlighted above, give comfort that financial risks are well contained though growing macroeconomic imbalances, unless addressed urgently, could threaten the financial stability. 20. A principal risk to financial stability is often country’s economic structure and the macroeconomic framework. Country’s with high concentration in one or two sectors often face risks to financial sector, if there is an over-exposure of the system to these sectors. Similarly, macroeconomic imbalances introduce economic vulnerabilities which in turn induce inflationary pressures and/or exchange rate volatility. These factors do pose system wide challenge to financial stability. 21. Another risk to Pakistan’s financial stability is its overall lack of financial sector diversification. Of particular concern is the size and issues surrounding the nonbank sector. Of the total financial sector assets, insurance companies account for barely 3%, mutual funds 3% (and are largely sponsored by banks) while other non-bank finance companies (NBFCs) are 2% of the system and holders of listed private bonds are less than 1%. Furthermore, NBFCs are fragmented and weakly capitalized. For financial sector stability, it is critical that such institutions be better capitalized and a conducive environment is created for the growth of promising segments (collective investment schemes, including mutual funds), niche markets and products are introduced for leasing companies, modarabas, housing finance and venture capital, and penetration is enhanced in the insurance industry. It is also important to consider that while market capitalization has grown impressively, its role in raising long term risk capital or debt for new industry over the last several years has been limited. 22. There is further scope for enhancing banking sector stability too. Although competition is emerging with the growth of mid-sized banks and foreign acquisitions, five largest banks hold 50.6% of total banking sector assets; though there has been a clear reduction in the level of concentration which was at 63.2% in 2000. While this is a concern, the presence of undercapitalized small banks is likely to pose risks particularly during periods of adverse economic cycles. 23. Another area where there is scope for strengthening financial sector stability is greater credit diversification. Over 50% of the bank credit portfolio is concentrated in corporate sector serving fewer industries. Diversification of bank’s loan portfolio to support more retail and infrastructure financing will be critical for the growth of banking sector. SBP needs to develop its capacities to monitor financial position and probability of default of the corporate and household sectors within the stability framework. 24. Cognizant of maturity mismatches, SBP has introduced different cash reserve requirements (CRR) for demand and time liabilities to encourage banks to mobilize long term deposits. Specifically, while the demand liabilities (including time liabilities of less than one year maturity) attract CRR of 8%, time liabilities of more than one year maturity are exempted from CRR. 25. Finally, now predominantly private sector-owned financial sector presents its own challenges. SBP is working towards developing adequate policy framework for consumer protection, development of Financial Safety Nets such as Deposit Insurance and a well-laid out “Lender of Last Resort” procedure to strike a balance between enhancing consumer protection and minimizing moral hazard. At the same time, there is need to encourage efficiency of financial intermediation by reducing banking spreads. SBP is further developing capacities to monitor operational risks associated with weak internal control systems, delays in adoption of information technology solutions and outsourcing of processes by banks. | state bank of pakistan | 2,008 | 5 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Asia Lecture, Emerging Markets, Madrid, 4 May 2008. | Shamshad Akhtar: Asia – impact of recent global developments and central bankers’ response Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Asia Lecture, Emerging Markets, Madrid, 4 May 2008. * A. * * Introduction 1. Deepening financial globalization, driven mainly by far-reaching financial market liberalization and openness and benign global economic environment, has helped nations accumulate capital surpluses and augment cross border flows. Exploiting excess liquidity, financial institutions over-leveraged themselves through esoteric and innovative structured products and loan markets (both on- and off-balance sheets). In an environment of enhanced risk appetite and high returns, households, corporates and other industry participants invested in these products. Growing defaults and lack of liquidity to back these securities, however, generated an unprecedented credit crunch. In the process of unwinding and settling their obligations, several global banks, investment houses and other entities faced substantial financial losses. Resultant loss of confidence of investors created additional risks to financial stability. 2. The risk appetite for these products consequently turned into risk aversion. Facing losses in asset backed securities and persistent dollar depreciation, investors opted to hedge themselves by investing in global commodities. While advanced countries were dealing with the losses emanating from securitized products, growing investor demand for global commodities resulted in an exceptional hike in international prices of strategic food, oil, metals and other products. 3. The world is not unaccustomed to episodes of crisis and has developed experience and expertise to deal with these events. What is unusual in this round is that the global economy is faced with multidimensional crises: (i) liquidity crunch in interbank and money markets, of an unprecedented nature, in the otherwise most lubricated and well nurtured markets; (ii) downturn and distress in housing markets; and (iii) bizarre trends in global commodities’ markets. Added to this is the unfolding food crisis. The vibrations and gyrations of a crisis that emerged in one small segment of the financial sector in the US were deeply felt across other segments around the globe. These events are a fresh reminder of the costs associated with financial globalization, particularly when there are gaps in the oversight of markets and risk management guidelines are compromised and violated. 4. Given that the epicenter of this wave of global financial crisis are the developed financial markets, the firefighting by the US and European central bankers is helping contain the contagion. Fed and ECB’s vigilance on markets, reliance on conventional tools, such as lowering of policy rates, and use of unconventional tools – ranging from special liquidity facilities offered on the basis of low grade assets as collateral – to rescue operations for housing and investment banks (traditionally not in the purview of central banks) are some examples of how these institutions dealt with the crisis. These central bankers are striking a balance between monetary stability and financial stability, while walking a tight rope of weighing the tradeoffs between economic growth and inflation risks. Steepest reduction in the Fed funds rate reflects that the US weighs economic growth risks more serious to its fundamentals and to the global economy while ECB and BOE weigh inflation risks more seriously. Irrespective of this positioning, all three have acted forcefully to stabilize financial markets by easing liquidity in the interbank and money markets. If the global economy accelerates by early 2009 as anticipated, all monetary authorities will generally shift their focus back to containing inflation. 5. In my remarks, I will confine myself to the impact of the recent global developments on Asia and the implications for central banks and their policy responses. In offering these perspectives, few qualifiers are in order: • The spillover impact of disruptions in developed markets historically has had a limited impact on Asia. As the region grew faster than the rest of the world, the economies expanded and inter-linkages deepened, with the channels of transmission maturing rapidly. • Asia’s resilience was proven after the 1997 Asian financial crisis as the region was quick to rebound and regain macroeconomic stability. Despite its growing exposures and linkages with world economy, Asia’s strong export base and oil revenues have helped the region to build external current account surpluses; consequently Asia’s foreign exchange reserves, which rose to $3.9 trillion (and constitute 62% of the world reserves) now act as a strong buffer. Smaller economies of Asia, however, have limited ability to withstand shocks and their macroeconomic stability has been disrupted and their reserves’ level has declined in the face of exogenous shocks. • Unlike past episodes of crisis, the global economy today faces multidimensional challenges. Interdependence among economies introduces its own complications. • Finally, what is worrisome is that neither the financial markets’ turmoil is over nor the US economic slowdown has bottomed out. Equally uncertain is the outlook for the oil and food prices. Unfolding events in these areas could deepen the impact of developments on Asia. 6. Economic growth outlook. In the wake of growing economic diversity and divergence of Asia, it is no surprise that the impact of global developments varies considerably across the region. Interestingly, Asia performed fairly well in the last two quarters of 2007 when, in the first round, the US slowdown was confined primarily to the housing sector. As the liquidity crunch deepened, defaults grew and financial losses magnified, resulting in a fall in US consumer spending and confidence. These and associated developments started to filter down across Asia and are now visibly impacting key economic indicators of the region. While the growth outlook for Asia has softened, the growth prospects remain sound and the overall base line of Asia is strong. 7. Despite multiple forecasts, there is a broad consensus that Asia’s economic growth is likely to slow down: • IMF – Regional Economic Outlook (REO) forecasts that Asia’s growth in 2008 will be 6.2% – or about 1¼ percentage points lower than 2007. Growth of China, with its growing global linkages, is anticipated to be 2.2% lower than the 2007 outcome, India about 1% and the rest of Asia 0.5%. • World Bank – East Asia Pacific Updates, 2008 forecasts that developing East Asia growth will falter by 1.5% to 8.5% relative to 2007 but that expected growth is in line with the trends prevailing in the past. Large deceleration in the growth of China in 2008 impacts the average for East Asia. • Asian Development Bank – Asian Development Outlook, 2008 forecasts that its member developing countries will grow by 7.6% or almost one percentage point lower than last year. • Fund managers and other private entities revised their forecast for different countries by 0.5% to 1.5%. 8. The 2008 outlook for Asia would depend on how uncertainty regarding the US and European economic scenarios resolves itself. While growth outlook has already been moderated, economic activity in Asia will be strong as domestic demand remains robust and is being backed by investment growth particularly in China, India, and ASEAN 5. 9. Trade prospects. After faltering somewhat, Asia’s exports have regained momentum; in the recent quarter they grew by double digits. Decline in the US and European markets’ demand hit Asia hardest in few sectors including IT, electronic, electrical and office machinery industry. Asia’s exports performance was nonetheless better than the experience of the 2001 recession, as commodity and non-traditional exports, and exports to newer markets continued to grow. 10. Growing trade integration within the region has also served Asia well. While Asia’s exports to countries outside the region have swelled to $1.7 trillion by 2006, (relative to $0.4 billion in the 1990s) intra regional trade grew faster from under $0.2 billion to $1.6 trillion. Consequently, intra regional trade constitutes almost half of the total trade in Asia, and is set to grow further as Asia is gearing itself for greater market diversification. Impetus to this will come as Japan continues to recover, China deepens its trade with Latin America and other regions, and India opens up further on the back of growing middle class incomes and demand. The regional integration is also evident from the growing momentum and scale of regional free trade agreements. 11. Larger economies of Asia and the ASEAN 5 have a dual cushion of continued large, if not growing, external current account surpluses and exceptionally high foreign exchange reserves. However, few economies face growing macroeconomic vulnerabilities. Largely reliant on import of oil and, now, food, external current account deficits in these countries have reached unsustainable levels. Macroeconomic instability and developments in the international environment have also impacted foreign inflows to these countries. In this scenario financing external current account deficits is a challenge complicated further by the exceptional rise in sovereign spreads in international markets as the liquidity constraints deepened. 12. Implications for financial markets. Benefiting from the recapitalization, restructuring and stronger regulatory and supervisory systems in the post financial-crisis period, Asian financial markets have been performing well. Emerging Asia’s financial assets, as percent of their GDP, rose to 306.3, higher than the ratios for Latin American, African or European countries (155.1, 168.7 and 139.0, respectively), but lower than the world ratio of 401.5. 13. Relative to trade, Asia’s financial markets are less integrated particularly within the region. Emerging Asia (excluding Japan) holds only 10 percent of the world’s total value of bonds, equities and bank assets. Growth and diversification of capital flows to Asia is impressive. Foreign direct and portfolio flows to Asia have reached almost $989 billion or 2% of the world flows and 9.3% of Asian GDP. Three-fourths of the portfolio flows to Asia were directed to equity markets. 14. In contrast, Asian investors have less than 20% of their equity portfolios (in most cases less than 10%) in markets outside the region and are less dependent on overseas bank lending. Notwithstanding, stock market correlations, co-movements of interest rates and bond yields, and foreign participation in selected markets, do reflect that Asia’s financial markets are gradually, but not completely, undergoing global integration. 15. In general, Asia’s (excluding Japan’s) exposure to the sub-prime mortgage market was limited and confined to few banks in relatively more developed financial markets. The related losses were estimated to be in the range of $20-30 billion and in most cases these losses have been accounted for. Asian central banks’ exposure to US mortgage-based securities was also limited, except for China, where these holdings were backed by Government mortgage entities. 16. Financial stress resulted in delays in certain financial deals with Asia but had otherwise little impact on the region’s banks and financial institutions. Steeper impact has been observed on securities markets, and to a lesser extent on bond markets, driven by revaluation of risks in financial markets and worries about the global economic outlook. In some cases this resulted mainly in correction of valuation/returns on securities. While the equity markets recovered towards the end of 2007 – with several indices hitting new highs in October – they came under pressure in the beginning of 2008 as myths regarding Asia’s decoupling from the US and Europe faded. By mid-March 2008, most Asian equity indices were down 15-25 percent for the year. Despite the dampening effects on the Asian equity markets, they largely outperformed the mature markets and the world average indices. 17. International debt markets did not go unscathed. Reflecting the liquidity constraints and higher risk premiums, spreads for offshore borrowing widened significantly for both sovereign and other borrowers. Spreads rose for Asia in line with the trends in emerging markets and virtually doubled and tripled (but were below US high yield debt markets). Risk premiums magnified further for countries facing complex economic and political environments. The iTraxx Asia ex‐Japan Credit Default Swap (CDS) Index (including sovereign, corporate and financial issuers) surged by almost 300 bps over the last nine months. 18. Inflationary pressures. Most worrisome have been the inflationary pressures facing Asia. Rise in oil prices towards the end of 2007 and its subsequent surge in 2008 reaching $120 per barrel, and the food supply shortages in economies that had approached self sufficiency, are two major problems. Oil importing economies are now facing high external current accounts deficits whose stress has resulted in currency depreciation. In other economies, rise in US dollar price of oil has been offset by an appreciation of exchange rates. 19. Inflationary pressures and expectation are on the rise as: (i) Governments allow full or partial pass-through to food and oil prices, (ii) core inflation rises due to fiscal pressures magnified by subsidies on food, agriculture inputs and oil products, and budgetary recourse to central bank borrowings, and (iii) investors seek safe havens in the commodities exchange markets. The depreciating dollar can also be given its share of blame for the record high price of oil, almost double its price just one year ago (from $63/barrel to $119/barrel). Given the fast pace of economic activity, it has not taken long for price changes in metals, commodities, and oil to manifest themselves in higher labor costs and increased prices of many finished goods and services. 20. Financial turmoil, its fallout and contagion, is by no means the only reason for the global commodity price pressures. It has to be recognized that the current trend in global commodity prices is not a one-off distortion or a cyclical spike. The global commodity prices uptrend reflects growing population stress and is likely to now stabilize at a new and higher level. Food prices hike is driven by multiple factors, key among which are: (i) rising population and consumption demand including the China and India factor, (ii) low and stagnating yields, and (iii) farmers switching to crop production for bio-fuels. Larger debate and financing support to resolve the food crisis is likely to rejuvenate food production, albeit with a lag. 21. Policy responses of central banks. As highlighted above, the first round effects of the financial market turmoil were largely contained in Asia, given their limited direct exposure to the sub-prime mortgage and other asset based securities. With grimmer economic outlook and concerns regarding financial stability, both at the home front and globally, Fed, BoE and ECB are taking steps to ease monetary policy through liquidity support and lowering interest rates to avert recessionary tendencies from permeating deeper. Asian countries face a different set of challenges, though, like developed countries, they have the difficult task of striking an adequate balance between growth and inflation risks. 22. Since economic growth was steadier in 2007, more immediate preoccupation of Asia’s central bankers since July 2007 has been to deal with growing inflationary pressures. Inflation rates in Asia rose beyond projections and in case of inflation targeting regimes resulted in clear breaches. China and India, the two large economies, have resorted to monetary tightening, but primarily through raising cash reserve requirements by 700 bps and 350 bps since July 2007, respectively. These attempts to curb liquidity in the system and excessive demand pressures have not arrested the structural rise in prices. Pakistan has been in a monetary tightening mode since April 2005 and has cumulatively raised the policy rate by 350 bps with the last two rounds of increase of 100 bps taking place after July 2007. Meanwhile, other countries have held the policy rates steady. In only few cases, such as Thailand and the Philippines, growth risks outweighed inflation risk. Consequently, policy rates were moderately lowered to ease monetary policy but with inflation creeping high, scope for loose monetary policy may no longer exist. 23. The complexity for central bankers in Asia is that food inflation, with 40-50% weightage in price indices, is a major driver of inflationary pressures. An excessive monetary tightening in this situation would end up creating complications for the economy without the desired impact on food inflation that is principally propelled by supply side constraints. At the same time, if monetary policy ignores stubbornly high food inflation, second round impacts would eventually strengthen the inflationary expectations. To resolve this dilemma, governments are resorting to fiscal subsidies to avoid full pass-through. High fiscal deficit countries cannot afford these subsidies and as such have resorted to a gradual and phased pass-through of rise in prices to consumers. 24. Exchange rate appreciation emerging in a number of Asian economies may offset some of the inflationary pressures. However this option is not available to some countries either because currencies are pegged or external current account deficits are high. Given these limitations, it is best for countries to focus on fiscal consolidation to allow fiscal space for subsidies. However, this should be perceived as a short term policy response, while encouraging appropriate investments in the agriculture sector to raise productivity and improve functioning of the wholesale and retail markets under vigilance of local authorities, being more non-inflationary ways of dealing with the current chaos in commodity markets. 25. The financial market turmoil and its consequences offer Asian central bankers a number of lessons. Financial globalization with all its benefits does carry significant risks which hit the weak and under-regulated financial systems more adversely than others. Liquidity crunch and an economic downturn may lead to losses on a wider range of securities, including some of the more highly-rated securities that Asian financial institutions hold in much larger amounts. Moreover, global banks might withdraw financing to Asian economies because of liquidity problems faced in their home markets, which might adversely affect credit conditions. 26. The present events are a reminder that the effects of contagion from small segments of financial markets (i.e. the sub-prime paper and its structured products which are a small proportion of financial assets) or small financial institutions cannot be underestimated as they can threaten and destabilize financial systems and – given the cross border exposures – can create unexpected turbulence for global financial markets and economy. 27. This dispels any notions of a decoupling from the US economy. The size and scale of interaction between Asia and the US brings immeasurable benefits when the going is good, but it will also bring a measure of misery when the economy is in trouble. Asian central banks and governments need to better integrate with each other to mitigate and hedge such risks in future, take advantage of higher returns, and participate in developments in their own region. 28. Increased appetite for, and under-pricing of risk, needs to be checked so that Asia does not repeat the US mistakes. Asian financial markets and regulators have to be wary of speculators and traders that will invariably be promoting a range of high risk financial products. Supervisory bodies must fully understand and meticulously examine the extremely technical financial products that they regulate. 29. Liquidity operations and excessive lowering of policy rates, while easing short term constraints, inducing financial stability, and reviving US and other economies, do however pose the attendant risk of inducing global inflationary pressures. The associated bail out of investors presents a “moral hazard”. Besides promoting once again the issuance of alternative investment vehicles without proper due diligence, floatation of these products and injection of liquidity carries the potential risk of recreating economic bubbles in stock and real estate markets. 30. Asian central banks must realign the institutional framework to face these repercussions while addressing the challenges of the highly intertwined, multidimensional crisis on economic growth. 31. In conclusion, let me reiterate that there is now a broad consensus that slowdown of the US and Europe is likely to have a more distinct impact on Asia. Impact has been slow to filter down to Asia in 2007, but is predicted to impact economic growth in 2008. The initial setback to exports in the categories of IT, electrical and electronic products has been offset by growth in nontraditional exports and diversification of trade to newer markets, so much so that Asian exports grew by double digits in a number of countries. 32. Losses on account of sub-prime mortgage markets were limited on the balance sheets of banks and financial institutions and have been written off. In the financial sector, the steepest decline was registered in the securities markets that were fast to recover with the Fed and ECB policy stance, however, the markets remained volatile with corrections in valuations already factored in. 33. Intertwined with financial market turmoil is risk aversion to financially innovative products, and investors’ move to global commodities whose demand pressures broke all historical price behavior patterns and reached new levels. This price spiral of strategic commodities such as oil, wheat and other products has created dilemmas as pass-through mechanisms are augmenting inflationary pressures, while not passing through this is complicating macroeconomic management. 34. Asia’s inherent strength and resilience remains intact, supported by all time high reserves being fed by surpluses in external current account and boosted regularly by robust export growth, which in the case of net oil exporting countries has received additional impetus from oil export revenues. This has allowed the region to withstand economic shocks but appropriate policy responses are critical to contain the impact of these shocks. 35. Asia’s central banks faced additional but different challenges than their counterparts in the West: headline inflation in China has increased to over 8% and in few other countries it has hit double digits. To the extent this is driven by uptrend in international oil and food prices with the latter being more a supply side phenomena, central banks in Asia have held on to their monetary policy stance. Asia in any case has been undergoing monetary tightening since 2007 (or a little earlier) and in some cases demand pressures have led monetary tightening via adjustments in reserve ratios while holding policy rates. Greater vigilance remains essential in order to ensure that hike in commodity prices does not set off second round inflationary expectations leading to rising core inflation which in some cases is already rising because of domestic overheating or over-borrowings by the Government. To the extent inflation rate is being contained through fiscal measures, this in turn will also impact monetary trends and require further tightening. | state bank of pakistan | 2,008 | 5 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 5th Annual Summit of the Islamic Financial Services Board, Amman, Jordan, 13 May 2008. | Shamshad Akhtar: Financial globalization and the Islamic financial services industry Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the 5th Annual Summit of the Islamic Financial Services Board, Amman, Jordan, 13 May 2008. * * * 1. Financial globalization has grown in size and scale. There is now a broad consensus that an effectively managed financial globalization has the potential to benefit from and contribute to: • Growing world trade integration, • Easing of investment and cross-border capital flows as economic liberalization gains momentum, • Development of interdependent production structures that have evolved to maximize comparative advantage, and • The revolution in information technology and institutional reforms. 2. These factors have deepened and diversified financial markets. However, the benefits of financial globalization have often come under test. This is largely when market distortions and risk management standards are compromised; these adversities, with leads and lags, usually result in failures and losses for financial markets and institutions. While the world has witnessed recurrent episodes of financial crisis, global developments since 2007 have had a profound and multiple impact given the multi-dimensional nature of the ensuing crisis. First, the financial market turmoil in the subprime mortgage market unfolded itself in the form of an unprecedented global liquidity crunch triggering huge financial and economic losses. Second, the world is now realizing the stress of growing global imbalances that have, for several months now, manifested themselves in the rising global commodity prices and have fuelled inflationary pressures. 3. While there are multiple lessons to be learnt from these developments, in principle, these events are a fresh reminder of the risks associated with over-leveraging and reckless offbalance sheet transactions given the weaknesses in regulatory and supervisory oversight of key segments of markets, and the excesses in consumption trends of the global economy which have compounded global imbalances and inequalities. 4. These events have again provoked debates regarding the pros and cons of financial globalization, the impact of which is incrementally visible, resulting in : (i) slowdown of world economy and consequently in trade in selected products and markets, (ii) volatility in equity markets which in some cases generated losses, and (iii) easing of liquidity in a number of ways by the affected central banks, which is now compounding inflationary pressures otherwise building up because of the international rise in food and oil prices. Corrective actions are underway and lessons being drawn from the unfolding events. 5. Good news is that the Islamic Finance (IF) industry has generally remained insulated from the recent episode in financial markets. This is because Islamic banks’ transactions are backed by real economic assets and risk management, benefiting from the application of and compliance with Shariah principles and guidelines, wherein the banks and investors have to share the profit and losses in accordance with the risks taken. While in conventional finance, risk-free capital encouraged over-leveraging and overexposures by transferring transactions to off-balance sheets conduits. IF services drive their inherent strengths from the Shariah guidelines and principles. Notwithstanding, IF services, like all businesses, could be impacted if the global slowdown deepens. 6. Abstracting from the current scenario which is still unfolding, broad evidence confirms that financial globalization, with adequate safeguards, promotes economic growth and development. Financial globalization has the potential to promote and reinforce IF by ensuring its conformity with conventional finance by fostering newer and better linkages with the regional and global financial markets. IF in turn can reinforce and support globalization by bringing to it financial innovation and stability, provided it is properly nurtured and developed in conformity with the internationally well-accepted and tested financial sector prudential and regulatory frameworks. In order to achieve a deeper and sustainable impact, IF would benefit by aligning and positioning itself in a way that it takes full advantage of financial globalization. 7. Notwithstanding, it has to be recognized that financial globalization can have unintended negative consequences. However, empirical evidence confirms that this happens under specific conditions. Without going into an elaborate debate on this subject, suffice to point out that this happens in cases where the financial systems lack diversification or are under- or weakly regulated, and when financial globalization marginalizes the developing markets and people. If IF is positioned to address these areas upfront, it will in fact help reinforce and augment conventional finance with its inherent principles and guidelines that place emphasis on supporting economic transactions, avoiding speculation and depending on proper alignment of the risk-reward equation. 8. Given these considerations, there are ways in which IF can benefit and enrich the process of financial globalization so as to mitigate or reduce its negative consequences. For instance, • IF’s potential to promote different types of risk-sharing methods, supported by emphasis on equity and asset backed financing, can help promote risk diversification and mitigation. • IF’s strong ethical principles for stakeholders can help distribute, widely and equitably, the fruits of financial globalization among the participants than has happened thus far. • Under IF, the lender supports transactions that are real and backed by tangible assets with profits linked with the risk taken, rather than encouraging deployment of riskless capital investments (interest and rent-seeking). • Greater reliance on profit and loss sharing enables IF to structure equity partnerships which carry identifiable risks and discourage speculation. • Internationalization of Sukuks and their flotation, expected to hit the $100 billion mark soon, is helping IF to better integrate itself with the global financial world; this will not only meet the region’s massive infrastructure project financing requirement, but will also help diversify financial markets. A number of sovereigns and developed markets are now floating sukuks which is fostering financial globalization through geographical and investor base diversification in IF products, while helping engineer and improvise sukuk structures to suit the funding needs – this flexibility is helping the Sukuk structure to gain recognition as a global product. 9. Globalization of IF will magnify along with its growing acceptance as a viable alternative financing mechanism as it illustrates its capacity to co-exist and compete with conventional finance. As highlighted above, internationalization of IF is growing but this is happening in a number of ways which will in due course set the stage for deepening the dynamics and interface between financial globalization and the IF industry. Some of these developments are discussed below. 10. Aside from widespread growing interest and investment in IF, its growth at one level has been catalyzed by the growing global imbalances as oil rich economies accumulated capital from the persistent rise in international oil prices. It is the accumulated surpluses and wealth of the oil exporting members of the Middle East, including the Gulf Cooperation Council (GCC), that have helped the global financial players to develop IF markets. Over 2002-2006, GCC capital outflows, as reported by the International Institute of Finance (IIF), rose to $530 billion: of this $300 billion outflows went to US, $100 billion to Europe and remaining to Asia and other destinations. 1 Reportedly, GCC net foreign assets rose to $1.8 trillion or 225% of the region’s GDP. 2 Standard & Poor’s estimate suggests that investible Arab capital now exceeds $2.3 trillion. 3 Boston Consulting Group estimates that Middle East investment entities’ combined asset pool is around $10.2 trillion. 4 Currently this wealth has been deployed across the private banking departments of global financial players such as UBS, Citigroup, Standard Chartered and HSBC etc. If the IF industry augments its absorptive capacity to cater to the growing demand for IF products, more and more capital being currently directed into conventional finance, will be invested in IF. 11. Emerging financial joint ventures and alliances between GCC and Europe, as well as Asia, have already kick-started the process of IF globalization. Islamic banks are at the centre of developing these financial linkages between the Arab world and Europe/Asia. Cross-border alliances among financial players have encouraged global banks to invest in IF, both in Europe and through their network in GCC and Asia. Also, the establishment of newer IF hubs and centers are likely to help retain the emerging capital flows from GCC within Asia. Leading Islamic finance houses, old and new, are investing in regional financial hubs aggressively to broaden their reach to capture the high net worth investments into IF. Extending the outreach, interest in IF is now emerging in US, Japan, China and Australia etc. Directional change in flows is already emerging, but meeting the demand for IF is critical for enhancing the competitiveness and sustainability of the IF industry and institutions, while raising their standing in global finance. 12. The large global financial players have been instrumental in fostering linkages and product innovation. This is largely because the investor community worldwide is being attracted by the “risk-return” and other innovative features of Islamic products, the product range IF offers, and the ethical investment philosophy and governance structure it promotes. Worldwide demand for Islamic financing is also gaining momentum as IF conforms itself to conventional finance by adopting proper regulatory and supervisory frameworks. Recognizing the implications of financial globalization on IF and IF’s implications for global finance, Multilateral Development Institutions have been supporting the Islamic Financial Services Board (IFSB) to ensure effective alignment in the regulatory frameworks, while accommodating modifications and refinements of the special features and modalities of IF. 13. Investments, partnerships and alliances between the public and private sector, and among global and regional financial hubs, have allowed a two-way transfer of capital flow and knowledge-sharing that is steadily promoting the integration of IF with global finance, while encouraging the required financial engineering and product innovation which will enhance IF standing and legitimacy, while enriching the world of global finance. 14. While the industry has the potential to grow by 20-30%, there are concerns that IF is fraught with diversity, fragmentation and heterogeneity. To foster IF to integrally benefit from, and contribute to, financial globalization, there is a need for countries to launch a coherent, coordinated and synchronized development of the IF industry at national levels which feeds into and reinforces the implementation of the IF strategy, approved by the Council of Governors of IFSB last year. To support and withstand financial globalization, IF needs to reorient itself to: “Tracking GCC petrodollars: how and where they are being invested around the world”, Institute of International Finance (2007). Economic Report on Gulf Cooperation Council Countries, Institute of International Finance, January 2008. “Globalization of Islamic funds”, Islamic Banking & Finance, Issue 11, August 2007. “Globalization of Islamic funds”, Islamic Banking & Finance, Issue 11, August 2007. • Consolidate and merge IF institutions to have the scale, efficiency and cost effectiveness to compete globally; • Promote “globalization” of IF modes and instruments that are now meeting the finance and investment needs for the different sectors; • Promote and adopt Islamic financial architecture that encourages standardization of legal structure and contracts, prudential regulation and supervision supported by appropriate risk management of the special features and structure of the new products, and accounting practices in line with AAOIFI standards; • Encourage harmonization and convergence of religious views (emerging from differences in interpretations of Fiqh-ul-Muamalat i.e. the Islamic law relating to financial transactions) to minimize Shariah risks associated with the IF products, operations and systems. Generally, IF instruments and practices adopted by one institution can be eroded if the Shariah board of another institution question their compatibility with Shariah. As the confidence of local and the worldwide potential market for IF rests critically on Shariah compliant mechanisms, there is a strong need for coherence amongst different schools of thought, and mutual acceptability of product within and across countries, while recognizing that diversity in Shariah opinions (fatwas) is enshrined in Islamic legal history and will thus remain a feature of the market. • Cultivate the IF industry as a multi-dimensional and multi-product market by exploiting scores of opportunities in fund, assets and wealth management, as well as proper financial engineering and innovation to support project and infrastructure financing, structured financial derivatives, and private equity, retail banking and Islamic mortgages. • Develop suitable frameworks and applications of PLS-based products. At present, the share of equity investment in IF ranges from 0 to 24% of the banking books of Islamic banks. PLS modalities like mudaraba and musharaka, based on equity partnership arrangements, offer interesting options for innovation. However, weaknesses in legal, regulatory and policy frameworks have impeded their growth. Some of the constraints of its effective application 5 include (i) equity holders and investors’ aversion to risk, given the uncertainties over return in PLS arrangements, (ii) absence of effective property rights in most countries, (iii) long term nature of PLS financing and (iv) higher taxation, compared to interest income, on equity transactions underlying PLS arrangements. Nevertheless, promoting PLS arrangements will not only offer new products but will also address the serious mismatch of assets and liabilities which has aggravated due to the heavy reliance of IFIs on short-term, low profit and fixed income assets. 15. In conclusion, it has to be recognized that IF services have been transformed from being a peripheral activity to a sizeable industry which is attracting global interest. Evidence and arguments presented above make the case that financial globalization will foster IF and given the inherent features and richness of Islamic principles, modalities and products’ growth in IF will be beneficial for supporting the process of regional and global financial deepening. Although currently the size of IF is small relative to the global financial system, it has promising growth prospects. Well-developed and integrated Islamic money, capital, and foreign exchange markets will not only be beneficial for borrowers and institutional investors, they can also further enhance the stability of IF institutions, providing them with improved portfolio, liquidity and risk management tools. The challenge for the industry is to consolidate “Lack of Profit Loss Sharing in Islamic Banking; Management and Control Imbalances”, Humayon Dar and John R. Presley (2001). itself to be able to better compete with global players through achieving scale, efficiency and cost effectiveness in addition to rapidly building its capacities to standardize regulation and supervision, and accounting practices, while strengthening the governance of the industry. | state bank of pakistan | 2,008 | 5 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the inauguration of the Development Finance Conference, organised by State Bank on the eve of 60th Anniversary of the State Bank of Pakistan, Karachi, 1 July 2008. | Shamshad Akhtar: Financial sector – ten-year vision and strategy Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the inauguration of the Development Finance Conference on “Expanding Frontiers of Financial Access in Pakistan”, organised by State Bank on the eve of 60th Anniversary of the State Bank of Pakistan, Karachi, 1 July 2008. * * * Pakistan’s financial system grew significantly in the last few years. At present, total financial assets have reached $175 billion (110% of GDP). The banking system constitutes 95% of the total assets of financial institutions and bank shares constitute 40% of the stock market capitalization. Among different segments of financial markets, banking sector has gained dynamism, profitability, respectability and strength. Deposit base rose to $60 billion and advances to $47 billion. Supported by growing financial intermediation process, banks aggregate profitability rose to $1.8 billion. Recapitalization and prudent lending has lowered net non-performing loans (NPLs) to below one percent of assets. Banks capitalization and quality of assets have helped raise the risk weighted capital adequacy ratio to 13.2 percent. These achievements are impressive, however: (i) A large segment of population and geography is still under served from the existing financial markets and this gap will grow as Pakistan’s population rises further. (ii) The financial system has to gear itself to meet the growing requirements of the economy in particular infrastructure which conservatively requires almost $150 billion over next few years; (iii) New types of risks have emerged as banks acquired different types of nonbank financial (NBF) institutions including investment finance, brokerage, asset management and insurance companies etc. Some of these have been merged into the banks while others remain as subsidiaries. Banks are beginning to cross-sell different financial products through their branch networks. This is a market driven development but does pose systemic risks and supervisory challenges. Some banks have also acquired strategic and non strategic stakes in nonfinancial companies. These create a different set of risks that will need to be thought through and dealt with carefully. (iv) Financial sector needs to be diversified as bulk of the country’s financing requirements is currently met by the banks. While market capitalization of stock market has increased significantly, new issuance of capital is small. Similarly, the debt markets constitute largely of government securities, while the corporate paper market is limited. (v) Finally, within regional context Pakistan’s financial system despite its growth is still small. For instance, the financial system of other Asian emerging financial market countries twice or three times larger in relative terms and the Gulf States have now geared themselves into regional financial hubs. Keeping in view these considerations, the State Bank of Pakistan’s (SBP) is now launching a ten year Financial Sector Strategy. This strategy has been developed based on (i) a comprehensive assessment and evaluation of the banking system that helps draw key lessons; (ii) Pakistan’s forward looking economic development strategy and vision; and (iii) learning from the emerging changes in global and regional financial architecture and financial advancement and innovation. This paper aims to capture the objectives and broad elements of the financial sector strategy which will be finalized and adopted by the third quarter of the 2008 after consultation with stakeholders. The scope of the paper is confined principally to reforms of banking sector and regulatory architecture which would require some principal changes or new legislation. The objective of the financial sector strategy will be to broaden and deepen the financial system to help Pakistan: (i) Achieve higher and sustainable economic growth, (ii) Develop a dynamic, robust and stronger system, (iii) Mobilize the domestic and foreign resources for private investment (which has to be the key driver of the economy), and (iv) Deepen financial penetration for poor and underserved regions. Prerequisite for financial sector growth is, however, macroeconomic and political stability and augmentation of the enabling policy environment in the real sector. Assuming these preconditions are restored, the ten year strategy will (i) Stimulate growth in financial assets to 165% of GDP, growth in deposit base by 13% to reach $217 billion, and advances to allow private sector credit/GDP ratio to rise from 27% to 42%; (ii) Be financially inclusive supporting the small savers and meeting the requirements of small borrowers in agriculture, housing, small and medium enterprises (SME) and microfinance sectors by raising financial penetration ratio through enabling policy environment and outreach expansion (coverage of per bank branch to improve from 19,000 to 15,000 persons). (iii) Developing financial infrastructure and automation to enhance the coverage of automated teller machines (ATMs) to 10,000; and (iv) Reduce the systemic risks of the financial system by developing an adequate safety net for the small depositors and the central bank’s lender of last resort functions as well as a framework for dealing with failing banks. To achieve these goals, SBP is in process of putting together a comprehensive reform program. SBP has developed and has full ownership of this reform agenda and received technical assistance from the International Monetary Fund, the Asian Development Bank and the DFID of United Kingdom to draw from international experience and expertise. Central bank governance Principal driving factor for the formulation and implementation reform is the autonomy and competence of the organization. Over the years, emerging evidence has confirmed the significant benefits of central bank autonomy (not just de jure autonomy but de facto autonomy too) for macroeconomic performance as central banks play a primary role in price stability, while also ensuring financial stability. This role has been supported by assigning requisite powers to central banks not only in monetary policy formulation, conduct and implementation but in effective enforcement of fiscal discipline. This has been achieved in several jurisdictions without any real additional costs or sacrifices in terms of output volatility or reduced economic growth. Further, central banks in number of jurisdictions have performed the role of regulator of the full or part of the financial system. The recent financial market turmoil has also brought under scrutiny the models and governance structures of central banks/financial regulators, while bringing to forefront the risks of leaving nonbank financial (NBF) sector virtually unattended. In absence of proper regulatory and supervisory oversight, the NBF sector’s overleveraging of the financial systems has exposed the global financial system to multiple risks. As defaults emerged the financial institutions lacked ability to service obligations. This episode has generated unprecedented liquidity crisis and bank losses whose undervaluation/closures/liquidation impacted the financial markets at large. Rescue operations and economy wide and household losses have not only impacted advanced countries but taken a toll on global financial system and send warning signals on need for change in financial regulatory architecture and its landscape. These attributes of central banks helps cushion the impact of political cycles on economic cycles. SBP over the years has acquired not only the required autonomy to steer the monetary policy and financial stability mandates, but has regulated and supervised well the banking sector reforms. Notwithstanding, SBP set up under the State Bank of Pakistan Act, 1956 has been amended occasionally to strengthen its powers and mandate but now it needs to be modernized in line with the international best practices. The key issues with SBP Act are that (i) it contains outdated provisions that have lost their validity in light of the administrative and structural changes at the economy level; (ii) governance structure of central bank which over the years has undoubtedly served well the interest of autonomy and accountability of central bank but does still contain provisions which undermine the functioning of central bank, (iii) if price stability is to be upheld, in line with the mandate adopted by other central banks, than provisions pertaining to the monetary and fiscal coordination need to be re-examined to ensure proper enforcement of fiscal discipline through more explicit restriction on central bank borrowings, (v) it ought to now include appropriate provision for the financial stability defining explicitly mandate of central bank in financial safety net, bank exit and lender of last resort functions and (iv) it includes provisions which ought not to be in primary legislation but in supportive regulations etc. In addition to modernizing the SBP Act, as a part of financial sector reforms central bank has reviewed the supportive laws such as the Banking Companies Ordinance, 1962 and other principal laws. In parallel, SBP has been working on a host of new laws to develop adequate financial safety nets such as the Deposit Protection Scheme (to be discussed later in this paper) and Consumer Protection and financial crimes law. The sections below further outline the major areas of thrust of the financial sector reforms, but do not as yet cover the full reform agenda. Financial Inclusion Program In Pakistan the level of financial exclusion is quite steep: only 17% of the population (30 million) has bank accounts and less than 4% (5.5 million) are borrowers. Moreover only 25% of the total bank deposits and 17% of the total borrowers are from rural areas. In value terms their shares are even smaller, 10% and 7% of the total value of deposits and advances, respectively. Limited access to services is captured by the low level of branch penetration, especially in rural areas and this has held back the growth of savings and impacted credit distribution system. To address issues of access, SBP has established a Development Finance Group which has developed a comprehensive Financial Inclusion Program (FIP) that aims to promote access to development finance for all small and underserved markets. In Pakistan context there is need to encourage shift in banks’ focus away from large companies to smaller companies and the household sector. Most credit to the enterprise sector goes to manufacturing, which receives a disproportionately large share of bank credit compared with this sector’s contribution to GDP (20%). Aggregate data for all credit by borrower size shows an extremely skewed distribution: 22,000 or 0.4% of all 5.2 million banks’ borrowers account for 65% of all bank credit—and the remaining 5+ million borrowers for the remaining one third. At the very top there is even more concentration; the largest 50 borrowers account for 37% 1 of all credit outstanding. Given that the manufacturing sector is the predominant recipient of credit, it is safe to assume that most of the large borrowers are concentrated in that sector. As of 31st March, 2008 of all banks/DFIs. The FIP, to be supported by DFID and other donors, is quite broad based and will help enhance the outreach. To start off, SBP and Pakistan Microfinance Network (PFM) has developed a multi-faceted microfinance strategy to triple the number of microfinance (MF) beneficiaries from 1 million to 3 million by 2010 and then to 10 million. To support this program, SBP has encouraged commercialization of microfinance industry so that it is financially and socially sustainable. Some of the specific actions being launched to facilitate this involves encouraging: (i) Microfinance institutions (MFIs) to develop commercially viable operations that are financially and socially sustainable operations and transform them into MFB to provide holistic services. Tax holiday for five years has been provided to MFIs once they transform themselves into full-fledged microfinance banks (MFBs). (ii) Development of partnership between commercial banks and MF providers and the post office (PO) network and MF providers. (POs already manage over 4 million savings accounts, mainly small accounts below Rs 10,000, through more than 12,000 branches.) There is scope for the PO and MF providers to join forces with the latter acting as intermediaries for funds from the PO, especially as many MF providers are constrained in their operations by limited funding. (iii) Flexible regulatory regime for MFBs to allow innovation and organic growth without compromising prudential objectives. Limits for MFBs (and MFIs) will be adjusted at least in line with inflation and a two-tier regime is to be considered under which MFBs (and MFIs) with track record of prudent governance, risk management and financial success could be given more room to operate. This includes capital adequacy requirements, which will be reviewed so as not to put MFBs (and MFIs) in a competitive position substantially worse than that of banks. (iv) Mobile phone-based banking services which is a cost effective way of bringing financial services even to the most remote areas of the country. This is an option with enormous potential as there already are almost two times as many mobile phone owners (some 80 million) than there are depositors. Mobile phone services reach almost every part of the country and would be an extremely cheap way for banks and other financial institutions to extend their reach. (v) Development of domestic and international MFI partnership. (vi) Financial literacy and customer awareness program. In parallel, SBP has been promoting Islamic Banks (IBs) to appeal to the population which has thus far excluded itself for faith reasons. A separate Islamic Finance Strategy paper has been developed which projects that given the growth rate in IBs businesses, Islamic Finance is expected to constitute almost 12% of the Pakistan financial system in next five years or so. To encourage sound growth SBP has laid out an elaborate prudential regulatory and supervisory framework which conforms to the International Islamic Financial Service Board’s (IFSB) framework in whose development Pakistan has played a key role. To ensure proper due diligence of the IF development SBP has constituted Shariah Advisory Board which approves broad policy and regulatory framework and new products etc. SBP is working to develop proper liquidity management framework and instruments to allow the IBs progress in a prudent and sound manner. SME sector faces a host of both demand and supply side constraints impeding delivery. On demand side, lack of planning and entrepreneurial skills and problems with SME policy framework remain a major hindrance, while on supply side banks perceive financing these entities as high risk in absence of credit history and collateral. Notwithstanding the growth in the SME financing has been significant and its share in total outstanding advances is close to 14.5% and the number of borrowers in the sector is around 185,000. In line with international best practice, SBP plans to promote SME financing through supportive mechanisms. This would involve help in designing specific products, and developing credit scoring system for SME finance and SME financial reporting system. In addition, banks are being encouraged to facilitate program based lending – in which banks establish general criteria for meeting the specific financing requirements of businesses – and cash flow based lending rather than collateral based lending. Work is underway to develop an appropriate credit enhancement mechanism which will facilitate bank lending to the sector. Also, SBP is exploring with industry possibility of development of venture capital funds focusing on SME promotion and offering training to commercial bankers on SME lending methodology and approaches. Agriculture lending has received a significant boost with the banks meeting the target of Rs200 billion set for 2007/2008. Outstanding agriculture advances account for 6% of total advances. However, the current flow of credit meets only 45% of the agriculture credit requirements. SBP strategy for agriculture credit focuses on doubling the number of borrowers from 2 million to 4 million and meeting 75-80% of the agriculture credit requirements. SBP has encouraged a revolving credit scheme for three years – under which farmers can borrow for one year and can continue to borrow without providing documentation each year; guidelines have been issued lending for livestock, fisheries and horticulture subsectors and programs are being launched for dairy sector. In addition, a small farmer financing scheme has been promoted based on group based lending and a crop loan insurance scheme has been structured which is now being offered by some insurance companies. Work has been completed on promoting agriculture Islamic finance and also providing capacity building both to farmers and bankers in regional languages. Finally, to promote rural areas, SBP has mandated banks to establish 20% of their new branches in rural areas. As competition for deposits grows and lending is backed by adequate margins, banks will find their rural operations to be more attractive. Innovative products and methods of selling them will also increase banks’ reach and may change the “brick-and-mortar” nature of branch operations. Strengthen consumer protection and financial education Over time competition backed by financial literacy and awareness will impose the right pressure on banks to upgrade their customer services. SBP on its part is focusing on effective compliance with customer service regulations and following it up with proper enforcement to motivate banks to render good service and deal fairly with customers. To supplement and reinforce this, SBP plans to: (i) Introduce a Consumer Protection Bill, in line with international best practices, which would among others provide guidance on issues of transparency, confidentiality, availability of statements, account servicing, protection against fraud, unfair contracts and lending practices, methods of debt collection, arbitrary penalties, etc. Supported by the legislation an appropriate dispute settlement mechanism will be established. Currently consumer protection is codified in SBP regulations but this will have to be also reviewed and updated in line with the new legislation. (ii) Encourage Pakistan Banks’ Association (PBA) to adopt a Banking Code to commit banks to fairness, disclosure and ethical standards. (iii) Strengthen the newly established Consumer Protection Department of SBP to monitor compliance with such new laws, regulations and codes. (iv) Introduce a depositor protection scheme to protect small depositors. (v) Transform and strengthen the role and functions of Banking Ombudsman, which will remain an independent body from the regulators, to be better aligned with the above developments. (vi) A long-term campaign to enhance financial literacy will be launched in rural and urban areas both by the commercial banks and SBP with the support of the IBP, NIBAF and PBA. Consolidate and strengthen the banking sector Further consolidation is necessary to ensure presence of stronger and well capitalized banks that can support diverse financial services and client requirements, while adequately managing risks. Even though the number of conventional commercial banks has declined from 41 to 29 through mergers and acquisitions and closures, there remain some banks with lagging performance. As the most attractive mergers already have been consummated, the pace of additional mergers requires SBP to further enhance the banks’ minimum capital requirement (MCR). Moratorium for issuance of new licenses, extended now to Islamic banks too, 2 will remain – exceptions, if any, will require new banks to comply with $300 million capital requirements. Meanwhile all existing banks will be provided with a time frame to comply with the new MCR. Outside the ambit of moratorium will be MFBs but licensing for these will henceforth be at the national and provincial levels. New institutional arrangements such as introduction of credit unions that aim to serve the lower tier markets will be examined favorably. In the banking sector, specialized government-owned banks have only made limited contribution in their niche markets. They have out-served their purpose and/or their dismal performance has impacted the SBP balance sheet (requiring regular provisioning for the losses). Compensating their losses is not an option given the fiscal stress. In view of this, proper resolution program is being worked out for these institutions. For instance: SME bank is being privatized, the House Building Finance Corporation (HBFC) will be restructured and privatized and the Zarai Taraqiati Bank Ltd. (ZTBL), a highly strategic case, needs to be restructured financially and operationally. The Industrial Development Bank has now been incorporated as a public company and will be available for sale. Privatization agenda should also be extended to insurance sector as this sector is quite critical for Pakistan’s overall financial sector development. Strengthen competition and efficiency Competition drives a market-based financial system that helps bring about efficiencies and innovations by encouraging price discovery and formation process. In Pakistan, banks with substantive market power and access to low cost funds by virtue of their age old captive clients have ended up distorting price mechanism as they are principal price setters. As a result, real returns have been negative for the bulk of deposits, which has deterred effective fund mobilization and distorted the yield curve and pricing for loans and advances. To assess the degree of competition in financial markets, SBP examines market structure indicators (such as the number of institutions) or concentration (Herfindahl or other indexes) as well as the performance measures such as bank margins or profitability – though it has to be acknowledged that these variables are influenced by multiple factors ranging from macroeconomic conditions to bank specific factors such as scale of operations and risk preferences etc. To enhance competitiveness, SBP will primarily focus on continuing to broaden and deepen financial system further. Notwithstanding, efforts are under way to (i) review the actual behavior and conduct of banks related to structure of banking industry and take the required actions, (ii) encourage contestability by allowing entry and (iii) promote development of NBF intermediation to improve bank competition, . Furthermore, competition in banking system is likely to grow as demand for advances results in need for higher deposit mobilization which would then alter the pricing for both advances and deposits. Islamic banking constituting over 4% of banking assets, are encountering competition from within and from conventional banks and we need to nurture and solidify their performance. Taking advance action, SBP has sought to remove structural distortions that have impeded competition. A case in point is the minimum deposit rate of 5% on all PLS savings product as banks had for quite some time enjoyed ample access to a pool of excessively cheap savings deposits. In addition, SBP regulations require greater transparency and disclosure in interest rates and rate setting. As market matures, competition will encourage better alignment of interest rates both on deposits and advances. Large corporate borrowers that have largely dependent thus far on banks, may over time find it more attractive raise financing from debt markets. In other countries such financing is typically cheaper than bank borrowing. Strengthen prudential regulation and supervision SBP has a broad set of prudential regulations that aim to strengthen risk management, internal controls and corporate governance in banks, while providing effective guidance for promotion of development finance and consumer related matters. The regulatory framework for banks is now quite complete, although it needs constant updating and upgrading to conform to evolving international best practices. Some challenges remain: (i) loan concentration, (ii) emergence of financial conglomerates and their supervision, and (iii) implementation of the Basel II regime. Given high concentration of credit to the manufacturing sector, there is need to re-examine the regulation relating to exposures of large company/borrowers and related companies. High exposure has developed as banks and companies have been reluctant to go to seek alternate sources of financing and instead seek relaxation of SBP prudential regulations to borrow from banking system. Excessive exposure poses a threat to broader financial stability, while deterring growth in nonbank finance sector. Stricter limitations on bank exposures to large companies would drive those companies to raise capital from debt and/or equity markets. This would support financial sector and risk diversification and contribute to financial stability. In developing prudential regulatory framework SBP will draw on the debate between the Rules versus Principle based regulatory regime. The former takes a legalistic approach in attempting to codify all prudential requirements into either primary law or regulations. This approach is common in Spanish speaking countries as well as the United States. While this approach provides certainty to the industry, it limits the flexibility of the supervisor to adapt to changing circumstances and experience. Thus it puts a high premium on thinking through every possible practical variation and also on having near perfect legal drafting. The problem with this approach is that financial regulation is more of an art than a science. Many of the rules that are introduced for prudential purposes need continuing modification and refinements based on experience. The danger of relying too heavily on detailed rule books/regulations is that the principle gets lost in the details. There is also a danger that the industry becomes unduly focused on avoiding the wording of the rules rather than the intent. The principles-based approach attempts to limit hard-coded law and regulations to broad statements of principle. For example, the law might identify the need for banks to implement sound risk management frameworks. However, rather than trying to identify every feature of such a system, the principles-based approach allows the supervisor to develop its framework and its own understanding of best practice in line with the principles. Given the pros and cons of two approaches, SBP will try to strike a balance between these two philosophies. The industry is still evolving and, as such, needs some guidance in the form of detailed rules. At the same time, the need to adapt quickly to changing circumstances and to learn from experience means that we need to retain flexibility around the detail that supports our principles. Basel II implementation SBP has initiated the implementation of the new Basel II minimum capital adequacy requirements. The Standardized Approach to credit risk and the Basic Indicator Approach to operational risk became effective at the beginning of 2008 after running the new regime in parallel with the old one last year (2007). Banks have made major advances in implementation of the new framework, though many are facing challenges in areas like integrated risk management policy, collateral management and the limited availability of credit ratings for counterparts. Almost one half of banks’ on-balance sheet exposures require external credit ratings but only one sixth of those exposures have ratings. Of those that have been rated, most are banks, while only a small portion of corporate exposures are rated. The policy issue for SBP is how fast to allow or require implementation of the more advanced approaches. Given the dearth of external ratings, banks will reap the full benefit of the new Basel II regime only when they can apply the advance approaches based on internal credit ratings. For this they need further improvements in their risk management systems. To push the reforms, SBP has made it mandatory for banks to carry out internal risk ratings though banks will be provided lead time for implementation. The application of the basic Basel II approaches is not likely to result in any major change in banks’ capital adequacy ratios (CARs). The impact studies done so far indicate that lower capital requirements against credit risk are offset by the new capital charge against operational risk, when compared against the previous Basel I regime. Only by moving to the advanced approaches can banks expect to lower their CARs. Financial conglomerates Commercial banks are de facto moving into conglomerate modes by venturing into other sectors. Some banks have acquired or merged NBF institutions such as investment finance, brokerage, asset management and insurance companies into the banks, while others remain as subsidiaries. Conglomerates have become the norm, as banks broaden their product offerings and seek cross-selling opportunities. Presently, 5 banks (and one DFI) own shares in insurance companies, 12 banks have interests in asset management companies and mutual funds, and many are involved in other areas like leasing, financial advisory and brokerage services, modaraba management and foreign exchange. Financial conglomerates present a major challenge for the SBP. It is generally acknowledged that financial conglomeration makes good business sense, and that these developments should be regulated but not stifled by regulation. The main challenges that financial conglomerates pose for regulators are: • First, unless there is strict implementation of sound banking practices, there is a danger that a bank can become a cheap source of finance to the other members of a group without proper recognition and management of the risks involved. • Second, failures elsewhere in the group can expose the bank to contagion risk. • Third, especially where the conglomerate group includes commercial businesses, there is a risk that the bank depositors end up carrying the residual risk for nonfinancial businesses. Regulators address these concerns through consolidated supervision which places a supervisory net around all members of the group. The primary intention is to prevent an otherwise sound bank from being impaired by association. As a part of supervisory reform agenda, SBP will be moving towards consolidated supervision system in compliance with Basle Core Principles. To allow for this appropriate structural change in financial sector regulatory architecture would be required and legislated. Regulatory architecture The emergence of financial conglomerates has had an impact on the shape of regulatory architectures around the world. Internationally there has been a marked trend towards regulatory amalgamation and, within that trend, towards creation of a single or minimum two agencies with responsibility for all regulation within the financial sector. The reason most commonly cited for this trend is the need to better cope with the regulation of financial conglomerates. Our current architecture in Pakistan is not well suited for consolidated supervision. Some members of financial conglomerates are under-regulated and no agency has power to regulate financial groups as a whole. At the centre of the case for reform in this area is the need for the SBP to regulate and supervise banking groups on a consolidated basis and to apply prudential norms to all aspects of the business of groups that include banks. This can be achieved in Pakistan context best by ensuring that all deposit and lending institutions are under oversight of SBP and the responsibility of lead supervisor for consolidated supervision be entrusted fully to SBP. The basic rationale for this proposal is to protect depositors and public liability from the contagion that can arise from financial conglomeration. This case is strengthened by the role that SBP plays in financial system stability and the independence and skill base it has to carry out this function effectively. Financial safety net framework Depositor protection scheme. Aside from yield, safety of depositors is one criterion for enhancing deposit mobilization. Since private banks, which form the bulk of the financial system, are outside the Banks’ (Nationalization) Act, 1974 SBP is developing a blue print for a limited deposit protection scheme (DPS) to protect small depositors. DPS increases depositor confidence in all banks and comforts small savers and helps the competitive position of small private banks in relation to large banks or government owned banks, which typically are viewed as safe and/or “too big to fail” (TBTF). DPS reduces the probability of open bank runs, which can be damaging to confidence in banks more generally and lead to contagion in other banks. The protection of deposits under a limited DPS typically would be strictly confined to small depositors which constitute majority of the depositors but represent only a small proportion of total deposits in value terms. A DPS typically establishes a Depositor Protection Fund (DPF) to facilitate depositor payouts funded by the initial capital contribution, premium payments from banks and its own investment income. The premium charged can be fixed across the board or risk based for each bank. Managing expectations associated with DPS is critical as it does not prevent all bank runs and systemic crises but it can be a helpful tool in managing a systemic crisis. The SBP has advanced plans for introducing a DPS in Pakistan and will soon be circulating a concept paper and supportive legislation for stakeholder consultation. Lender of last resort. A principal role of SBP is to maintain confidence in the banking system in times of systemic illiquidity. In light of this, internally SBP needs to define clearly Lender of Last Resort (LOLR) functions and the supportive liquidity arrangements. Currently SBP provides liquidity for solvent banks facing temporary liquidity problems using different instruments, like repos, access the discount window, or using other monetary policy instruments like outright securities purchases (OMOs or directed) or changes in the cash reserve ratio (CRR). Since SBP has a strong banking surveillance mechanism as well as regular banking inspection, the probability of banks having solvency problems is low but one cannot rule out such cases. Banks do have high exposures in loans and shares to certain companies and economic groups – often related parties – and liquidity and solvency issues could emerge despite high vigilance. In view of this, SBP plans to develop a policy framework and guidelines for its LOLR functions. Exit framework. A strong legal framework for bank exit is already provided for in the draft amended Banking Companies Ordinance. Under this SBP would have strong powers to intervene, reorganize or close unviable or failing banks. SBP has experience of handling and intervening in problem banks and their subsequent liquidation or managed mergers. SBP will further develop a suitable range of resolution options to deal with TBTF banks. In parallel, there is need to develop a Prompt Corrective Action (PCA) regime that obliges SBP to take specific corrective actions once certain trigger ratios are reached. The typical PCA regime is based on CARs and if the CAR falls to below the regulatory minimum CAR certain prescribed actions are triggered. Development of Core Financial Infrastructure. Host of initiatives are under implementation or to be launched. a) Retail payment system: SBP is launching today the 1st of July 2008 the Pakistan Real Time Gross Settlement (RTGS) system for wholesale transactions. In addition, work has started for modernization of the retail payments and settlement system which will encourage electronic and mobile phone based transactions, while taking due consideration of privacy and security matters and the development of an appropriate legal framework. b) Credit Information Bureau: The SBP’s electronic Credit Information Bureau (eCIB) has already helped credit risk management in all financial institutions. With up-todate (almost real-time) data and coverage of almost 5 million consumer and commercial borrowers, it provides financial institutions, both large and small, an invaluable risk management tool. The data includes not only outstanding amounts but also repayment histories and some non-financial information. The comprehensive coverage of corporate borrowers down to very small consumer finance amounts provides a unique statistical basis for credit scoring techniques and other methodologies. SBP will further develop operational software for borrower analysis and credit scoring which will help in credit analysis of banks. c) Credit rating agencies: Corporate ratings are needed for the standardized approach of Basel II implementation as well as for the development of a private debt securities market and for listing of companies on the stock exchange. There are two rating agencies who have rated a few companies, as there is little need and few incentives for companies to subject themselves to external scrutiny. The incentive framework for the services provided by private rating agencies needs to be analyzed with a view towards identifying measures and incentives that will result in more company ratings. That would also help facilitate private listings of private debt securities. d) Land and property registries: Land and property titles are available in urban but not in rural areas. Improved land titling systems in rural areas could be seen as a necessary underpinning for an improved credit extension process, by allowing collateralized lending for the agriculture, SME and housing sectors. Security of title is essential. SBP is exploring ways to facilitate pilot studies and efforts to develop off the shelf systems and make it affordable for local and provincial governments to introduce new registries and systems over the medium term. e) The judicial system: An efficient financial system requires legal certainty and enforceability of contracts. The present court system needs to be further equipped to deal with financial transactions and disputes. This would require a long-term program to train judges in commercial and financial law and perhaps to establish more specialized courts to deal with financial matters. Conclusion Drawing up the financial sector strategy for next ten years the paper has outlined the vision, objectives and strategy for financial sector. This paper concentrates largely on reforms of banking sector and central bank –essentially focusing on its role as regulator. Driving this reform is the country’s overall development program which being ambitious requires resources for both the public and private sector. Pakistan’s financial markets need to grow at a faster pace to not only meet the domestic requirements but to be able to position itself to receive the foreign inflows that will be critical to meeting our infrastructure and industry financing requirements. Financial sector broadening and deepening is critical to ensure the profitability and sustainability of banks, while ensuring that our citizens have access to development finance to change their lives. It is essential to structure and put in place financial safety nets with supportive legislation on a timely basis for banking sector to grow in a sound and efficient manner, while managing properly its systemic risks. Empowering and gearing the primary regulator will be key to keeping on track and effectively implementing the reform agenda. In conclusion it is important to highlight that besides banking sector reforms, the broadening and deepening of financial markets requires equal emphasis on development of securities and debt markets along with the insurance and pension reforms which have lagged behind the banking sector reforms. Adhering to macroeconomic stability and developing an enabling environment for real sector, both at the federal and provincial level, and a functioning judicial system would be key to keeping the necessary momentum for financial sector reforms. | state bank of pakistan | 2,008 | 7 |
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual General Meeting of the Institute of Bankers, Pakistan, Karachi, 31 October 2008. | Shamshad Akhtar: Pakistan – framework for consolidated supervision Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Annual General Meeting of the Institute of Bankers, Pakistan, Karachi, 31 October 2008. * * * Financial markets have not only been growing at a rapid pace, but have also been marked by continuous change. Key structural transformation has been the evolution of large and complex global financial institutions and structures that, given their inherent size and strengths, have promoted financial engineering and innovation, exploited new avenues of financial leveraging accompanied by greater risk appetite, and infusion of information technology. Together these developments have changed the financial landscape. Over the period, various market developments along with few key legislative changes, such as repealing of the Glass Steagall Act, 1933 (which rolled back the restrictions imposed on banks for mixing their business with securities and investment banks) in the late nineties, fostered new financial structures and strategic alliances that removed the distinction between activities specific to various types of financial institutions. Though the recent global financial market turmoil has triggered questions regarding the risks associated with the emerging types of financial structures, however a more relevant debate is regarding the gaps and weaknesses in the regulatory and supervisory structures that allowed over-leveraging and the operations of several financial industry segments to operate without appropriate oversight. Recognizing the need to evolve an appropriate oversight policy mechanism for its evolving financial structure, SBP, as a part of its overall financial sector reforms launched in July 2008, has advocated the need for legislature to empower the central bank to augment its oversight of the financial sector. In my remarks this morning I propose to outline the economic and financial benefits of financial conglomeration and the risk and supervisory challenges arising out of these complex financial structures. I propose to then share with you the legislative reforms launched by SBP in this area which have recently been approved, in principle, by the Cabinet and are to be tabled for Parliament consideration. Rationale for consolidated supervision Worldwide, the process of change has allowed many financial organizations, which used to engage in the primary business of banking, asset management or insurance activities on a standalone basis, to adopt more flexible structures whereby banks opened up a wide range of subsidiaries and affiliates that primarily engage in businesses other than their core business. The main economic and financial benefit which encourages the formation of such groups is the enhanced ability to achieve economies of scale and to capture synergies across complementary financial services business lines. These synergies result in improved operational efficiency and effectiveness due to lower costs, reduced prices, and improved innovation in products and services. However, at the same time the emergence of such groups has also added complex linkages and relationships among economic agents. Consequently, they have also necessitated a paradigm shift in the supervisory approaches all across the globe to assess, manage, and mitigate risks stemming from such arrangements. Like other countries, these developments have steadily gained momentum in the Pakistani financial sector. The existing regulatory framework in Pakistan under SBP gradually became more open, flexible and allowed the banks to set up subsidiaries to operate Non-bank financial businesses. The prevalent structure under which non-bank financial services are being offered is mostly through the parent – subsidiary form of structure wherein banks are parent of their non-banking subsidiaries, or in some cases banks have Non-banking finance companies (NFBCs) as associates. Some elements of Universal banking also exist, for example banks are allowed to undertake investment banking, and leasing businesses on their own balance sheet as well. While the central bank showed flexibility in allowing these developments, the underlying legal architecture was not changed in line with the market needs and developments. As such, the current legislation and regulatory tools are not adequate to effectively address the potential risks to the safety and soundness of the financial sector. The safety and soundness of the banking sector, being at the core of all activities of the financial sector, is critical for the general public, for the financial sector itself and for the economy as a whole. The governing law of the banking sector viz. the Banking Companies Ordinance (BCO) was introduced in 1962 and occasional changes were made in it in response to the challenges of different phases of development. The significant challenges posed by universal banking, large financial groups and holding company structures now warrant a matching legal framework to avoid any major disruptions in the economy and in the process of financial intermediation. Recognizing these challenges, SBP has sought in principle approval from the requisite forums for amendments in the BCO to enable it to supervise banks, groups and financial holding companies in line with international trends. Besides forestalling various risks, these amendments would enable significant benefits in the form of operational efficiency, lower costs, reduced prices and innovation in products and services. Moreover, one of the Core Principles for effective banking supervision (CP-24) issued by the Basel Committee on Banking Supervision requires that a banking supervisor should be able to supervise the banking groups on a consolidated basis. Presently, Pakistan is either compliant or largely compliant with all the core principles except those dealing with consolidated supervision. The proposed amendments in the BCO would also enable Pakistan to ensure compliance with this principle. Major risks arising from complex structures and supervisory challenges While the increasing integration and the drive towards financial conglomeration has opened up possibilities of greater efficiency through increased economies of scale and scope, at the same time it has also generated novel risks and has consequently raised a number of supervisory concerns. A few of these risks and concerns are as follows: • One of the foremost risks is contagion risk which can manifest itself in psychological as well as financial forms. Financial distress in one entity could impair the reputation of the other entities and the market participants may be reluctant to engage in business with them. The reputational problem can often lead to financial distress in the entire group, as the parent or the other group associates may have to help out the distressed entity in order to safeguard the group from reputational risk. Such other group entity could be a subsidiary of the bank, with the potential of downstream risk, or parent of the bank or affiliate under the control of parent i.e. upstream risk. • A Bank or DFI, together with other group entities under its control, could take exposures on a single borrower, borrowing group, or sector that are beyond prudential limits. Generally, on individual basis, there are per party exposure limits. However, various entities in a group may end up with an unusually large exposure on a collective basis. Moreover, since the entities within a group may be subject to different regulations, this may lead to regulatory arbitrage allowing banks to take advantage of the less stringent regulatory regime applicable on some of its subsidiaries. There might be specific intra-group linkages that could nullify the impact of conventional risk mitigation techniques at the group level by simply shifting the risk from one of the group entities to another. • Another problem is the overstatement of capital or double gearing whereby the capital of one entity is used to satisfy the requirements of more than one affiliate entities. This phenomenon is typical where investments are made by the parent body in its subsidiaries. Double gearing results in the overstatement of capital and can also lead to regulatory arbitrage. • Another aspect which is often difficult to detect is of intra group transactions, which might not be on arms-length basis. This increases the likelihood of fraud or siphoning-off of funds. • Liquidity risk arising from asset liability mismatch is also of great significance. Universal banking, since it houses diverse products with different asset liability structures and risk profiles, can be considered the most risky. In conventional banking, where universal banking is allowed, banks need to create firewalls so that no asset liability mismatches occur, and internal transfers of funds raised from one type of liability (i.e. short term deposits) are not deployed against a source which typically provides products with long term maturity (i.e. investment banking, insurance etc). • In the absence of a formal Holding Company structure, the corporate structures at the group level are quite opaque and in various cases create ambiguities about the roles and responsibilities of the board of one entity vis-à-vis another. Similarly, interference in the managerial functions of one entity by the officials of another has also been witnessed. Increasing complexities in the ownership and managerial structure of a group can make the supervision of financial institutions in the group difficult. • In view of the dynamic ownership structure of our banking industry, entry of foreign players in our market and investment by our banks abroad, it is necessary to take a holistic view and work towards an appropriate supervisory structure (consolidated supervision) to avoid any problem in future. Changes sought in the legal framework and supervisory regime These concerns and the risks associated with group relations warrant a comprehensive framework for supervision that evaluates the strength of an entire group, taking into account all the risks which may affect a bank/DFI, regardless of whether these risks are carried in the books of the bank/DFI or related entities. SBP firmly believes that the financial sector as a whole has a lot to gain through increased integration and conglomeration. However, the newly emerging phenomenon has to be properly monitored and governed under an appropriate legal framework to mitigate the potential risks. Keeping these factors in mind, three major changes are being proposed in the BCO. Firstly, the current supervisory set up has to be changed to bring under the fold of SBP, all deposit-taking Non Bank Financial Companies (NBFCs). The major rationale for this proposal is that these NBFCs are engaged in activities which are quite incidental to banking, both on the liability as well as the asset side. Bringing such entities under SBP would lead to greater supervisory efficiency, as being the regulator of banks, its supervisory approach is well equipped for their kind of business and the resulting risk profile. In this regard, the BCO ought to bring under its folds, besides banks and DFIs, NBFCs like Investment Banks, Leasing Companies, Housing Finance Companies that are until now outside its regulatory purview. Secondly, another change being sought is to authorize SBP to designate and regulate financial groups. Financial group for this purpose will be any group in which at least one of the entities is directly regulated by SBP. This is an extremely important step because it will enable SBP to effectively monitor the potentially dubious intra group transactions involving banks and NBFCs, and would also enable it to curtail the possible contagion risk. The proposed amendment would also enable SBP to seek information from the unregulated commercial entities and conduct limited inspection for verification of such information. For entities in a financial group which fall under the purview of the securities regulator’s supervision, the current supervisory mechanism also needs to be amended to move towards greater consolidated supervision. Under the proposed supervisory mechanism, the concept of lead and functional supervisors has been introduced. SBP would be the Lead supervisor for a financial group for consolidated supervision. Functional supervisor would be the regulatory body responsible to carry out supervision of the entity on a stand-alone basis under the relevant laws in force for the time being. In order to ensure that consolidated supervision is done effectively, and that there are minimal enforcement issues, the power to seek information, conduct onsite inspection in collaboration with the functional regulator, recommend enforcement action to the functional regulator etc. are being sought for the lead supervisor. Thirdly, the time is ripe for the introduction of a Financial Holding Company (FHC) concept. SBP has so far facilitated the increasing integration of various segments of the financial sector through various rules and regulations, and the next logical step is the creation of enabling legal provisions for the establishment of more efficient forms of conglomerate structures such as the FHC model. The FHC model is becoming popular in different countries, e.g. USA, Hong Kong, Singapore, India etc. The benefits of adopting a financial holding company model are as follows: (i) One of the key advantages of the FHC form of structure is that it provides separation of business activities and investment activities of financial institutions within a group. (ii) This structure would prevent the double gearing of bank’s capital and facilitate the growth of the financial sector, as new capital injection would be required for expanding businesses. (iii) It would be easy to establish firewalls and protect banks from risks arising out of non-banking activities. While banks will not be able to directly benefit from any profits of their non bank companies, the overall group will be strengthened. (iv) The sponsor shareholding of banking as well as non banking companies will become transparent and help SBP in ensuring that these institutions operate at arm’s length. The majority shareholding in a bank will be channeled through the FHC, and since under the proposed amendments, FHC supervision is with SBP, the shareholdings can be more closely monitored. (v) The structure provides organic growth without increasing contagion risk as it is very unlikely that the whole group will fail. In order to facilitate the FHC model, we are also seeking several amendments in the BCO covering its definition, licensing and supervision (which will be by SBP), capital requirement and various other aspects. In anticipation of these legal changes, SBP is also preparing supportive regulations to aid the effective development of financial conglomeration and their oversight. In conclusion, the proposed legal and regulatory changes, discussed above, to strengthen the oversight of the financial sector, are an integral element of the Ten Year Strategy and blueprint of financial sector reforms prepared by the central bank. Concurrently, SBP has also launched wide ranging reforms including capital augmentation of banks, shift to riskbased supervisory approaches, and proper implementation of Basel II. The private sector has responded well to SBP’s initiatives and a number of banks are launching work to take benefit of the emerging legal and regulatory changes to position their financial institutions better to compete in a more aggressive regional and global environment. | state bank of pakistan | 2,008 | 11 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the formal launching of Samba Bank Ltd. in Pakistan, Karachi, 1 November 2008. | Shamshad Akhtar: Reflections on global and domestic developments Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the formal launching of Samba Bank Ltd. in Pakistan, Karachi, 1 November 2008. * * * Year 2008 is and will be remembered as one of the most turbulent years in world’s economic history. Impact of the sequence of global events, ranging from global financial market turmoil to surge in global commodity prices, has impacted regions differently and unevenly. United States being the epicenter of the Tsunami of financial market upheaval, has witnessed deeper and steeper reverberations whose tremors have impacted all of Europe. From what started as turmoil in one segment of financial markets i.e. Subprime mortgage market and the CDOs etc., which constituted a very small part of the global financial assets, the ravaging fire has spread across all segments of financial sector, and across continents. Flight to safety also put pressure on commodity prices which appeared to be an alternate avenue to hedge investors from financial market upheavals. Financial markets’ indulgence in over-leveraging and reckless issuance of mortgage securities without due diligence, with resetting of pricing in a rising interest rate environment, overwhelmed both the issuer and the investor. Major money and interbank markets witnessed liquidity crunch as counterparties faced settlement difficulties and defaulted, adversely impacting credit markets. The problem magnified as the global liquidity crisis eventually hurt global financial institutions that one after the other collapsed under the stress. This was marked by falling share prices of financial institutions, rising cost of funding and credit default protection, and depressed asset prices. From a liquidity crisis, world financial markets faced a host of insolvency of global financial houses as the deleveraging gained momentum. Amidst all this, equity markets fell across continents and lost sizeable market capitalization with severe wealth effects at both industry and household levels. Financial markets and housing problems have significantly impacted global economic outlook that is now expected to slow down to 3% with advanced economies already in recession. Central bankers and regulators have been now firefighting for over 15 odd months. Aside from the steady easing of monetary policy, liquidity injections of unprecedented levels through offers of rounds of term facilities and specialized arrangements, and taking off illiquid securities off the financial institutions’ books etc., to a range of fiscal tax breaks and financial market revival packages that aim to recapitalize banks, liquidate troubled assets and further lubricate financial institutions have been offered. Global struggle to stabilize financial markets continues but has already changed the emerging financial landscape and has intensified exciting debates regarding the financial regulatory and supervisory architecture. The global scene has shaken confidence across economies and markets. Amidst all this, there are several reviews on how Asia fared and withstood the global financial shocks. Generally, Asia has been impacted but the impact has been steeper in countries with weaker macroeconomic fundamentals and low foreign exchange reserves and those with high exposure to CDOs and related products. As events have unfolded, myths regarding decoupling of Asia have evaporated. Abstracting from the larger debate of emerging complications for Asia, I propose to now concentrate on Pakistan. But before I dwell upon the domestic market, it is important to offer a qualifier that in the present environment there is a strong risk that analysis gets detracted by the global financial crisis and its diagnosis, and there is a tendency to draw parallelism between those developments and events and what has been happening in smaller developing countries. There is need for extreme caution and prudence in one’s analysis to ensure that we offer correct diagnosis of the highly impacted countries. What is happening in advanced countries is a financial market turmoil which manifested itself into a liquidity crisis that has now turned into an insolvency problem. The options and solutions being adopted are highly controversial, and unless accompanied by appropriate actions, could carry moral hazard and loss of tax payer’s money. In the context of Pakistan, the diagnosis is different. So rather than facing a financial crisis, Pakistan is caught in a complex macroeconomic problem as twin deficits rose to unprecedented proportion in fiscal year 2007/2008 which remained unattended for some period. Being an open and highly import dependent economy, Pakistan has been hit aggressively by the surge in global commodity prices whose impact magnified as the oil and other strategic import prices rose. As a result, the origins of economic ailments lie in the sharp growth in the domestic fiscal deficit and the external current deficit. Among others, a principal factor for growth in macro-economic imbalance is the continuous rise in import oil prices. On domestic account, subsidies on oil rose to Rs175 billion and on external account side oil import bill was equivalent to 6.9% of GDP or almost 80% of external current account deficit, as the price per barrel of oil touched its heights. During FY08, average price per barrel was $94.4 and the pressure intensified in Q1 of FY09 with average price barrel reaching close to $115.5. Another complexity was with local produce being short of requirements as well as distributional problems, both of which required the Government to import food items which were not anticipated at the start of the year. Concurrent with high global commodity prices, both public and private sector imports in value terms were much higher. Imports cumulatively in FY08 reached $40 billion – reflecting a growth of 30.9%. Burden of fiscal expansion was clearly unsustainable. The level of stress of the macroeconomic burden can be judged by the growing recourse of the budget on central bank financing, visible in decline in foreign exchange reserves and the depreciation in the currency. Imported inflationary trends and persistent growth in inflationary financing, food inflation as well as pass through of oil, utility and exchange rate adjustments all have combined and have resulted in high inflation. Unless addressed, this high inflation will hurt the competitiveness of Pakistan economy and has eroded the purchasing power of the poor most. Proactive monetary tightening over FY08 was needed and but for it there may have been more complications. The strengths of financial markets came under test during this chaotic period. The equity markets vibrated the most in line with the regional and international markets trends, but the domestic events also played their role. The banking system performed reasonably well despite the growing public and private sector demands for credit, but sentiments, rumor mongering and speculations regarding banks did trigger temporary liquidity constraints. Central bank’s timely intervention has continued to lubricate the financial markets. In the first round between 11 October to almost 20 October, 2008, the central bank released close to Rs250 billion and on 1 November we have additionally released close to Rs 30 billion. The stress on liquidity of course stems from the high public sector borrowings (both Government and parastatals) from the banking system, withdrawal of Government deposits, seasonal eid cash withdrawals from the banks, and the low growth in deposits with few weeks of panic deposit withdrawals. Steadily public confidence is being restored and banks are regaining lost deposits. The banking system has managed to thus far meet the financial requirements of the public sector, while also catering for the stock market as well as the non bank finance sector. However, a deeper analysis of financial stability which is underway has once again brought to the forefront the need for a more balanced growth of the various components of the financial sector. The efficiency of scale that emerges with the availability of long-term and alternative financing options from capital markets, has been conspicuous by its absence. The continued integration and deepening of financial markets is a significant issue for policy makers, and particularly for central banks that are entrusted with the formulation and implementation of monetary policy, since smoothly functioning and efficient financial markets are crucial in ensuring a smooth transmission of monetary impulses. The financial sector is too bank-centric, and the outreach and growth of the Non‐Bank Finance Companies and the Insurance sector have languished in recent years. NBFCs face direct competition from banks and are not likely to grow significantly until their funding sources and costs are streamlined. At the same time, growth in the insurance sector is weak, and private pension funds have only recently started to gather some pace. The insurance sector is unlikely to grow unless it gets an infusion of innovation and efficiency. This may require privatization and possible breakup of the dominant state-owned company. The interest from banks to associate themselves with insurance companies and develop new products for cross-selling may also revitalize the sector. Private pension funds have an enormous potential as indicated by the growth of such funds in other emerging markets, where they have become important and in some cases, principal institutional investors and the main providers of long-term funds. To build on the pace and momentum of financial sector reforms, SBP launched the next 10 years’ financial sector vision and strategy in July 2008. This strategy has been developed based on a comprehensive assessment and evaluation of the banking and the broader financial system that has helped identify the key issues and limitations. In order for the financial sector to develop and reach its potential, broad‐based growth will be required, not only of the banking sector but also of other financial institutions and markets. Despite spectacular value growth in recent years – much of which has disappeared in 2008 – the relative size of the equity market is still well below peer countries and must grow in the future, based on new company listings and issues. The biggest growth potential lies in the private debt securities market, the development of which would be essential for private investment, especially in transportation and energy infrastructure as well as in housing. The objective of the financial sector strategy will be to broaden and deepen the financial system to help Pakistan: (i) Achieve higher and sustainable economic growth, (ii) Develop a dynamic, robust and stronger system, (iii) Mobilize the domestic and foreign resources for private investment (which has to be the key driver of the economy), and (iv) Deepen financial penetration for poor and underserved regions. The major areas of reforms advocated in the financial sector strategy are: (i) Central Bank Governance: No reform can be complete without also further strengthening of the central bank. In this context, SBP has launched work to modernize the central bank legislation in line with the international best practices. Ours is one of the oldest laws in the world and as such it includes some outdated provisions, even though the law has served the central bank well in delivering several of its function. The new SBP Act ought to provide more autonomy of SBP, along with proper accountability, to pursue clearly defined goals of monetary and financial stability and would make explicit how the SBP has to report on its performance to the Cabinet and Parliament. (ii) Adoption of a holistic financial inclusion program which is quite far reaching both in its depth and breadth. Recognizing how underserved people and the regions of Pakistan are by financial markets, SBP has advocated commercialization of the microfinance industry which will help provide financially and socially sustainable financial services. Under this program, effort will be made to enhance outreach to initially 3 million people relative to fewer than one million a year back. Ultimate goal being to raise it to 10 million. In the same view SBP is steering the Islamic finance industry to also deepen financial penetration to serve the requirement of that segment of population and industry which has self excluded itself for faith reasons. SBP is planning to launch several initiatives to enhance SME financing and such initiatives include, among others, development of credit scoring, credit enhancement mechanism and innovative product and modalities etc. Plan is to also meet 75-80% of agriculture requirements and SBP is steering several initiatives ranging from crop loan insurance to offering guidelines for financing livestock, fisheries and horticulture etc. (iii) Strengthen consumer protection and financial education. Under this rubric, SBP plans to introduce a Consumer Protection Bill, requires PBA to adopt a Banking Code to commit banks to fairness, disclosure and ethical standards, while nurturing competitive pricing of products, strengthen the Consumer Protection Department which was recently established in SBP, transforming banking sector ombudsman, introduce the small depositor protection scheme and launch campaign of financial literacy. (iv) Consolidate and strengthen the banking sector by promoting continued mergers and acquisitions, while seeking to restructure the outstanding public financial institutions. To promote consolidation, SBP will maintain its moratorium on new licenses but will on exceptional basis issue license with capital requirements of $300 million – both existing conventional and Islamic banks will need to comply with these requirements over an agreed timetable. Licenses for Microfinance banks will continue but confined at national and provincial levels only. (v) Strengthening competition and efficiency. Among others, SBP will be seeking for removal of structural distortions facing the banking sector that has resulted in suboptimal pricing regime for the depositor and borrowers. A major competitive force for banks would however involve a financial sector wide campaign to stimulate the equity and debt markets so that banks compete effectively with their competitor institutions. (vi) Strengthen prudential regulation and supervision – while reputable experts have confirmed the adequacy of the regulatory regime, there is in my view need for debate and reflection of an adequate balance to be struck between rules versus principle based regulatory regime – but ultimately it’s the right enforcement which will ensure this regime is respected. In line with the global trend, SBP has launched Basel II implementation which requires banks to align their capital with the risks taken. Requirement of capital would be lower only if banks work with corporate sector to seek appropriate external rating or credit scoring mechanisms. On its part the central bank is launching a project to use e-CIB to develop an industry wide scoring system based on credit history as captured by e-CIB. (vii) Commercial banks now have de facto moved into conglomerate structure with or without holding companies framework. By and large banks have acquired stakes in NBF institutions including insurance, brokerage, financial advisory services etc. Financial conglomerate present a major regulatory and supervisory challenge as such structures are prone to contagion risk. (viii) To address these concerns, there is need to reconsider the regulatory architecture. Our current regulatory architecture is not well suited for consolidated supervision and no agency has powers to oversee financial/nonfinancial conglomerate. SBP proposes to transfer all deposit and lending institutions for oversight to SBP and to entrust it with the responsibility of lead supervisor for consolidated supervision. This has been a major omission in financial sector laws and regulations. (ix) Develop financial safety net frameworks which range from the introduction of small depositor protection scheme, empowering the central bank with the lender of last resort functions and developing an appropriate bank exit frameworks. It is critical that all these schemes are developed in line with international best practices while avoiding the moral hazard consequences. (x) Development of core financial infrastructure is critical which ranges from development of RTGS and retail payment system to credit rating agencies and land and property registries and judicial system. | state bank of pakistan | 2,008 | 11 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the convocation of the Institute of Business Management, Karachi, 6 December 2008. | Shamshad Akhtar: The effectiveness of monetary policy in Pakistan Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the convocation of the Institute of Business Management, Karachi, 6 December 2008. * A. * * Introduction Economic policies aim to increase the welfare of the general public, and monetary policy supports this broad objective by focusing its efforts to promote price stability. Embedded in this objective is the belief that persistent inflation would compromise the long term economic prospects of the country. The objective of monetary policy in Pakistan, as laid down in the SBP Act of 1956, is to achieve the targets of inflation and growth set annually by the government. In pursuit of this mandate, SBP formulates the country’s monetary policy that is consistent with these announced targets. In my remarks today, I plan to provide perspective on: • First, why central banks focus on price stability? • Second, how the monetary policy transmission mechanisms work? • Third, what are the principal features of Pakistan’s monetary policy framework? • Fourth, selected thoughts on effectiveness of Pakistan’s monetary policy framework • Finally, what measures are needed to improve the effectiveness of the monetary policy framework in Pakistan? These questions have been a subject of much debate lately, as monetary tightening – an inevitable policy response for regaining macroeconomic stability – has aroused anxiety but better public understanding of this question will help them to appreciate central bank’s monetary policy stance. B. Why focus on price stability? Before getting into other intricacies of monetary policy, it is useful to bring forth the importance of price stability as an overriding objective of monetary policy. Actual inflation outcome in the economy is driven largely by the level of output gap (the difference between what the economy is demanding and what it can potentially produce) and inflation expectations. When the output gap widens, the actual output is more than what the economy can sustain in the long run with stable inflation. This reflects excessive demand for available resources in the economy, which pushes up general prices. In order to stem the increase in resource cost and the general price level in the economy, this gap needs to be narrowed or stabilized. This can be achieved by either reducing the demand in the short run or increasing the productive capacity over the medium to long run. Reducing aggregate demand, however, entails reduction in current output and an increase in the unemployment level in the economy. The famous classical Phillips curve that captures the trade-off between stabilizing inflation and controlling unemployment was criticized by Phelps and Friedman in the late 1960s. They argued that if inflation expectations react to changes in actual inflation, then any trade-off between inflation and unemployment would be short-lived at best. If wages are set once a year and for some reason the output prices increase, then the producers have an incentive to increase their output by hiring more workers. However it is only possible if workers' expectations of inflation remain unchanged during the period of increase in output prices. If workers adjust their expectations in accordance with actual inflation and demand higher nominal wages, it leaves relatively little incentive for firms to increase the output. Therefore the focus has shifted away from this trade-off and new consensus has emerged in the literature that price stability is key to long run growth prospects. Both theory and evidence suggest that monetary stimulus can only affect real economic activity in the short-run. In the long run, however, there is no conflict between low inflation and full utilization of economic resources. Ensuring price stability, in turn, requires effective management and anchoring of inflation expectations. With stable prices, economic decisions can be made with less uncertainty and therefore markets can function without concern about unpredictable fluctuations in the purchasing power of money. On the other hand, high and unanticipated inflation lowers the quality of the signals coming from the price system as producers and consumers find it difficult to distinguish price changes arising from changes in the supply and demand for products from changes arising from the high level of general inflation. In the market economy, prices represent basic means of transmission of information; the increased noise associated with high inflation lowers the effectiveness of the market system. High and unanticipated inflation makes it impossible to plan for relatively longer outlook, creating incentives for households and firms to shorten their decision horizons and to spend resources in managing inflation risks rather than focusing on the most productive activities. Ben Bernanke argued that the Fed’s mandated goals of price stability and maximum employment are almost entirely complementary: “price stability is an end of monetary policy; it is also a means by which policy can achieve its other objectives”. 1 This argument has also been supported by Keneth Rogoff (1985) who advocated that the central bank should place larger weight on inflation stabilization, in order to increase the welfare of the society. Therefore, the competing goals of growth and price stability, which may seem to be at odds with each other, in fact boils down to a single objective i.e. price stability. In this backdrop, there is no surprise that most of the central banks aim at maintaining low and stable inflation. Central banks place more weight and demonstrate increased willingness on controlling inflation relative to output growth, and financial and exchange rate stability. It is important to acknowledge, however, that in practical policy making, adhering to revealed preferences is rather difficult. The reason is that central banks do not operate in a vacuum and require coordination with other policy making institutions, in particular the fiscal authority. In addition, the social and cultural make-up of a country and political economy considerations often require central banks to accommodate conflicting policies. In other words, sticking to an announced rule-based monetary policy can be difficult in practice; “enlightened discretion” is preferred by most central banks. Thus, SBP’s decision to focus on arresting the persistent inflationary trends is tantamount to a pro-growth policy, not a growth retarding one. C. Monetary policy transmission mechanism The monetary transmission mechanism refers to a process through which monetary policy decisions affect the level of economic activity in the economy and the inflation rate. Understanding the transmission mechanism of monetary policy is crucial for appropriate design and efficient conduct of monetary policy. As monetary policy actions affect policy variables with a considerable lag and with high degree of variability and uncertainty, it is important to predict the possible impact and extent of monetary policy actions on the real variables. Thus, by its very nature, monetary policy tends to be forward-looking. It is also important to know which transmission channels are more effective in terms of transmitting changes in monetary policy actions to ultimate policy goals. Since various financial sector developments particularly regarding introduction of new financial products, technological changes, institutional strengthening, and expectations about future policy, etc. http://www.federalreserve.gov/newsevents/speech/bernanke2006.02.24a.htm#f3#mainNav can potentially change economic effects of the monetary policy measures, there is a need to regularly update, empirically test and reinterpret monetary policy transmission channels. The impact of monetary policy is perceived to transmit in to the real economic activity through five channels. • The first channel and most widely studied and understood channel of monetary policy transmission relies on the link between changes in the short-term nominal interest rate (induced by changes in the policy rate) and the long-term real interest rate that ultimately affect components of aggregate demand such as consumption and investment in an economy. As such, it is the changes in the long-term real interest rates that have its impact on aggregate consumption, business investment and other components of aggregate demand. • The second channel, known as the credit channel, involves changes in monetary policy that not only affects the ability of firms to borrow money (by affecting their net worth) but also affects the ability of banks to lend money. The strength of this channel depends on the degree to which the central bank has allowed banks to extend loans and the dependence of borrowers on bank loans. These factors are clearly influenced by the structure of the financial system and its regulation. • The third channel of monetary policy transmission focuses on asset prices (other than the interest rate) such as the market value of securities (bonds and equities) and prices of real estate. A policy-induced change in the nominal interest rate affects the price of bonds and stocks that may change the market value of firms relative to the replacement cost of capital, affecting investment. Moreover, a change in the prices of securities entails a change in wealth which can affect the consumption of households. • Fourth, a policy-induced change in the domestic interest rate also affects the exchange rate that in turn affects the foreign financial flows, net exports and thus aggregate demand. The strength of the exchange rate channel depends on the responsiveness of the exchange rate to monetary shocks, the degree of openness of the economy, sensitivity of foreign private inflows and net exports to exchange rate variations, and the net worth of firms and thus their borrowing capacity if they have taken exposure to foreign currency. Moreover, exchange rate changes lead to changes in the domestic price of imported consumption goods and imported production inputs affecting inflation directly. • Since expectations influence the inflation dynamics, there is a fifth channel that is based on the economic agents’ expectations of the future prospects of the economy and likely stance of the monetary policy. According to this “expectations channel”, most economic variables are determined in a forward-looking manner and are affected by the expected monetary policy actions. Thus, a consistent, credible, and transparent monetary policy can potentially affect the likely path of the economy by simply affecting expectations. D. Monetary policy framework in Pakistan Considering the economic and financial market structure in Pakistan, SBP has for sometime pursued a monetary targeting regime with broad money supply (M2) as a nominal anchor to achieve the objective of controlling inflation without any prejudice to growth. The process of monetary policy formulation usually begins at the start of the fiscal year when SBP sets a target of M2 growth in line with government’s targets of inflation and growth (usually in the month of May) and an estimation of money demand in the economy. The basic idea is to keep the money supply close to its estimated demand level, as both a significant excess and a shortfall may lead to considerable deviations in actual outcomes of inflation and real GDP growth from their respective targets. Underlying this framework are two strong assumptions: first, there is a strong and reliable relationship between the goal variable (inflation or real GDP) and M2; and second, the SBP can control growth in M2. While containing the M2 growth close to its target level is the key consideration in the current monetary framework, the composition of the money supply does matter and at times requires policy actions even if these actions lead to a deviation in monetary growth from its target level. To understand this point, it is necessary to know the major components of money supply and their relative importance. Net foreign Assets (NFA) and Net Domestic Assets (NDA) of the banking system are the two major components of money supply. The NFA is the excess of foreign exchange inflows over outflows to the banking system, or in other terms it is a reflection of underlying trends in the country’s external Balance of Payment (BoP) position. It is estimated by the projected values of all major external transactions such as trade, workers’ remittances, debt servicing, foreign investment, and debt flows etc. The NDA of the banking system, which primarily consists of credit to the government and the private sector, reflects changes in the fiscal and the real sectors of the economy. It is estimated as a residual of M2 and the NFA. Further breakup of NDA is estimated on the basis of projected credit needs of the government and the private sector. Now coming to the importance of these components of the money supply, depletion in NFA is generally considered as an unhealthy development. Sharp NFA depletion reflects worsening BOP position and a pressure on exchange rate. In such a case, a higher NDA growth, though helps in expanding M2 to reach its target level, may further deteriorate external accounts, sharper depreciation of local currency, and higher depletion of country’s foreign exchange reserves. Although since FY07, only the indicative M2 growth target is being announced, SBP also takes into consideration the causative factors for monetary expansion while pursing this target. Considering the changes in monetary aggregates and other economic variables, the changes in monetary policy are signaled through adjustments in the policy discount rate (3-day repo rate). Further, the changes in the policy rate are complemented by appropriate liquidity management mainly through Open Market Operations (OMOs) and if required changes in the Cash Reserve Requirement (CRR) and Statutory Liquid Reserve requirement (SLR) are also made. E. Effectiveness of monetary policy in Pakistan Significance of various channels that transmit the monetary policy shocks in Pakistan to the real economy has been analyzed by few economists. Ahmad et al. (2005) found that credit channel is the most important conduit for transmitting monetary policy actions to the real economic activity. Evidence confirms transmission through the active asset price channel and exchange rate channel. According to this study, monetary policy shocks impact real output after a lag of 7 to 11 months. Tasneem and Waheed (2006), on the other hand, investigated whether different sectors of the economy respond differently to monetary shocks. The presence of sector wise differences in the monetary transmission mechanism has profound implications for macroeconomic management as the central bank then has to weigh the varying consequences of its actions on different sectors. Investigating the transmission of changes in interest rate to seven sub sectors of the economy, the authors found evidence supporting sector-specific variation in the real effects of monetary policy. They found that the interest rate shock on manufacturing, wholesale and retail trade, and finance and insurance sectors transmit after a lag of 6 to 12 months. On the other hand, monetary policy shocks have negligible impact on agriculture, mining and quarrying, construction and ownership of dwelling sectors. Generally, historical evidence does reflect that Pakistan has been a high inflation and high interest economy given its inherent structural weaknesses. The role and effectiveness of monetary policy appears more visible in the 2000s when financial sector reforms started bearing fruits in terms of a more market based money and foreign exchange markets. Entering the 21st century, the loose monetary policy stance in the face of low inflation, low growth and low twin deficits, along with structural measures to open up the economy and alleviate some first round constraints, triggered the economy on a long term growth trajectory of above 7 percent. Monetary policy stance was however altered as the inflationary pressures started to build up in 2005. At the end of the fiscal year, the economy, which had been showing sustained steady growth since FY01, registered a historically high level of growth (9 percent), average inflation rose sharply (9.3 percent) and the external current account balance turned into deficit (-1.4 percent of GDP). Coinciding with these developments, the fiscal module started to show signs of stress as the fiscal balance was converted into a deficit and the stock of external debt and liabilities, which had been declining since FY00 after the Paris Club rescheduling, began increasing. These indicators largely capture the high and growing aggregate demand in the economy on account of sustained increase in peoples’ income. With the emerging domestic and global price pressures, SBP tightened its monetary policy after a prolonged gap of a few years. The efforts to rein-in inflation, however, proved less effective due to a rebound in international commodity prices and a rise in domestic food prices later on. The rise in the international commodity prices, particularly oil, exacerbated the fight against inflation. The international oil prices (Arabian Light) rose from US$27.1 at end 2004 to US$50.9 at end 2006, whereas international food prices rose by 24, 24 and 21 percent during 2004, 2005 and 2006 respectively. 2 Realizing the complications of monetary management and adverse global and domestic economic developments, the implementation of SBP monetary policy during FY06 varied significantly from the preceding fiscal years. In addition to the rise in the policy rate, the central bank focused on the short-end of the yield curve, draining excess liquidity from the inter-bank money market and pushing up short-tenor rates. Consequently, not only did the overnight rates remain close to the discount rate through most of the year, the volatility in these rates also declined. These tight monetary conditions along with the Government’s administrative measures to control food inflation helped in scaling down average inflation from 9.3 percent in FY05 to 7.9 percent in FY06, within the 8.0 percent annual target. This was certainly an encouraging development, particularly as it was achieved without affecting economic growth as the real GDP growth remained strong at 6.6 percent in FY06. Monetary policy tightening was strengthened further. For FY07, the government set an inflation target of 6.5 percent. To achieve this, a further moderation in aggregate demand during FY07 was required as the core inflation witnessed a relatively smaller decline in FY06, indicating that demand-side inflationary pressures were strong. In this perspective, SBP further tightened its monetary policy in July 2006 raising the CRR and SLR for the scheduled banks; and its policy rate by 50 basis points (bps) to 9.5 percent. Moreover, proactive liquidity management helped in transmitting the monetary tightening signals to key interest rates in the economy. For instance, the Karachi Inter Bank Offer Rate (KIBOR) of 6 month tenor increased from 9.6 percent in June 2006 to 10.02 percent at end-June 2007 and the banks’ weighted average lending and deposits rates (on outstanding amount) increased by 0.93 percentage points and 1.1 percentage points, respectively, during FY07. In retrospect, it appears evident that monetary tightening in FY07 did not put any adverse impact on economic growth, as not only was the real GDP growth target of 7.0 percent for FY07 was met, the growth was quite broad based. At the same time, the impact of the monetary tightening was most evident in the continued deceleration in core inflation during Changes in annual average food price index; source: IMF commodity price data. FY07. One measure of core inflation, the non-food non-energy CPI, continued its downtrend from YoY high of 7.8 percent in October 2005, to 6.3 percent at end-FY06, and to 5.1 percent by the end of FY07. However, much of the gains from the tight monetary policy on overall CPI inflation were offset by the unexpected rise in food inflation. On the downside, however, broad money supply (M2) grew by 19.3 percent during FY07, exceeding the annual target by 5.8 percentage points. Slippages in money supply growth largely stemmed from an expansion in NFA due to the higher than expected foreign exchange inflows. Equally stressful was the impact of Government borrowings from the central bank during the course of the year. The pressure from the fiscal account was due to mismatch in its external budgetary inflows and expenditures. With the privatization inflows and the receipts from a sovereign debt offering at end-FY07, the Government managed to end the year with retirement of central bank borrowings, on the margin. By end-FY07, SBP holdings of government papers were still around Rs 452 billion, despite a net retirement of Rs 56.0 billion during the year. Another major aberration in FY07 emanated from the high level of SBP refinancing extended, for both working capital and long-term investment, to exporters. Aside from monetary management complexities, these schemes have been distorting the incentive structure in the economy. FY08 and beginning of FY09 was even more challenging FY08 was an exceptionally difficult year. The domestic macroeconomic and political vulnerabilities coupled with a very challenging global environment caused slippages in macroeconomic targets by a wide margin. After a relatively long period of macroeconomic stability and prosperity, the global economy faced multifarious challenges: (i) hit by the sub prime mortgage crisis in U.S in 2007, the international financial markets had been in turmoil, the impact of which was felt across markets and continents; (ii) rising global commodity prices, with crude oil and food staples prices skyrocketing; and (iii) a gradual slide in the U.S dollar against major currencies. Combination of these events induced a degree of recessionary tendencies and inflationary pressures across developed and developing countries. Policy-makers were gripped with the dual challenge of slowdown in growth and unprecedented rising inflationary pressures. Central bankers faced a demanding task of weighing the trade-off between growth and price stability. With the exception of few developed countries, most central banks showed a strong bias towards addressing the risk of inflation and responded with tightening of monetary policies. On the domestic front, the external current account deficit and fiscal deficit widened considerably to unsustainable level (8.4 and 7.4 percent of GDP). The subsidy payments worth Rs 407 billion by Government, which account for almost half of the fiscal deficit, shielded domestic consumers from high international POL and commodity prices and distorted the natural demand adjustment mechanism. While the government passed on price increase to consumers, the rising international oil and other importable prices continued to take a toll on the economy. Rising demand has cost the country dearly in terms of foreign exchange spent on importing large volumes of these commodities. Rising fiscal deficit and lower than required financing flows resulted in exceptional recourse of the Government to the highly inflationary central bank borrowing for financing deficit. At the same time the surge in imports persisted. As a result, inflation accelerated and its expectations strengthened due to pass through of international oil prices to the domestic market, increases in the electricity tariff and the general sales tax, and rising exchange rate depreciation. These developments resulted in a further rise in headline as well as core inflation (20 percent weighted trimmed measure) to 25 percent and 21.7 percent respectively in October 2008. Considering the size of macroeconomic imbalances and the emerging inflationary pressures, SBP remained committed to achieve price stability over the medium term and thus had to launch steeper monetary tightening to tame the demand pressures and restore macroeconomic stability in FY09. SBP thus increased the policy rate from 13.5 to 15 percent. F. What needs to be done to improve the effectiveness of monetary policy? Apart from taking policy measures to address the emerging challenges, SBP also introduced structural changes in the process of monetary policy formulation and conduct to make the monetary policy formulation and implementation more transparent, efficient, and effective. Specifically, during the last couple of years, SBP focused on • Institutionalizing the process of policy formulation and conduct, • Stepping up movement towards a more market based credit allocation mechanism, • Developing its analytical and operational capacity, • Improving its capabilities to assess future developments to act proactively, and • Improving upon the communication of policy stance to the general public. However, the following areas need attention and are key for effective monetary management. 1. Effectiveness of monetary and fiscal coordination would be helpful. Section 9A and 9B of the SBP Act (amended in 1994) articulates the institutional mechanism for economic policy making and coordination and defines the ground rules for both the process and the policy making. However, the track record of the Monetary and Fiscal Policies Coordination Board (MFPCB), established in February 1994 that requires quarterly meetings of the SBP and the government, has been less than satisfactory. Furthermore, the sequencing of economy-wide projections is done in isolation of the budget and monetary policy making process, and the budget making process has not respected the monetary compulsions. With rising spending and stagnating revenues, the budget assumes at the start of the year certain recourse to the central bank rather than treat it as mere ways and means advances. 2. For effective analysis of developments and policy making, timely and quality information is extremely important. However, due to weaknesses in the data collection and reporting mechanism of the various agencies of the country, information is not available with desired frequency and timeliness. Also there are concerns over the quality of data. Unlike many developed and developing countries, data on quarterly GDP, employment and wages, etc. is not available in case of Pakistan. Moreover, the data on key macroeconomic variables (such as government expenditure and revenue, output of large-scale manufacturing, crop estimates, etc.) is usually available with substantial lags. This constrains an in-depth analysis of the current economic situation and evolving trends, and hinders the ability of the SBP to develop a forward-looking policy stance. 3. Unlike many countries, both developed and developing, there is no prescribed limit on government borrowing from SBP defined in the SBP Act or the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005. Besides being highly inflationary, government borrowing from SBP also complicates liquidity management. Borrowing from the central bank injects liquidity in the system through increased currency in circulation and deposits of the government with the banks. In both cases, the impact of tight monetary stance is diluted as this automatic creation of money increases money supply without any prior notice. Moreover, access to potentially unlimited borrowings from the SBP provides little incentives to the government to put the fiscal accounts in order. Therefore, the foremost task to improve the effectiveness of monetary policy is to prohibit the practice of government borrowings from the SBP. In this regard, appropriate provisions are required to cease or limit government recourse to central bank financing through amendments in the SBP Act and the FRDL Act 2005. 4. Another issue is to make a clear distinction between exchange rate management and monetary management. Currently, there is a general perception that the State Bank is bound to keep the exchange rate at some predefined level and any movement away from this level is then considered as an inefficiency of the SBP. There is a need to understand that for an open economy, it is impossible to pursue an independent monetary and exchange rate policy as well as allowing capital to move freely across the border. Since the SBP endeavors to achieve price stability through achieving monetary targets by changes in the policy rate, it is not possible to maintain exchange rates at some level with free capital mobility. This can only be achieved by putting complete restrictions on capital movements, which is not possible. SBPs responsibility is to ensure an environment where foreign exchange flows are driven by economic fundamental and are not mis-guided by rent seeking speculation. 5. Finally, based on experience particularly gained during the last two months is to differentiate between liquidity management and monetary policy stance. Recently, when the banking system experienced extraordinary stress due to shallow liquidity in the system, rumor mongering heightened the general public anxiety over few banks’ sustainability. Consequently, the SBP had to intervene in the market by injecting ample liquidity through various measures. In some quarters, these changes were deemed as a change in the Bank’s tight monetary policy stance. However, this was not the case and the Bank had to clearly and repeatedly communicate that the existing stance is being continued. Later on, the Bank further tightened its monetary policy. It must be understood that quite often, liquidity management can drive the market interest rates away from the direction desired under the monetary policy stance. However, this has to be temporary and the interest rates are bound to move in the policy stance direction. To resolve this issue, the SBP is studying various options, including the introduction of a “Standing Deposit Facility” to keep the interbank rate within a corridor. In conclusion, it is imperative that above steps be taken urgently. Over the period, however, this needs to be complemented with much deeper structural reforms to synchronize and reform the medium term planning for the budget and monetary policy formulation process. Several studies and technical assistance have provided extensive guidance in this area, but the lack of capacities and short term compulsions have often withheld such reforms. What is important is to recognize that a medium term development strategy, independently worked out, would help minimize one agency interest which has often been a source of coordination difficulties. It would also help the budget making process more rule based than the incrementally driven process to satisfy conflicting demands. Reference: Ahmed N., H Shah, A. I. Agha, Y. A. Mubarik (2005), “Transmission Mechanism of Monetary Policy in Pakistan,” SBP Working Paper Series No. 09, State Bank of Pakistan. Tasneem, A. and Waheed, M. (2006), “Sectoral Effects of Monetary Policy: Evidence from Pakistan.” Pakistan Development Review, Volume 45, No. 4, Part II winter. Khan, Mohsin S. and S. A. Senhadji (2001), “Threshold Effects in the Relationship between Inflation and Growth”, IMF Staff Papers, Vol. 48 (1) pp. 1-21. Rogoff, Kenneth (1985), “The Optimal Degree of Commitment to an Intermediate Monetary Target”, Quarterly Journal of Economics, Vol. 100, No.4, pp. 1169-1189. | state bank of pakistan | 2,008 | 12 |
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Launch of Microfinance Initiatives, Karachi, 19 December 2008. | Shamshad Akhtar: Launch of microfinance initiatives Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Launch of Microfinance Initiatives, Karachi, 19 December 2008. * * * 1. Approximately 30 million Pakistanis are living in poverty. Despite consensus that microfinance is an effective tool to alleviate poverty, there is a wide gap between demand and supply of financial services for the poor and marginalized segments of population. The current outreach of microfinance services, 1.8 million customers, while a significant improvement over last few years, is a mere 5% of the potential microfinance market. Where there are challenges there are also numerous opportunities for growth of microfinance businesses. SBP and the Government of Pakistan are committed to increasing outreach and facilitating the development of the microfinance sector. To kick start real action, SBP with industry developed a Microfinance Strategy which was adopted in 2007. This strategy has set growth targets of increasing the numbers of microfinance borrowers to 3 million by the end of 2010 and 10 million by 2015. 2. The microfinance outreach increased by 47% at the end of December 2007 and by 13% as of September of 2008 as the concept of commercialization or for-profit microfinance business started to permeate. NGOs and MFIs have been seeking additional sources of funding in an effort to expand their operations and distribution of services. The enabling regulatory environment promoted by the SBP has helped MFIs to create innovative partnerships with commercial banks or transform themselves into a regulated entity which allows them to accept deposits and utilize mainstream sources of capital. Pakistan has proven to be leader in the Asian region in commercialized microfinance and is the first country to introduce a comprehensive legal, regulatory, and supervisory framework for formal microfinance in Asia. SBP initiatives for the promotion of microfinance 3. To realize the growth targets of microfinance, SBP has identified three concurrent steps the industry needs to undergo in order to fulfill set goals: 1) Sustainable cost-covering operating/business model; 2) Mobilize private domestic capital; and 3) Build human resource systems. 4. In order to develop these critical areas of the microfinance industry, SBP has undertaken several steps, which include, but not limited to: (i) State Bank launched the Financial Inclusion Program, aimed at eliminating market failures. FIP is a £50 million program funded by the UK Department for International Development (DFID) with several initiatives aimed at improving access to financial services for poor and marginalized groups and for small enterprises in Pakistan. (ii) State Bank has issued Branchless Banking Regulations, which is the regulatory framework to promote banking in remote areas using technology. (iii) SBP encouraged microfinance institutions to transform into regulated entities. (iv) SBP encouraged partnerships between the post office (PO) network and MF providers. Post Offices already manage over 4 million savings accounts, mainly small accounts below Rs 10,000, through more than 12,000 branches. There is scope for the Post Office and MF providers to join forces with the latter acting as intermediaries for funds raised by POs, especially as MF providers are constrained by limited funding. (v) SBP is encouraging new international players including BRAC and ASA who have already started microfinance operations in Pakistan. (vi) SBP has set up a special Micro finance focal group with an independent head and qualified staff to support these and other financial inclusion initiatives. 4. Many of these initiatives are recent and have yet to demonstrate effect vis-à-vis improved outlook for microfinance. However, the effectiveness of some of these initiatives may be improved in light of inferences drawn from microfinance industry trends. Broadly, the current outlook for microfinance remains optimistic, but we must examine emerging trends with caution. • First, the industry is still young and continues to be largely dependent on donor assistance to grow, which though necessary at infancy stage is an unsustainable approach to long-term development. It is, however, critical that MFBs move toward deposit mobilization to increase funds for on-lending to achieve of the National Strategy of reaching 10 million clients by 2015. • Second, cost-efficiency is especially important in the current environment of the global financial crisis where rising cost of borrowing will eventually impact cost of lending for MFIs and MFBs as they move towards commercial funding. Hopefully, the introduction of international players may encourage local organizations to develop cost efficient structures and improve the quality of available human resource. • Third, resource deficiency exists for microfinance not only in the form of funding. Human resource capacity must also be strengthened to provide quality microfinance services. Capacity building will take time as human resource development will primarily have to come from organic means given the unique nature of the microfinance industry. • Lastly, there are concerns over gender and regional participation will have to be critically examined and addressed in order to make microfinance’s ability to fight poverty more meaningful. New initiatives 5. Today the biggest challenge faced by microfinance is scaling up. Although microfinance operations can become successful in achieving sustainability, however, initially these cannot grow on solely deposit mobilization or retained earnings, nor can it raise capital in financial markets. In order for microfinance to play a bigger role in improving livelihood opportunities for the poor and alleviate poverty, it must be scaledup significantly and must become sustainable to be able to generate profits and mobilize deposits and capital from alternative sources. This would require a number of things including institutional strengthening and specific interventions to resolve market failures. The commercialization for greater outreach and sustainability require greater institutional building blocks which in turn require new partnerships. 6. I am pleased to announce that SBP today is launching three facilities for the support of microfinance sector to promote financial inclusion. 1) The Microfinance Credit Guarantee Facility 2) The Institutional Strengthening Fund; and 3) The Improving Access to Finance Services Fund 7. These measures are expected to ease liquidity constraints of microfinance providers in view of the tighter liquidity conditions and sudden spike in inflation which has severely affected the poor and marginalized segments of the society. The Microfinance Credit Guarantee Facility 8. This is expected to increase the flow of credit to microfinance sector. The facility aims to incentivize banks/DFIs to channelize funds to MFBs/MFIs for on lending to low income segment of the population. The facility will provide credit guarantees of up to 40 percent of the funding provided by Banks/DFIs and aims to develop market and graduate poor borrowers to mainstream financial service providers. The facility will be established at SBP with UK Government Financial Inclusion Program grant funds equivalent of up to GBP 10 million to be used as the guarantee fund. The State Bank has issued necessary guidelines for operationalizing the facility which were finalized after due consultation with stakeholders. 9. Commercial banks are allowed options to undertake microfinance business directly and in partnership with MFIs by providing wholesale funds to them for on-lending through four different modes i.e. a) MF counters in existing branches, b) standalone MF Branches, c) establishment of independent subsidiary MFB, and d) linkage with NGO-MFI. The MCG facility is expected to help raise local currency funds for eligible MFIs/MFBs. The loans portfolio under the guarantee scheme will be administered by banks. The facility will also help build links between micro borrowers and formal financial institutions. The familiarization of the bank with the client should eventually lead to the "graduation" of the borrower. The facility shall provide partial Guarantee to minimize the perceived risk premium by covering part of the losses incurred on funds made available to MFBs/MFIs with the advantage of leveraging the guarantee fund a number of times while keeping the incentive for banks/DFIs to collect the loan. The lending of MCG facility will help these institutions to play their role in the growth of micro credit more effectively. The Institutional Strengthening Fund 10. This Fund is designed to build capacity of the microfinance sector. The fund is expected to enhance potential for growth and create depth in outreach by improving human resource quality, service delivery and increasing service availability to potential microfinance clients. The fund is established at the State Bank under the UK Government’s Financial Inclusion Program that involved funds equivalent to Pound Sterling 10 million for institutional strengthening. The fund will provide grants for capacity building to generate on-lending resources through commercial sources, equity investments or deposit mobilization strategy through improvement in management, governance, internal controls and functions. The fund will also provide grants for employing cost reduction mechanisms for increasing outreach in rural and remote areas through product innovation, development or use of technology. In addition, the fund will provide grants for business development services to MFI clients or improving quality of services; and developing capacity for transformation of MFIs into licensed microfinance banks. 11. SBP has developed detailed guidelines, selection criteria and application format for ISF. The fund will primarily focus on institutions that are already regulated, or are in the process of seeking a license or have solid plans for restructuring in the near future. SBP regulatory oversight will ensure transparency and good governance practices, which will ultimately lead to greater investment in the microfinance industry. Moreover, ISF is capped at US$1 million per year per grantee and subject to at least 25% matching grant from the grantee. Grants may be made on an annual basis and institutions that qualify for funding in a year may also qualify for funding in another year subject to good performance and submission of another successful proposal through the approved application procedure. Improving access to financial services 12. This component is designed to enhance capacity of the microfinance sector and promote financial literacy. The fund has been established at the State Bank with help of an endowment of USD 20 million under the ADB-supported “Improving Access to Financial Services Program – IAFSP”. The fund will provide benefits for and have positive impacts on rural and urban communities, in particular the poor & the women. 13. These benefits are quantitative and qualitative in nature and include (i) capacity building and training of financial services providers to promote expansion into rural areas; product and service innovation, including savings, remittances and Islamic financial services; adoption and integration of new technologies and applications for improving access to financial services; (ii) capacity building and training of Government and regulatory authorities to support development of an inclusive financial sector and implementation of measures under the Program; and (iii) literacy programs (financial and basic) conducted by or on behalf of financial services providers for clients and potential clients to improve access to financial services and the utilization of finance. 14. To initiate provision of grants SBP has developed detailed guidelines, selection criteria and application format for the IAFSF. The fund will initially focus on regulated institutions to ensure transparency and good governance practices to attract investment in the microfinance industry. Grants shall be provided to projects that meet the criteria for improving basic & financial literacy of current and potential microfinance consumers besides promoting utilization of cost effective means for financial service delivery and expanding outreach to rural and remote areas. 15. In conclusion, I would like to highlight that all the SBP initiatives have strong support of the industry simply because of the partnership we have with the Pakistan Micro Finance industry and network. Ultimate success of these initiatives lies with both the banking and microfinance industry and we count on their continued dedication for promotion of microfinance industry. | state bank of pakistan | 2,009 | 2 |
Keynote address by Mr Syed Salim Raza, Governor of the State Bank of Pakistan, at the Institute of Bankers, Karachi, 18 June 2009. | Syed Salim Raza: Reflections on financial sector dynamics Keynote address by Mr Syed Salim Raza, Governor of the State Bank of Pakistan, at the Institute of Bankers, Karachi, 18 June 2009. * * * It gives me great pleasure to chair this event organized by the Institute of Bankers and to share some thoughts with senior bankers and the distinguished personalities attending. I wish to congratulate all those who have passed the IBP examination and have qualified for the awards to be distributed today. They deserve much appreciation on their achievement. I am sure the banking industry will utilize their knowledge for the larger benefit of our society and economy. I would like to take this opportunity to share some views on emerging trends in the financial sector. Even though financial institutions in Pakistan have remained largely insulated from the shocks of the global financial crisis, we cannot ignore the implications of events which started in the summer of 2007 in the global financial system. The crisis brought forth the realization that organizations which are not just too-big-tofail but also too-interconnected-tofail, are the major source of systemic risk. It reinforced the fact that complete reliance on mathematical model-based risk management systems is insufficient in assessing the wide array of risks faced by the financial sector, some of which need a more qualitative analysis and judgment. Most importantly, it showed how its protracted duration severely impaired the basic function of the financial sector i.e. efficient allocation of resources in the process of financial intermediation. As I will elaborate, the regulatory focus in Pakistan has strived to prevent and mitigate the occurrence of these factors as the financial sector continues to evolve and progress. The banking sector in Pakistan has undergone a sea change in the last few years. The unprecedented performance in terms of profitability, in building up a resilient capital base as reflected in the aggregate Capital Adequacy Ratio (CAR), implementation of Basel II and stringent provisioning requirements etc. have all contributed in providing a cushion against shocks from both the external and domestic macro-financial environment. Banks in Pakistan have been able to withstand the headwinds from weakening macroeconomic fundamentals since FY07. Now that the economy is poised for a turnaround, the banking sector has an even more emphatic role to play in supporting the real sector by meeting its financing needs. Admittedly, banks face a challenging environment going forward: first, there is increased credit risk in the industry, a large part of which emanates from the nature of economic cycles. Credit booms inevitably lead to higher NPLs in subsequent years. The loan portfolio of the banking sector registered an annual average growth of over 20.0 percent in recent years (CY02 to CY07). Some correction in the loan portfolio was, therefore, to be expected. Also, the build-up of macroeconomic pressures which eventually led to a slowdown in economic growth in FY09 aggravated the increase in NPLs of the banking system. This is a cyclical process and is expected to stabilize with the improvement in macroeconomic fundamentals. Sensitivity analysis by the SBP suggests that the banking sector is well placed to withstand credit risk shocks of a modest nature. The provisioning coverage ratio of around 70 percent at end March 2009 also shows a prudent and proactive approach towards credit risk management. Secondly, competition from NSS instruments offering a relatively higher rate of return has put increasing pressure on banks’ deposit generation capacity. Since the beginning of FY09, NSS instruments have seen a net inflow of Rs 206.7 billion, as compared to Rs. 86.6 billion in FY08. On one hand this augurs well in substantiating financial savings and meets the government’s objective of raising funds for deficit financing from non‐bank sources. However it does also imply that banks need to make concrete efforts to ensure sustained deposit growth by tapping the unbanked market, increasing financial penetration and facilitating the process of financial intermediation. Third, given the associated pressure on profitability levels, small banks faced the challenge of meeting the minimum capital requirements (MCR) specified by the State Bank of Pakistan in 2008. In response to the challenges in the macro-financial environment, we have rationalized the MCR and the time period in which it needs to be implemented, thus providing breathing space to the industry in difficult conditions, fostering competition and a levelplaying field in the industry. Notwithstanding these developments, banks in Pakistan are meeting the financing demands of not just the private sector, but as seen in the recent past, of the public sector enterprises as well. Private sector credit to GDP ratio has declined from 26.2 percent in FY08 to 20.2 percent by April FY09. Such developments reinforce the need for diversification in the available financing options. One of the most illustrative examples of the grave implications of a skewed financial sector is the East Asian crisis, where banks were the predominant provider of finance. Post-crisis reflection on events brought forth the realization of the significance of alternative debt markets and in particular, money and bond markets, as a complementary source of finance. Moreover, the continued integration and deepening of financial markets is a significant issue for policy makers, and particularly for central banks entrusted with the formulation and implementation of monetary policy, since well-integrated and efficient financial markets are crucial in ensuring a smooth transmission of monetary impulses to the economy. Indeed, banking sector dominance is an impediment to the fundamental principle of market competition; it leads to inefficiencies and therefore to sub‐optimal outcomes in the loan market, which may jeopardize the stability of the financial system. Consider the following: (i) When the banking sector has to face competition from a well developed local currency bond market, it is forced to improve the efficiency of its operations and develop corporate financial services beyond primary lending. In Pakistan, the banking sector faces very little competition from the corporate debt market. Indeed, extraordinary banking spreads, as witnessed in Pakistan recently, provide some evidence of the lack of strong competition and efficiency in Pakistan’s financial markets. So our capacity for corporate finance remains undeveloped. (ii) The short tenor of bank loans, itself a consequence of the nature of banks’ deposits in Pakistan, leads to maturity mismatch issues in the banks’ asset and liability portfolios. This essentially means that long-term funding needs are financed by a consistent roll-over of short-term loans and in times of tight liquidity, borrowers may find themselves unable to roll over their maturing obligations. Access to bond markets then serves the purpose of a complimentary, rather than the alternative source of finance, as encapsulated in the much cited example of the essential “spare tyre” that a financial system needs. This is particularly true when a growing economy like Pakistan needs to raise sufficient funds for financing long‐term infrastructure projects. (iii) When firms can raise their own funds through the issuance of market bonds, they are less dependent on banks and therefore not vulnerable to difficulties that banks might face. This also puts pressure on banks to diversify and widen their portfolio and service range, as they no longer possess captive clients. Consequently, banks can focus more on enterprisers in the economy that typically face credit constraints due to their small size, relatively new stage of development, or simply asymmetrical information. At present, the banks’ loan portfolio is highly skewed towards big sized loans. Only 0.5 percent of total bank borrowers with loans size of more than Rs 10.0 million take up 71.7 percent of banks’ loan portfolio. Among others, this indicates high concentration risk in the banking sector. Default of any of the three largest fund-based exposures can cause the aggregate CAR to fall below the minimum requirements. These risks can be easily managed in the presence of well developed capital markets. (iv) One inherent characteristic of bond and securities finance is the provision of better risk-sharing than banks. When securities are spread across a large number of individuals, the risk is more efficiently diversified. Better risk sharing then is an incentive for creditors to commit themselves for longer periods of time, thus facilitating the borrowers in meeting their long-term funding needs. Indeed, all this adds up to the stability of the financial system. Similar to the trend observed in most Asian countries, the major drivers of financial assets in Pakistan are deposits and government bonds, whereas corporate bond issuances remain a miniscule portion, with the total outstanding (listed) issues at Rs. 66.2 billion (0.5 percent of GDP). Pakistan Investment Bonds (PIBs), introduced in the year 2000, remain the longest tenor sovereign bonds, providing the benchmark yield curve for private issuances, whereas National Savings Schemes (NSS), on the other hand, with tenors up to 10 years, provide risk‐free investment options to retail and institutional investors. The funds mobilized through NSS reached Rs. 1.3 trillion by end April-09 (9.9 percent of GDP). Historically, the key obstacle to the development of the corporate debt market has been the competition for long term investment alternatives from the NSS instruments, which offer zero risk yields higher than returns on corporate bonds. In order to align NSS rates with marketbased yields on instruments of similar tenors, the yields on NSS instruments were first reduced, and then pegged to the yields on the government’s market-based long term bonds. From March 2000, institutional investors were barred from incremental investment in NSS. These measures helped in developing bond market to some extent as the number of issuance increased subsequently. The corporate sector issued 69 TFCs worth Rs 45.7 billion during FY01 to FY07. Market activity slowed down in the following years due to both overall slowdown in economic activities and the policy-reversal by the government to re-allow institutional investment in NSS. The corporate sector issued only two bonds worth Rs 6.1 billion during FY09. In view of the above, the following factors could potentially facilitate the development of a debt market in Pakistan. (i) The banking sector, which has a virtual monopoly on providing financing to all sectors of the economy, can play a central role in the development of the debt market. Banks are often among the most important issuers, holders, dealers, advisers, underwriters and guarantors in the market. Given the skewed nature of their balance sheets with maturity mismatch issues, banks can issue long-term bonds for Asset Liability Management (ALM). This is particularly relevant from the perspective of financing long term projects. To further manage their risk profiles in changing interest rate environments, there are now sophisticated risk‐management tools such as Interest Rate Swaps (IRS) at their disposal. (ii) The central bank has a crucial role in promoting secondary market trading of debt securities – by improving the effectiveness of monetary policy implementation. Efforts to reduce the volatility of short-term interest rates, while credibly signaling the policy stance, go a long way in increasing investor confidence while promoting the maturity transformation of financial intermediaries’ portfolios. Moreover, stable money market rates foster repo activity and anchor the yield curve as trading develops in longer maturities. SBP has focused essentially on improving the transmission of the policy rate, by managing market liquidity and maintaining the O/N repo rates close to the discount rate. This approach has proved to be very effective and SBP will continue to work towards further improving the mechanisms of monetary policy implementation. (iii) Development of the term structure of interest rates depends on regular issues in the primary market, increased trading activity in the secondary market, and providing ease of entry and exit to both the issuers and the investors. Regular auctions of Pakistan Investment Bonds (PIBs) since May 2006 is a step in this direction. Developing bond markets and enhancing the capacity of public- and private-sector borrowers to issue long-dated, domestic currency denominated debt securities is high on the country’s policy agenda. Among other factors, the presence of the requisite investor base is crucial for the development of both the primary and the secondary markets in debt securities. The regulatory environment should provide the right incentive framework to encourage both individual and institutional investors to invest, and trade in, debt instruments. A wide range of investors, with varying risk preferences, time horizons and trading motives would ensure active trading and liquidity. Having shared these thoughts, I would like to conclude by saying that SBP stands committed to develop and diversify the financial sector in order to enhance its role in supporting economic growth. Pakistan is standing at a juncture where investment in infrastructure is crucially needed to facilitate the process of economic growth. The very nature of infrastructure projects, where funding is required for long tenors and cash flows only start to materialize after a certain time, is such that options for effective financing will only be possible once there is requisite support from the development of the local currency bond market and the financial sector provides access to a wide range of diversified financing options. | state bank of pakistan | 2,009 | 10 |
Speech by Mr Syed Salim Raza, Governor of the State Bank of Pakistan, at the Pakistan Branchless Banking Conference 2010, Karachi, 17 April 2010. | Syed Salim Raza: Need for alternative delivery channels in promoting access to finance Speech by Mr Syed Salim Raza, Governor of the State Bank of Pakistan, at the Pakistan Branchless Banking Conference 2010, Karachi, 17 April 2010. * * * Dr. Muhammad Yasin, Chairman Pakistan Telecommunication Authority, Mr. Ali Arshad Hakeem, Chairman NADRA, Mr. Haroon Sharif, Regional Advisor DFID, Distinguished Speakers, Ladies and Gentlemen, 1. On behalf of SBP, may I extend a very warm welcome to all, to Pakistan’s Branchless Banking Conference 2010. Today’s forum has participants from diverse backgrounds, from the banking, microfinance, and telecommunication sectors, as well as donors and government agencies, setting the stage for a creative and fruitful working session. 2. There are about 4 billion unbanked people 1 in the world, which is more than twothirds of the population of low and middle-income countries. In Pakistan, the ratio of financial exclusion is even higher. In spite of the availability of an enabling policy environment, and government and donors-supported incentives, the existing outreach is about 12%. It is in our greatest self interest to develop inclusive financial systems which provide low income and marginalized communities with increased access to viable financial services, thus allowing them to become a critical component in, and contribute to, the country’s economic development. Alternative delivery channels 3. Traditionally, the provision of financial services to the low income population is often based on personal, one-to-one relationships, making it human resource intensive. Thus, financial institutions have to incur high costs for building and maintaining branch networks and developing trained personnel. Alternative delivery channels can reduce these costs and offer a balance between personalized services and emerging transactional services, such as mobile banking. Research conducted by the CGAP Technology Program in 2008 found that using third-party agents costs on average 30 times less globally and 76 times less in Pakistan and replacing them with a mobile phone further cuts costs in half. 2 The most common of these delivery channels include mobile phones, third party agents, and use of PoS terminals. 4. In addition to significant cost reduction, alternative delivery channels expand outreach to areas in which the traditional bricks and mortar approach is unfeasible, and also increases product diversification by making savings and remittance products convenient, efficient and profitable. On the client side, such delivery channels provide unprecedented convenience through remote payments. Here, I would like to mention that SBP is facilitating the microfinance sector in rationalizing current high cost structures. GoP has granted certain M. Pickens, D. Porteous, and Sarah Rotman, “Scenarios for Branchless Banking in 2020”, Focus Note No. 57, CGAP and DFID, Oct 2009. G. Ivatury and I. Mas, “The Early Experience with Branchless Banking”, Focus Note No. 46, CGAP, April 2008. tax incentives to the sector. We expect that NADRA would also favorably consider its fee structure for clients’ verification for MFBs. Branchless Banking – international experience 5. Ladies & Gentlemen, mobile banking has come out globally as the most innovative alternate delivery channel in recent years. Mobile banking has successfully accelerated financial inclusion and changed the financial landscape in many developing countries. Mobile phones are compensating for inadequate infrastructure, slow postal services, and the limited coverage of banking systems in these countries. 6. Take for example, Kenya where the largest mobile service provider, Safaricom launched M-PESA in 2007. It now has nearly 7 million clients in a country of 38 million people. It records an average of 10,000 new registrations per day. M-PESA offers mobile phone-based services to clients across the country through a network of more than 10,000 agents for account opening, handling of deposits and withdrawals into the customer’s virtual “wallet,” and customer support services. These agents can take cash from customers and credit it to their mobile account, and transfer money to other registered users. M-PESA has significantly reduced many of the spatial and temporal barriers to money transfer. The important outcome of M-PESA is the penetration of money flows to rural and hard-to-reach areas. According to a recent study, the income of Kenyan household using M-PESA has increased by up to 30% since they started mobile banking. 7. In Asia, Philippines was an early user of mobile banking initiatives. The central bank of Philippines (BSP) has played an active role in the emergence of mobile banking. The BSP allowed two models for mobile banking. In first model i.e. bank-based model, the BSP allowed banks to outsource functions to one mobile operator i.e. Smart Money in 2001. In the second model i.e. nonbank-based model, BSP registered G-Xchange (a subsidiary of a giant telecom, Globe) as a remittance agent in 2004. Under both the models, merchants were allowed to conduct KYC. 8. Most mobile phone based banking in Philippines has been supported by the two giant mobile network operators – Globe and Smart. Out of 39 million “Smart” subscribers, 2.5 million are using “Smart Money”; and out of 23 million Globe subscribers, 1.2 million are using GCash services. According to the BSP, the average home remittance costs the sender between 2.5% to 5% in the conventional system whereas the same routed through GCash or Smart Money would cost less than 2%. Low-income Filipinos now use “mobile money” to send and receive domestic remittances – on average US$50. They use “mobile money” to purchase airtime and make purchases remotely. Moreover, the policy makers are currently focusing on “savings” as a future service for mobile banking. Branchless Banking – Pakistan 9. Ladies & Gentlemen, now let us look at Pakistan. Our financial sector is going through a dynamic transition, led by increasing uptake of technology solutions. This transition can be seen in recent e-banking data, with a transactional volume of 46.4 million e-payments valuing Rs. 4.1 trillion during a single quarter of October–December 2009. These volumes are expected to grow substantially as Pakistan has currently 95 million mobile users compared to 26 million bank accounts, highlighting the inherent potential for mobile banking in Pakistan. 10. Pakistan is the first country in South-Asia to have issued Branchless Banking Regulations, providing commercial and microfinance banks a supportive regulatory environment for developing partnerships and innovative delivery channels. Our regulations support the bank-led model, in which the entire control & responsibility of the product and program rests with the authorized financial institution. Due to inherent risks and existing legal framework, the telco-led model has not been permitted at the moment. These actions were reinforced by the Ministry of Information Technology and Pakistan Telecommunication Authority, which issued policy directives to provide technical support for the implementation of Branchless Banking in Pakistan. 11. With an enabling regulatory structure and growing technology sector, Pakistani banks and microfinance players can now utilize international best practices and models to diversify their financial services and develop partnerships for managing special initiatives. 12. As a result of Branchless Banking regulations, at present three models are operating in Pakistan. The first is MFB’s kiosks at retailer’s premises. Under this model, the First Micro Finance Bank (FMFB) developed partnership with Pakistan Post to expand its delivery channels. Under this model, more than 40,000 borrowers have been reached out through 68 offices of Pakistan Post. 13. The second model is “Retailers” acting as MFB’s agents. In October 2009, Telenor and Tameer launched the largest Branchless Banking initiative in Pakistan, Easy Paisa. This allows individuals to use services such as utility bills payment, domestic remittances, and a deposit account (M-wallet) by visiting their nearest EasyPaisa authorized shop, Telenor Franchise, Telenor Sales & Service Center or Tameer Bank branch. Tameer has utility bills payment arrangement with nine utility companies. Tameer has opened over 25,000 Branchless Banking customers accounts. Cumulative volume of transactions of Branchless Banking services till the end of March 2010 is over Rs. 4 billion with over 1.3 million transactions. Going forward, Tameer will also introduce foreign inward remittances. 14. The third model is led by commercial banks. MCB Bank is currently providing both transactional and non-transactional services through mobile phones to its registered customers. MCB Bank has registered over 60,000 customers with 200–300 new customers signing up each on MCB Mobile. MCB Bank has transacted over Rs. 1 billion with over 175,000 transactions. In addition, another commercial bank, UBL is also providing Branchless Banking. UBL’s model is different from Tameer’s since it is based on selection of individual agents that will work as “Direct Agents”. UBL has also successfully worked for IDPs for dispersal of government fund and multilateral donor funds through their Branchless Banking infrastructure. In addition, SBP has recently allowed Dubai Islamic Bank to offer Branchless Banking at convenient public locations like Shopping Malls, Clubs, Societies and Schools where potential customers exist. The Branchless Banking services shall be provided by creating a Branchless Banking Desk at these public locations where Dubai Islamic Bank’s staff shall serve the customers’ banking needs. 15. In addition, a new model is emerging in which a retailer or a telco establishes its own microfinance bank. I am happy that a few large retail organizations and mobile network operators are currently in the process of establishing their own Microfinance banks to leverage their retail networks and mobile phone technology to extend the distribution of financial services throughout Pakistan. This new model has a great potential to expand the frontiers of financial access especially in the far-flung areas. At present, State Bank is reviewing their applications for the grant of microfinance bank license. Concluding remarks 16. As Branchless Banking channels become increasingly available, the speed at which financial services reach the un-served population will depend on the actions and decisions of both the public and private sectors. State Bank has developed a regulatory environment which extends the frontiers of Branchless Banking. SBP will continue to actively engage with financial as well as non-financial players to stimulate the adoption of innovative delivery channels for expanding the frontiers of financial access. 17. Supported with the necessary regulatory environment, the private sector has to take the necessary steps for rapid uptake of Branchless Banking. The providers should set realistic expectations of their time horizons and potential returns. Those institutions which build their competence to manage potential risks early, will have more robust results. 18. The increasing use of Branchless Banking will help lift the trajectory of financial inclusion in the country. Critical to this trajectory are the decisions that we take and it is our joint responsibility to build a healthy and proactive financial sector in the country. I wish for vigorous and productive discussions at today’s Conference and look forward to have your valuable insights and recommendations for our current as well as future Branchless Banking development initiatives. | state bank of pakistan | 2,010 | 4 |
Speech by Mr Muhammad Kamran Shehzad, Deputy Governor of the State Bank of Pakistan, at the National Conference on Alternative Dispute Resolution (ADR), Lahore, 29-30 April 2010. | Muhammad Kamran Shehzad: Commercial mediation in emerging markets – role of State Bank in promoting mediation for resolution of banking disputes Speech by Mr Muhammad Kamran Shehzad, Deputy Governor of the State Bank of Pakistan, at the National Conference on Alternative Dispute Resolution (ADR), Lahore, 29–30 April 2010. * * * I feel privileged to be here today and share some thoughts on ADR mechanism for the resolution of banking disputes in Pakistan. Let me admit at the outset that Pakistani banking sector is not yet fully geared to avail maximum benefit from mechanism like mediation for settlement of disputes. The main reason seems to be the lack of awareness and perceptions of losing legitimate legal rights especially in the matters of recovery of loans. However, due to world-wide popularity of ADR, these perceptions are changing and both banks and their customers are becoming aware of alternatives available for settling disputes without compromising their interests. Keeping in view the potential of ADR as a viable dispute resolution mechanism, there is always a natural preference for it over litigation. However, there is need to disseminate the pros and cons of ADR in a correct perspective so that parties realize the significance of ADR. I believe that collective efforts of all stakeholders and an integrated approach can familiarize ADR in banking circles and SBP as a regulator on its part is willing to support this initiative. In the general sense, ADR means out of court settlement of disputes by way of mediation, conciliation, arbitration or expert determination. Arbitration is more relevant in the international context since overseas investors and parties generally require Arbitration clause in agreements. The mediation on the other hand is more relevant, cost effective and speedy way of resolving commercial disputes under which parties agree to ask a third person to help them find a solution to their dispute. Due to phenomenal growth and expansion of international transactions worth trillion of US dollars across borders and territories, disputes also increased manifold between citizens and governments and citizens of one country with citizens of another country. The cases filed by the parties in courts for resolution of disputes and enforcement of contracts overburdened the legal machinery. The developed countries therefore, introduced the concept of settling disputes outside the court under the name of Alternate Dispute Resolution in 1970s. The emerging economies and more specifically countries like Singapore, Malaysia, Hong Kong and Indonesia already have developed a certain kind of ADR system as per their local environment and legal systems. Indonesia has particularly established a solid system of ADR for banking system. The central bank – Bank Indonesia has issued detailed circular for banks to avail ADR for settling disputes and hence banking mediation has been institutionalized. Malaysia has also established Financial Mediation Bureau as an independent body to help resolve disputes between financial institutions and their customers. Monetary Authority of Singapore has been promoting the ADR mechanism through educational supportive programs. The central bank of Morocco created a system of resolving bank and borrowers disputes. It may be noted that the concept of settling disputes outside court is historically well known to Pakistani society in the form of Punchayat and Jirga etc. The experience of long consumption of time through formal judicial system is very common phenomenon. The courts are over-burdened due to huge backlog of cases. It is in this perspective that Law and Justice Commission of Pakistan recommended ADR to provide relief to the parties engaged in litigation. Accordingly, the Government in 2002 had made amendments in Civil Procedure Code under which Section 89 B was inserted to empower civil court to adopt ADR subject to consent of the parties. A consequential amendment was also made in Order X of C.P.C to empower the court to pass necessary orders for expediting the trial proceedings. Unfortunately, these provisions have somehow not been fully utilized due to which objective and benefit of these amendments is currently not visible. It would be important to keep in view the fundamentals of banking sector in Pakistan while examining the relevance and significance of ADR in the prevailing circumstances. Besides walk-in customers, over 25 million people currently have regular accounts with banks in Pakistan. The deposits of the banking system stand at about rupees 4.8 trillion whereas loans and advances extended by banks as of December, 2009 were rupees 3.2 trillion. The amount of nonperforming loans at present is rupees 432 billion. The banks have filed 56320 recovery and execution cases in courts involving rupees 215 billion. The cases filed by borrowers and customers other than recovery suits are in addition to the aforesaid cases. The foregoing facts amply clarifies that there is overreliance on courts for all disputes which the parties cannot resolve themselves. Due to high stakes, parties are sensitive to protect their rights. Therefore, there is a dire need of putting in place a mechanism of dispute resolution which is speedy, cost effective and just to maintain confidence and continuity of banking transactions. Let us look at some elements of existing mechanisms of dispute resolution where SBP is wholly or partially involved. The events like privatization of financial institutions, liberalization in the economy, stiff competition among the market players, advancements in information technology and telecommunication have brought about newer aspects of complexities along with growth of the banking sector. The increasing complexity in the products being offered by banks and substantial growth in consumer credit has caused a significant increase in the number of complaints with diverse nature of disputes. Although SBP continued to redress public grievances against banks, the increasing number of complaints require a reliable and independent source of complaint redressal. Therefore, institution of Banking Mohtasib Pakistan was established in 2005 under Part VI A of Banking Companies Ordinance, 1962. It may be clarified that jurisdiction of Banking Mohtasib is well defined and not restricted to maladministration of public sector banks only. The Banking Mohtasib is competent to entertain complaints from customers, borrowers, banks or from any concerned person. In the first instance, the Banking Mohtasib has been mandated, under the law, to try and facilitate an amicable resolution or settlement by resorting to mediation, failing which he can pass an order that if not appealed against within a defined timeframe becomes final and operative. As per Report of Banking Mohtasib, it has disposed off 2879 complaints in 2009. While it is a very modest beginning, State Bank is assisting Banking Mohtasib to increase its capacity and outreach to facilitate the aggrieved customers of the bank. SBP’ Consumer Protection Department: Besides direct complaints received from general public, State Bank is appellate authority against decisions of Banking Mohtasib under the same Part VI A of Banking Companies Ordinance. Till 2008, SBP was handling public complaints through Banking Policy and Regulations Department. However, in the wake of increasing number of complaints as also due to its enhanced responsibility as appellate authority against decisions of Banking Mohtasib, SBP created a specialized department namely, Consumer Protection Department to resolve banking disputes in a more focused and professional manner. The department was able to dispose of 8000 complaints during the year 2008 whereas during 2009 a total number of 13000 complaints were handled. The very objective is to provide a faster, cheaper and efficient way of redressing public grievances and resolving disputes. SBP feels that it has contributed toward reduction of court cases which in the absence of the mechanism were sure to go in courts. In addition, various courts have been sending cases to SBP where matters involved technical scrutiny and analysis of facts. As per court orders, SBP successfully resolved a number of disputes involving banks and customers. It is pertinent to mention that SBP had issued directive under Circular No. 17 of 2004 in terms of which banks are required to put in place a complaint handling system. The objective is to promptly resolve the issues received directly by banks or referred by other quarters including SBP. However, the mechanism cannot be relied since bank being a party to the dispute would have natural inclination to prejudice the other party. In a related development, High Court while disposing of several Writ Petitions relating to recovery of finance had emphasized the importance of ADR. The Hon’ble Court observed that litigation is not only time consuming but also has adverse implications for business environment. The Court further desired SBP to issue instructions to banks that before approaching courts, attempt should be made to resolve disputes through mediation/ reconciliation. Subsequent to Court Orders, Karachi Centre for Dispute Resolution (KCDR) met SBP and desired issuance of instructions to banks for availing remedies available through the Centre and support holding of seminar for banks. Accordingly, SBP circulated aforementioned Court Order to banks on March 09, 2009 with the view to let the banks know about availability of ADR mechanism and give an indication that both the Courts and SBP support the use of ADR. A seminar was also held for banks through Pakistan Banks Association in SBP in May, 2009. The foregoing facts fully explain that SBP supports the idea of resolving disputes outside the court. The expeditious settlement of issues would be in the interest of banking system in particular and economy in general. The bank management would be able to devote their time to business and other prioritized areas instead of being bogged down in lengthy time consuming disputes with their customers. Likewise customers would also be able to settle their cases and move forward with their businesses. It is, therefore, a win-win proposition for all stakeholders. Unfortunately as per feedback received from KCDR (Karachi Centre for Dispute Resolution), the number of cases referred by banks to it is extremely low on one hand and even the referred cases were haplessly non-productive due to non-traceability of parties or issues involving willful defaults. The customers of banks also prefer to lodge complaint against banks either with Banking Mohtasib or directly with SBP. The exact reasons of low number of fit cases not being referred to KCDR cannot be explained; prima facie it could be partially due to the following factors. First as I mentioned earlier is the lack of awareness about the available mechanism or institutions like KCDR for alternate dispute resolution. This can be taken care of with some workshops and seminars or conferences on ADR. Second, high profile cases involving big amounts are directly filed in courts to secure banks’ interest in a more formalized way especially to avoid charges of negligence or collusion. Thirdly, the failure of mediation results again in continuation of legal proceedings. Since there has been a tendency in defaulters to stretch legal proceedings as much as they can, the banks may have an apprehension that ADR would also be used by such unscrupulous elements to further delay the course of justice. Where amounts are small, parties prefer to send a single page application to SBP without incurring any cost. SBP enjoys high degree of public trust and complainant believes that SBP takes action on merit. The customers of banks not only get final decision of the case but interim interaction is also maintained for further information or sometimes meeting in SBP. In this way, customers get relief without incurring any cost or going through any hassle. SBP has presence all over Pakistan. Although complaints are handled in Karachi, the field offices of SBP properly guide general public to process their applications. Neither Banking Mohtasib nor SBP charge anything for complaint redressals. The fee charged by KCDR may in some cases be the reason especially in small disputes. Going forward, there are certain expectations from SBP to promote ADR. Setting up an independent mediation centre: SBP feels that currently institution of Banking Mohtasib and Consumer Protection Department are functioning satisfactorily. Further, SBP considers KCDR as a reliable center. The parallel system of mediation would not be appropriate due to defined role and responsibilities of SBP under the banking legislation. However, SBP would welcome cases referred by Courts or any other quarter involving banking disputes. Awareness events from SBP Platform: SBP supports this and intends to hold meeting of Senior Executives of banks in SBP. KCDR would be invited to explain in detail the facilities and benefits of mediation. Besides, it would be clarified to banks that SBP not only has any reservations over utilization of mediation but supports it due to its advantages over litigation. Inclusion of mediation in curriculum of banking courses/training Programs: This is also agreeable. New entrants and existing staff are provided necessary training through NIBAF and inclusion of suitable material on the subject would be helpful in creating awareness and understanding of the mechanism. We would obviously welcome suggestions of KCDR in finalizing curriculum and imparting training. Issuance of policy directives to banks: It would not be appropriate to prescribe a particular way of seeking remedies especially keeping in view the regulatory role of SBP. The directives issued by SBP are binding on banks and as a matter of policy we can facilitate, encourage but not force banks to avail facilities of KCDR. This is the decision which parties have to make themselves. Otherwise, directives issued by SBP run counter to the spirit of ADR/ mediation which is necessarily a mechanism based on mutual consent of the parties. Mediation under “terms and conditions” of various products: We are of the view that Pakistan Banks Association is in a better position to evaluate whether banks should include it as a condition of the agreement or not. SBP is neutral in that it is for banks to decide which option they want to avail in case of disputes. Taking advantage of this forum, my message today is same as observed by Hon’ble Court that prior to filing cases in courts, the option of mediation/reconciliation should be explored to avoid unnecessary costs, time and inconvenience. This would not only benefit the parties but facilitate release of valuable resources for the businesses which are critically dependent upon timely availability of funds. Further, the court system would be receiving lesser number of cases and hence its efficiency will increase. In my view, mediation has at least the following positive points as compared to formal court litigation: i) ADR enables settlement between the parties with their consent and cooperation. Therefore, unlike court case, none is loser but a win-win situation for the parties. ii) The costs of ADR relative to court expenses are substantially low. Further, the cost of ADR is shared by the parties whereas under court decision loser has to pay costs if allowed by the Court. iii) ADR provides solutions quickly, cost effectively and privately as against lengthy procedures of court proceedings, high expenses and no privacy. iv) ADR not only economizes on case expenses but saves valuable time of human resource and management as well as stress related to Court cases. v) The parties set venue and timing for ADR proceedings whereas Court rules are to be strictly followed for court proceedings. vi) The parties use delaying tactics due to which court cases linger on for years. The next date of hearing comes after months. The parties under ADR cooperate and the matter can be resolved even before a week. Finally, I thank IFC and KCDR for organizing the event which I believe will achieve its objective of disseminating ADR knowledge and creating awareness. SBP will continue to play its due role for early resolution of banking disputes. | state bank of pakistan | 2,010 | 5 |
Keynote address by Mr Muhammad Kamran Shehzad, Deputy Governor of the State Bank of Pakistan, at the Seminar on Collaboration of Banking Sector and Financial Institutions with the National Accountability Bureau NAB in Combating Corruption, Karachi, 5 October 2010. | Muhammad Kamran Shehzad: Combating corruption in the banking sector Keynote address by Mr Muhammad Kamran Shehzad, Deputy Governor of the State Bank of Pakistan, at the Seminar on Collaboration of Banking Sector and Financial Institutions with the National Accountability Bureau (NAB) in Combating Corruption, Karachi, 5 October 2010. * * * Ladies and Gentlemen, it is my pleasure and privilege to address this august gathering of eminent bankers, financial experts and other stakeholders. Let me first state clearly that coordination & co-operation of the Banking Sector as well as Regulator with National Accountability Bureau is of prime importance in combating corruption and corrupt practices in the banking sector. The majority of banking cases are white color crimes done in such a professional manner that their detection and subsequent preparation of strong cases is an uphill task. Even in the developed economies prevention of white colour crimes, remains a big issues to tackle. In Pakistan corruption is a major cause of concern in majority of public sector organizations which has weakened their strength and efficiency and thus they have become a burden on the exchequer. The critical factor behind such failures are mis-management, bad Human Resource Management, immorality, in efficiency and greed. Corruption reduces the welfare activities of the society due to loss of efficiency and effectiveness, reduction of the revenue available for development work and thus weaken the system. Ladies and Gentlemen, The behavior and culture of banking sector has altogether been changed in the last two decades. It has transformed itself from 85% in public sector in 1990’s, to present more than 80% in private sector. This quantum change has been taken positively & supported by the State Bank. The newly transformed private banking sector is performing responsibly and cooperating with regulators and investigating agencies for eradication of banking crimes. SBP and NAB since its inception in collaboration with each other had agreed on a joint mechanism through which information required for investigation purposes from banking sector, under section 19 of National Accountability Ordinance, 1999, are obtained through SBP in the greater interest of the fragile economic conditions of the country. Although NAB has absolute powers to obtain these information directly from the banking company yet the collaboration was made to repose confidence in banking community. A dedicated NAB Cell at SBP was established which effectively coordinates with banks/DFIs to ensure expeditious supply of information. The whole process is aimed at facilitating the Bureau in discharge of its responsibility of vital national interest, without unduly disrupting the financial institutions & creating any sort of panic amongst the borrowers or the clients of the banks. Several cases of delicate in nature were dealt with in close cooperation amongst SBP, NAB & concerned banking company in a professional way. SBP has been forwarding complaints received from the banks/DFIs to Bureau for initiating investigation, under the provisions of NAO, against those entities/persons which had cheated/deprived the public of their hard earned money through illegal brokerage and banking business. SBP, in collaboration with SECP, has been advertising a message titled “Public Warning” in print media to keep the general public aware of the fake schemes / scams launched by the fraudulent companies / noncorporate entities / individuals. State Bank of Pakistan has also been playing its role in facilitating the Banking Sector in their efforts to recover from borrowers their long outstanding defaulted loan amounts by referring such cases of Willful Loan default to NAB for inquiry, investigation and proceedings against them wherever required. About 100 such cases amounting to Rs. 17.5 billion approximately were processed & referred to NAB under section 31-D of National Accountability Ordinance, 1999. I appreciate the role of NAB in speedy processing of these cases which helped not only in recovery of defaulted amount but also saved depositors money. The names of the corrupt persons convicted by NAB under the provisions of NAO, 1999 are also shared with the Banking Industry. The persons convicted under 25(b) of NAO, 1999 are debarred from obtaining any fresh loans from Banking Sector for a period of ten year from the date of conviction. Such weeding out of corrupt elements, from the potential clientele of banking sector, has lead to more prudent lending decisions other than developing a critical data base for the sector. Ladies and Gentlemen, Development of human resource in the banking industry on sustainable basis is a continuous process. Taking lead in this front on an ongoing basis and conducting workshops, seminars, awareness programs, training sessions internally as well as for the benefit of the banking industry has become an integral part of our efforts to curb corrupt practices, money laundering and countering the financing of terrorism. The financial institutions are now less proned to be used as “the safe heavens” for the corrupt persons owing to the effective coordination mechanism developed amongst the financial institutions, SBP and NAB. The introduction of compliance culture and establishment of a separate compliance department manned with skilled and professional officers has also helped in eradication of unlawful and corrupt practices. Ladies and Gentlemen, A strong regulator is needed to act as a vigilant watchdog on the banks and banking industry as a whole. You would be delighted to know that SBP has also been maintaining a centralized database with multiple objectives of cross-matching the antecedents of persons being appointed on Key Positions in banks/DFIs as per the requirement under its Fit & Proper Test (FPT) Criteria. Such cross-matching at hiring stage may ensure the entry and presence of professionals with highest integrity and ethical standards in the banking industry. The database almost contains 5000 records of persons terminated/dismissed from banks/DFIs on various charges. In my view, 50 percent of the job of the regulator is completed if the right persons are appointed and the corporate governance guidelines are observed in letter and spirit. With such grid of human resources, we foresee a high comfort level to manage the common irregularities, procedural lapses and financial scams in the banking industry. On the other hand prudential regulations and their effective enforcement is one of the vital instruments which help regulator to keep a discipline in financial dealings. These regulations have a significant long lasting impact to safeguard the interest of depositors, ensuring prudence in lending and eradication of unlawful banking practices. Ensuring complete compliance of these prudent standards, a strong oversight of functions is inevitable from Boards of Directors, Chief Executives and senior management of the banks. State Bank of Pakistan is comfortable with its cooperation with NAB that has strengthened over a period of time. This has also been instrumental in gradually weeding out the irregularities from the banking system, hence facilitated smooth functioning of the banking system. Looking to professional zeal, exhibited commitment and deliberations on the subject in this seminar, I am hopeful that the cooperation among SBP, NAB & the Banking Sector would further strengthen and go a long way to combat corruption from the banking industry and the society at large. While the NAB is performing its role quite satisfactorily and enjoying the confidence of banking industry I would like to see NAB on its way ahead as an organization with indigenous strength of technical staff fully equipped to investigate financial crimes, forensic investigation, having international collaboration with key investigating agencies. I am also confident that NAB on its part shall continue to retain the confidence of the banking sector built over the years and achieved through quality, integrity and professionalism of investigator. At the end, I congratulate NAB for conducting such a successful seminars for exploring further options to improve the investigation system enhancing cooperation amongst stakeholders and eliminate corruption from society. I assure them that regulator and banking sector of Pakistan within their legal jurisdiction stands behind them to augment their noble cause. | state bank of pakistan | 2,010 | 10 |
Address by Mr Shahid H Kardar, Governor of the State Bank of Pakistan, to the Federation of Pakistan Chamber of Commerce and Industry, Karachi 13 December 2010. | Shahid H Kardar: Understanding inflation and SBP’s monetary policy stance Address by Mr Shahid H Kardar, Governor of the State Bank of Pakistan, to the Federation of Pakistan Chamber of Commerce and Industry, Karachi 13 December 2010. * * * The debate on the role of monetary policy in ensuring macroeconomic stability in general and price stability in particular has intensified after the global financial and economic crisis of 2008/2009. While it may take some time before a consensus emerges on the appropriate monetary policy strategy, almost all economists and central bankers in global policy circles, whether they favor or criticize the current monetary policy stance, still believe that containing inflation is and should be the fundamental objective of monetary policy. In Pakistan, a similar debate, albeit with different backdrop and parameters, on the causes of inflation and role of monetary policy has intensified over the last few years. Most observers agree that inflation, which is persisting at a high level for almost three years now, is one of the major economic issues currently faced by the country. However, they are skeptical about the effectiveness of monetary policy in bringing it down. Some commentators believe that it is entirely a “supply-side” phenomenon and monetary policy cannot play any role in containing inflation. Others cite fiscal weaknesses and the large budgetary deficit as the main reason for inflation and point out that monetary policy cannot influence the behavior of the government. In my remarks today, I would like to share with you my thoughts and perspectives on this important topic. We, at SBP, firmly believe that implementing a coherent strategy for monetary policy may not be enough if the elements of the strategy are not sufficiently well communicated or understood, and if the responsibility for the outcomes of the monetary policy stance is not clearly delineated. But, before I get into the specifics of inflationary phenomenon in Pakistan and discuss the rationale for SBP’s current monetary policy stance, I would like to discuss three conceptual points. First, the process of price determination at the basic level. Second, the behavior of inflation. Third, understanding the trade-offs faced by policy makers. This discourse would not only help us in appreciating the scope and effectiveness of monetary policy but also the limits and constraints faced by the State Bank in achieving its objectives. It is important to understand the relationship between the cost of producing a good and its price at the firm level before any discussion on the causes of inflation in an economy. Suppose it costs Rs10 to produce a good, which includes the wage bill, cost of raw-material, acquiring and installing machines, and all other expenses. To remain in the business and earn profits, the producer would like to sell it at Rs10 plus “x”. The Rs“x” is generally termed as a mark up and depends on the degree of competition in the industry, nature of the product, overall administrative efficiency of producers and government authorities, adequate supply-chain infrastructure etc. What is over-looked in this simplistic example is the role of productivity of the factors of production, be it workers or machines. If the productivity is low and declining, then the final price tends to be higher even if the cost of acquiring the factors of production remains the same. Put differently, the price can be kept stable or even reduced by increasing the productivity of workers and better and efficient use of technology. The monetary policy stance geared towards containment of overall inflation and thus stability of prices eases the pressures on the cost of production but cannot increase the productivity. Factors positively influencing productivity include stable law and order conditions, a healthy and skilled labor force, effective governance, and uninterrupted availability of energy. A micro-level understanding of the price determination process is helpful, but a discussion on the behavior of prices or inflation at the aggregate level is also important. Three broad parameters are worth mentioning in this regard: i)- expectations about the continuation of inflationary trends; ii)- the output gap or the difference between aggregate domestic demand and the ability and capacity of the economy to meet that demand; and, iii)- cost push or supply shocks. Expectations of likely inflation path have strong feedback effects on actual inflation. Such expectations could be based on past inflationary trends or may be formed by the expected impact of government policies, or lack thereof, on inflation. For example, if an economy experiences high and rising inflation for some time then people tend to expect that this trend would continue and seek higher wages to at least maintain their purchasing power. Typically, adjustment in wages tends to be slower than increases in the prices of goods and services that people consume. This leads to discontent and pressure on government authorities to control inflation and keep it stable. Thus, managing the expectations of inflation by devising and implementing consistent and predictable economic policies is a critical task which is normally performed by central banks around the globe. However, the supporting role of other policies, such as fiscal policy, in assuring the public that the government is pursuing anti-inflationary policies should not be underestimated. Failure to do so in a credible manner creates uncertainty and distorts the decisions of the general public and businesses. In turn, this exacerbates inflationary pressures. Regarding the impact of a “gap” in output on inflation, an important point is that aggregate demand alone cannot explain inflation. It should be compared to the ability of the economy to produce and supply that demand. Thus, inflationary pressure can exist in an economy even if the aggregate demand is relatively contained. In other words, if the productive capacity of the economy is decreasing, inflation can persist with the same level of aggregate demand. However, assessing the prevailing output gap is a difficult task for economic mangers. It involves judging the capacity or potential of the economy, which is almost impossible to measure. Lack of timely availability of relevant data on aggregate demand, such as consumption and investment expenditures of the private and public sector, further complicates the task. The authorities, therefore, tend to rely on available indicators that help in assessing aggregate demand pressures and the productive capacity of the economy. The behavior of monetary variables, such as credit demand of the private sector and fiscal authorities and trends in the foreign exchange reserve position of the country, serve as useful leading indicators of aggregate demand. The reason is that most transactions taking place in the economy involve the use of money, whether in the documented or undocumented parts of an economy. Not surprisingly, phrases like “inflation is always and everywhere a monetary phenomenon” and “too much money chasing too few goods” are used to describe inflationary pressures. Supply shocks include unexpected shocks to the cost of production, natural disasters that affect the production and the supply chain, and intervention in markets through administrative measures. Such factors typically have a temporary effect on the level of prices but do not influence the rate of change of prices, that is, inflation. Importantly, if such shocks continue to hit the economy at regular intervals, as is the case with reduction in electricity and petroleum subsidies in Pakistan, then their effect filters into other prices and fuels inflationary expectations. The last conceptual point that I want to highlight is that every economic policy decision entails a trade-off among desirable impact on key variables. We cannot have everything that we wish without paying a price. For example, we all understand that a rise in aggregate demand relative to the available productive capacity leads to inflation. An effort to contain inflation through a tight monetary policy stance tends to have a dampening effect on economic activity. In most instances, the adjustments that the private sector has to make are more pronounced compared to those made by the public sector. Similarly, deterioration in the external accounts, either because of a large gap between payments and receipts or lack of funds to finance it, cannot continue without an adjustment in the exchange rate. Attempts to maintain stability in the exchange rate by supplying the required foreign currency cannot be achieved on a sustained basis without interest rate increases. The reason is because injection of foreign currency by a central bank, when the outflow of foreign currency in the country is greater than the inflow, requires purchase of domestic currency in exchange. This reduces availability of liquidity of domestic currency, which pushes up market interest rates. To ease the liquidity pressures, the central bank can inject the domestic currency through its normal Open Market Operations. However, this strategy becomes difficult to maintain if the foreign currency outflows continue to remain higher than inflows and if the domestic inflation starts to increase because of ample availability of domestic currency. The same principle applies to fiscal matters. The governments cannot for long periods continue to spend more than the revenues it mobilizes. The amount of borrowings required to close the gap comes with a cost – interest payments in the future. Failure to increase revenues in proportion to increases in expenditures compounds the problem as the interest expense continue to rise, leading to more borrowings and rising debt levels. Measures to raise revenues such as increases in taxes or cuts in expenditures such as reduction in subsidies tend to increase the cost of production and possibly inflation. The point I am essentially trying to make is that for a policy decision to be effective adjustment in some area of the economy is required. If the required adjustment is not taking place or if there are other policies that are diluting or neutralizing it, then the credibility of decision makers suffers, leading to uncertainty. What is required is that policy makers articulate an agenda of priorities for the future of the economy, communicate it to the general public, develop political consensus, take timely and coordinated decisions, and implement the agenda over a number of years. Delays or uncertainty in any aspect of this strategy results in less than desirable outcomes making the trade-offs among key priorities tougher. Against this conceptual backdrop, let’s talk about the specifics of the current high inflation phenomenon in Pakistan and the role of monetary policy in dealing with the issue. In cumulative terms, Pakistan’s economy has experienced an inflation of 66 percent between October 2010 and June 2007. This is almost twice the level of inflation seen during June 2003 and June 2007, which was 36 percent. What makes the last three years so different from the three years before that? To begin, let’s dissect the inflation data a bit to shed light on this issue, starting with food prices. The behavior of food group, which has a share of 40 percent in the overall Consumer Price Index (CPI), is not much different across these periods. It is true that food prices grew by 88 percent between June 2007 and October 2010 and by 47 percent between June 2003 and June 2007. But, their share in CPI inflation in both these periods is not much different; 56 and 51 percent respectively. Moreover, virtually the same items across these time periods are responsible for 80 percent of food inflation. Key among these are wheat flour, sugar, fresh milk, meat, and vegetables. So, is this food inflation entirely because of “supply shocks”? Is there anything different that can be highlighted? Let’s take the example of wheat and sugar. Between June 2003 and June 2007, the price of a 10 kg bag of wheat increased from Rs85 to Rs119; a cumulative price increase of 40 percent. In the next three years, it increased to Rs260; a cumulative price increase of 120 percent. But, the international price of wheat increased by only 22 percent. So, what happened? Did productivity collapse or input prices just shot up? We all know that the government increased the “support price” of wheat. Would we consider it a supply shock or a policy decision? Same is the case with sugar prices. After increasing by 46 percent during June 2003 and June 2007, the sugar prices increased by 184 percent in the next three years. The point here is that such price increases cannot be considered as pure supply shocks. For instance, the government would not have been able to procure more than 10 million tons of wheat at higher than its international price without borrowing extensively from the banking system. Not surprisingly, the credit extended for “commodity operations”, including both wheat and sugar, grew by 288 percent during the last three years compared to 33 percent in the three years before that. Borrowings of this scale would not have been possible without an upward pressure on market interest rates. Thus, the borrowings of government agencies for financing its wheat, urea, and sugar trading operations is Rs382 billion at just under 3 percentage points above KIBOR, indicating the interest rate regime that the private sector would have to face in competition with the sovereign. Further, this led to an injection of a lot of cash in the rural areas, which was used for higher expenditures on consumer durables and possibly other food items as well. Thus, an initial “supply shock” turned into a “demand shock” and adversely affected expectation of inflation remaining high. To further understand the difference between price setting at the commodity level and the aggregate level, let’s look at the evolution of prices of petroleum products, electricity and gas. Traditionally, these prices have been heavily subsidized by the government. So, one would expect that this approach would keep a lid on the prices of these products in the market. And when these subsidies are scaled back, the increase in their prices and the impact on overall inflation would become pronounced. A careful look at the data reveals that this is not necessarily the case. For example, the price of diesel increased from Rs20 per liter to Rs38 per liter during June 2003 and June 2007 – a cumulative increase of 90 percent – and has increased to Rs79 per liter by October 2010 – an increase of another 108 percent. The difference is not that large to claim that this is the main reason for a relatively higher rate of inflation in the last three years. In fact, in case of price of petrol the opposite is true. It grew by 37 percent between June 2007 and October 2010 and by 72 percent between June 2003 and June 2007.The increases in the price of electricity were, however, sharper in recent years; 62 percent on average compared to 5 percent respectively. On the other hand, the borrowings of Public Sector Enterprises, which partially explains transfer of subsidies from the government’s budgetary expenditures directly to the power sector entities, grew by 305 percent during October 2010 and June 2007 compared to only 17 percent during 2003 and June 2007. The contribution of this towards growth in money and thus overall inflation should not be discounted. However, even if we exclude the food and energy group prices from CPI, we observe substantial increase in inflationary pressures. Both non-food-non-energy (NFNE) and trimmed measures of core inflation validate this observation. For example, NFNE grew by 58 percent in the last three years compared to 28 percent in the three years before that. Did the reduction in subsidies help in reducing the fiscal deficit and easing aggregate demand pressure? Unfortunately, it did not happen. In cumulative terms, the fiscal deficit grew by 146 percent in nominal terms during June 2007 and June 2010 compared to 113 percent during June 2003 and June 2007. If we take out the interest payments, which have been mentioned as a factor adding to the fiscal problems, and look at the primary deficit, the fiscal driven aggregate demand pressures look more pronounced. The primary deficit grew by 3182 percent in the last three years compared to an improvement of 140 percent in the three years before that. The same is the case with revenue deficit – the difference between current expenditures and total revenues. This deficit increased by 298 percent compared to only 27 percent respectively. Thus, there is an unquestionable increase in aggregate demand pressure because of the public sector. What is more worrying is the trend in the financing pressures of this substantial fiscal expansion on the resources of the banking system. During June 2007 and November 2010, the cumulative borrowings from the banking system increased by 187 percent compared to 58 percent during June 2003 and June 2007.We all know that, within the banking system, the government has substantially increased its reliance on borrowing from the SBP. The stock of outstanding borrowings of the government from the SBP is in excess of Rs1500 billion today compared to only Rs53 billion at end-June 2003. Imagine the effect on market interest rate if the government had borrowed this amount from the scheduled banks. Undoubtedly, interest rates would have been much higher. Moreover, since the interest rate by definition is the price one has to pay to bring future resources into the present, the borrowings and the increase in debt of this scale is not possible without a corresponding increase in interest rates. The continuation of these trends is fueling expectations of inflation and, resultantly, in interest rates remaining high. Thus, if anything, the criticism on SBP’s current monetary policy stance could be that it has not been tight enough. The reason for the SBP pursuing a relatively “loose” monetary policy is our concern that it would further crowd out the private sector and negatively impact the growth rate. Faced with this trade-off, SBP has been trying to strike a very difficult balance between such considerations. There is no denying that private sector has borne the brunt of required adjustment in the economy and government has considerably crowded out the private sector both through reduced availability and price of credit. Between June 2003 and June 2007 private sector credit cumulatively grew by 162 percent, while it increased by only 24 percent between June 2007 and November 2010. In turn, this has negatively affected the future productive capacity of the economy, making it more difficult to meet the relatively lower aggregate demand and bring inflation down. Another downside of the heavy presence of the government and its borrowings from the SBP has been the deterioration of the currency to deposit ratio of the banking system. During June 2007 and June 2003, currency in circulation grew by 70 percent and total deposits of the banking system, excluding government deposits, grew by 104 percent. In the following three years, currency in circulation increased by 82 percent while deposits increased by only 40 percent. While currency in circulation has a strong positive relationship with overall inflation, deposits represent the main funding source for the banking system. A decline in deposits tends to have a contractionary effect on market liquidity and puts an upward pressure on market interest rates. How did the economy cope with these aggregate demand pressures? During 2003 and 2007, the contribution of the private sector and the government sector were “balanced”. Nonetheless, aggregate demand pressures relative to the available productive capacity of the economy were substantial. This can be gauged by observing the cumulative growth of 2605 percent increase in the trade deficit. Which raises the obvious question of why inflation, interest rates, and even the exchange rate were relatively stable? The reason is because the economy was largely able to finance this demand from capital inflows from abroad, as can be seen in a growth of 1462 percent in foreign investments and 83 percent growth in Net Foreign Assets (NFA) of the banking system. The situation looks totally different when we look at the period between June 2007 and November 2010. In response to growing demand pressures, SBP had started tightening its monetary policy stance and it did have an effect. Helped by a decline in international commodity prices, the trade deficit grew by only 18 percent during this period. And the reason SBP has continued with this stance is because foreign investments have contracted by 74 percent and NFA declined by 37 percent. In other words, while aggregate demand has declined but so has the ability of the economy to meet this demand and flow of resources from abroad to fill this gap. Had SBP not responded, the inflation outlook and reserve position of the country would have been worse. For instance, the growth in broad money and thus inflation would have been much higher if the private sector had also continued to borrow unchecked from the banking system along with the public sector. Some observer can comment that availability of cheap credit to the private sector would have added to the productive capacity, helping reduce the output gap. However, given the deterioration in the law and order conditions and energy sector problems in the last three years, it is highly unlikely that investments in the country, by both local and foreign investors, would have grown rapidly. In any case, rising inflation would have made the businesses uncompetitive by increasing the cost of production. So, what have we learned about the dynamics of inflation in Pakistan? In broad terms, inflationary pressures have been a mix of upward adjustments in administrated prices, a persistence of output gap and inconsistent macroeconomic policies negatively influencing expectations of inflation. Monetary policy has played its part in correcting the macroeconomic imbalances, but other government policies have not been that supportive. The future strategy to control inflation must include coordinated and timely response to changing macroeconomic conditions along with a concerted effort to raise the productive capacity of the economy. Delays in implementing such a strategy would only make the policy trade-offs much more difficult resulting in continuing uncertainty regarding desirable economic outcomes. | state bank of pakistan | 2,010 | 12 |
Inaugural address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 5th Pakistan Microfinance Country Forum, Karachi, 2 December 2011. | Yaseen Anwar: Microfinance developments in Pakistan Inaugural address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 5th Pakistan Microfinance Country Forum, Karachi, 2 December 2011. * * * Distinguished Speakers, Guests, Ladies and Gentlemen! I am delighted to be invited to the 5th Pakistan Microfinance Country Forum. Microfinance in Pakistan has made good progress but must make major breakthroughs to reach millions of underserved people who require a wide variety of financial services. Pakistan has one of the lowest financial penetration levels in the World with 56% of the adult population totally excluded, and another 32% informally served. However, despite considerable support from the Government, donors and the State Bank of Pakistan, the microfinance sector has only been able to tap a small fraction of the potential market, with current active borrowers standing at roughly 2 million. Now, I would like to share SBP’s vision on the development of microfinance and financial inclusion in Pakistan and some of the initiatives taken by SBP. The history of microfinance is not very old in Pakistan. In fact, efforts to mainstream Microfinance into the formal financial system started in 2000 & 2001 when the Government promulgated the Microfinance Ordinance. The passage of the law the allowed private sector to establish Microfinance Banks that are licensed and regulated by State Bank of Pakistan. Since then, we have witnessed the establishment of new MFBs, transformations of large MFIs, diversification of funding sources, development of inclusive financial services, emergence of alternative delivery channels, and piloting of “Microfinance – Credit Information Bureau” (MCIB). These developments are indeed a sign of growth and maturity and a direct outcome of the enabling regulatory framework and market development initiatives for microfinance. The success of microfinance in Pakistan is widely acknowledged by the international community. Our microfinance regulatory framework has been ranked globally at the top in 2010 and 2011 by the independent “the Economic Intelligence Unit” of UK’s “The Economist” Magazine. In developing regulations for microfinance, the State Bank has pursued a bottom-up approach along with use of strong analytical and problem solving skills and industry consultation. Since the inception of microfinance banking in Pakistan, our goal has been to determine the proportionality of a regulation before it is put in place. Hence, the regulatory approach has remained gradual and in line with the evolution of the sector. The evolution or trajectory of microfinance has so far remained positive despite the fact that many challenges arose along the way which I will cover later. Presently, nine MFBs are operating in Pakistan. All these MFBs are privately owned and reflect diversity of ownership and approaches to microfinance banking. Considering that the market has potential and the regulatory framework is supportive, the ownership in MFBs has flowed both from local and international investors including banks, development agencies, investment funds, mobile network operators, and large domestic MFIs. One of the success stories in microfinance sector is the unique opportunity in Pakistan to utilize alternative delivery channels due to the presence of a sound and pro-growth regulatory framework, dense population, and high demand for financial services. The motivation for developing alternative channels for service delivery is twofold: firstly, there is enormous scope for expanding outreach, especially to hard-to-reach rural areas. The emerging models relying on “banking agents” will greatly extend the distribution of financial services to the poor and marginalized segments. Secondly, alternative delivery channels promise significant cost reduction to institutions. The traditional microfinance business is based on personal, one-on-one relationships. Thus, personnel expenses often account for a BIS central bankers’ speeches significant portion of microfinance operating expenses. The use of banking agents will help to reduce the operating costs of the sector. The recent development in mobile phone banking is highly encouraging. The expansion in the retail network of microfinance has arisen overwhelmingly from agents and mobile phone channels. Within a span of just two years, there are now almost 18,000 branchless banking outlets surpassing the 10,000 conventional bank branches. The combined daily transaction volume of the two prominent branchless banking models “Easypaisa” and “Omni” now averages over 175,000, with an average size of Rs. 3,700. As per an independent World Bank – CGAP study, the small size of the transaction indicates enhanced access to finance by the poor and the marginalized unbanked people, an important milestone for financial inclusion. The early successes of mobile banking in Pakistan are attributable to the collaborative efforts of a wide range of stakeholders, including the Government, regulatory authorities, development agencies, NADRA, telecom operators, financial institutions, and technology firms. SBP continues to work with all stakeholders, in order to support this nascent industry that is expected to be a key driver in expanding financial services to all of Pakistan. The sheer diversity of the stakeholders, many of which had not worked in businesses together, underlines the need for continued close coordination to foster a marketdriven mobile banking eco-system. I must acknowledge the important role our partner donors continue to play in facilitating this sector to develop a sound footing. I would like to especially thank the UKAid and Asian Development Bank for funding support for microfinance development. Under the programs sponsored by these donors, a number of market interventions are managed by SBP. Some of these initiatives are as follows: The Institutional Strengthening Fund (ISF) a UK £10million grant facility launched in December 2008, is intended to strengthen institutional & human resource capacity of MFB/Is to enhance scale and sustainability of microfinance services. The ISF has thus far approved Rs. 522 million for 11 microfinance providers including top and middle tier MFBs and MFIs. Under the arrangements, the ISF will support 15 projects for investment in HR, IT, product development, Risk management systems, business plans and branchless banking development. Also, under ISF, the Pakistan Microfinance Network (PMN) was provided funding support to conduct research and develop the industry’s infrastructure such as the testing of pilot microfinance Credit Information Bureau (CIB) in Lahore. Going forward, ISF will consider how to further support important systemic areas such as upgrading CIB to the national level. The Microfinance Credit Guarantee Facility (MCGF) a £10 million guarantee facility, was launched by SBP in December 2008, to mobilize wholesale commercial funding for microfinance providers through partial guarantees to commercial banks. The facility hasthus far mobilized commercial funding of Rs. 3,225/- million for four microfinance providers for onward lending to around 200,000 new micro borrowers. Going forward, the facility will aim to raise commercial debt from non bank sources, diversifying sources of commercial capital for microfinance providers. The facility will be instrumental in mainstreaming microfinance providers and resolve some of its funding constraints on a permanent basis. Similarly, the Financial Innovation Challenge Fund (FICF), a £10million innovation grant facility, was launched by SBP in May 2011, to provide grants to foster innovation and test new markets, lower cost of delivery, enable systems and procedures to be more efficient and provide new ways of meeting the larger demand for financial services. The first FICF challenge round was held on Financially Inclusive Government to Persons (G2P) Payments. Banks, public sector institutions, Microfinance institutions, government agencies, pension funds, and academic institutions were invited to apply for the promotion of financial inclusive G2P payments through bank accounts at branchless banking outlets and also provide other financial services to the G2P payments beneficiaries. A number of applications have been BIS central bankers’ speeches received from these institutions which are now being evaluated for the first round of G2P payments Challenge. Financial literacy has assumed greater importance in recent years and is now considered an important systemic area for promoting financial inclusion and ultimately financial stability. Both developed and developing countries, therefore, are focusing on programs for financial literacy/education. SBP has started a pilot Financial Literacy Program (FLP) with the private sector as an implementing partner. The Program is the first ever initiative to promote financial literacy among the general public at the national level. The dissemination will be made through TV channels, regional Radio, print media and mobile network operators. In addition, field training and street theatres will also be used to target beneficiaries. The program will impart knowledge about basic financial concepts such as budgeting, savings, investments, debt management, financial products and branchless banking. The pilot phase will target about 50,000 beneficiaries with emphasis on low income strata. After completion of the pilot, an impact assessment of the pilot will be conducted and based on the results and recommendation the program will be scaled to the national level. Although these early successes in microfinance industry are laudable, they have yet to create a major dent in the widespread financial exclusion. Currently, microcredit is reaching only 2 million borrowers whereas the size of the target market is estimated to be 25 to 30 million. While this high level of financial exclusion is somewhat disappointing, it does highlight the frontier of opportunities and bodes well for development of the microfinance industry to become a major participant within the overall financial sector while serving the millions of underserved and unbanked people. I, therefore, urge all stakeholders to step up their efforts in their area. As we know, Pakistan has unfortunately faced an increased occurrence of natural calamities. In 2010 and 2011, floods and rains destroyed lives, properties, and businesses, particularly of those living in rural and peri-urban areas. The poor have also been adversely affected by volatility in food prices and fuel costs. Increased power outage has been another major concern. Furthermore, the current global financial turmoil may in the long run adversely affect the flow in funding from the global financial markets. This state of affairs poses a number of challenges for the microfinance sector. I will highlight some of these and try to offer general solutions. The first and foremost challenge is organizational development. Every institution must determine and pursue this goal by having in place appropriate governance structures, management teams, business policies & plans, risk management practices, product development & innovation and use of appropriate technologies. Quality Human Resource is a prerequisite for achieving this goal. The second challenge is funding avenues for microfinance service providers. It is a proven fact that in order to have a financially sustainable model, MFBs should assign more emphasis on savings mobilization and develop strategies and the infrastructure to mobilize deposits. Thirdly, MFBs need to improve the quality of growth through promoting inclusive financial services with up-scaling credit operations. Lending operations must extend to different economic and geographic segments. SBP will issue regulatory guidelines to MFBs for upscaling of loans, and develop a reporting structure to assess the geographic distribution of microfinance growth. Donor funding can support product development, capacity building, and market surveys. Fourthly, institutions must assign equal importance to consumer protection and awareness. SBP will also review and strengthen its regulatory and supervisory processes to ensure protection of microfinance clients’ rights. BIS central bankers’ speeches In the new Microfinance Strategic framework 2011–15, SBP has laid out a detailed strategy to promote sustainable growth of the sector. The strategy’s effectiveness and success hinges on growth dynamism fundamentally coming from microfinance operators themselves. The role of SBP is to develop the banking infrastructure, encourage the use of successful global practices, and provide the regulatory and supervisory mechanism to enable MFBs to develop viable business models. To sum up, I would like to reaffirm the need for microfinance development for fostering a propoor and sustainable development in Pakistan. Microfinance has come of age, and the sector needs to discontinue dependence on external catalysts and focus on improving its financial and operating performance by setting targets for borrowers, savers, portfolio quality, and self-sufficiency. Considerable work still needs to be undertaken to ensure that all microfinance banks and institutions are acting responsibly. It is also important for the industry to continue to innovate, create new partnerships with the growing branchless banking networks, and to evolve and provide financial access to the unbanked. Let me once again thank the organizers for holding important event and I wish the Conference all success. BIS central bankers’ speeches | state bank of pakistan | 2,011 | 12 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 12th Management Association of Pakistan Convention, Karachi, 14 December 2011. | Yaseen Anwar: Leadership challenges for business success Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 12th Management Association of Pakistan Convention, Karachi, 14 December 2011. * * * Honorable delegates, members of MAP, ladies and gentlemen, It is indeed a pleasure for me to be with you today, on the occasion of the 12th Management Association of Pakistan (MAP) Convention on “Leadership Challenges for Business Success”. First of all, I must express my gratitude to MAP for inviting me to this gathering and providing me an opportunity to share my thoughts with the country’s business leaders. At the outset, I would like to commend MAP for its role over the last four decades in disseminating management knowledge that has helped in elevating the overall leadership aptitude of our managers. The quality of business leadership and human resources play a significant role in sustaining growth and competitiveness. MAP has facilitated this by providing a platform to business leaders and professional managers to deliberate managerial developments and establish strong social and professional networking. This yearly convention on key issues provides an opportunity for participants to meet exchange and learn from each other’s experience. The theme of this convention is most appropriate, revolving around the concepts of Leadership and its role in business progression in a turbulent time. Leadership itself is a wide and crucial topic that can be discussed throughout the duration of this convention. Having worked with leading global financial organizations in different markets, including now at the State Bank, I understand the issues and challenges facing businesses and their leadership, particular during these difficult times. Answers to all our problems are certainly not readily available to us. However, conventions such as these enable us to share our experiences and arrive at some shared conclusions. The world today is passing through a turbulent phase that requires a realignment of our leadership approach to managing a business. Today’s business leader is faced with a multitude of challenges, both on external and internal fronts. The complexities arising in the eco-system of any business may arise in the shape of macro economic imbalances that include sagging demand, inflation, volatility in financial markets etc. While demanding situations on the internal front arise from personnel management, investment decisions, alignment and realignment of business objectives, there should be no ambiguity that there are always complex matrices linking external challenges with internal ones and therefore, successful business leaders will never make internal business decisions in isolation. An uninformed business leader is a leader without a vision and quite likely without any success. Ladies and Gentlemen, we meet today at a challenging time with many headwinds going forward. The global economy is on a downhill path and financial turbulence continues to affect the masses across the globe. All this started in 2007/2008 as the private debt subprime crises related to the US housing market transformed into a systemic financial crisis that spread from the US to the Euro area. More recently, this has turned into a sovereign debt crisis. The crisis, now in its fifth year, has morphed into a new phase of a political crisis. In the Euro region, important steps have been taken to address the current problems. However, political differences within economies undergoing adjustment and among economies providing support have impeded achievement of a lasting solution. We have already witnessed causalities of these crises. Similarly the political processes in the United States and Japan are facing challenges in reaching consensus on medium term fiscal adjustments. What we have seen is a complete transformation resulting from the worst crisis of modern times. All these events have challenged the approach of financial leadership, business leadership, Economic Managers and Political leaders. BIS central bankers’ speeches Notwithstanding, we also have some bright spots in the form of emerging market economies with positive growth prospects. This is primarily because these economies have dealt with relatively more frequent, though small scale crises on their domestic fronts. Of the advanced countries, Australia and Canada have been least affected by the Global Financial Crisis because of their relatively stricter regulatory regimes and handson approach. The approaches of these economies and their leaders seem more practical and proactive, a trait necessary for leadership and a necessary part of a vision about the future. As mentioned earlier, this conference is significant in the sense that it comes at a time when the financial services sector across the world is in the midst of a crises. Since the disruption has become acute, there is a debate over a number of issues relating to management and supervision of the financial services industry. In order to be effective, the concern and tone for risk management must start at the top. You would agree that while the management may get influenced by business targets and short term profitability, the Board, representing owner’s perspective, always targets for long term viability and sustained growth of the bank. By virtue of this different perspective and its legal powers, the board is better positioned to enhance the role of risk management in a bank. That is why SBP has always emphasized the involvement of the Board and made it accountable for establishing enterprise wide risk management framework. While the overall responsibility of risk management rests with the Board of Directors, it is the duty of the CEO to display leadership and transform the strategic direction set by the Board in the shape of policies and procedures and to institute an effective hierarchy to execute and implement those policies. SBP desires a more active role of the Board in setting the strategic direction of a bank as well as to bring them under accountability. The formulation of policies relating to risk management only would not solve the purpose unless these were clear and effectively communicated down the line. The CEO as a leader must ensure that these policies are embedded in the culture of the organization. For the value of risk management to be realized, integration is essential. Therefore, the emphasis should be on integrating risk management into the existing management structure and processes, rather than operating as an appendage. The above discussion highlights four key areas that have contributed to the crisis and remain relevant for both financial and non-financial firms; weaknesses in corporate governance arrangements; excessive risk taking for short term gains, inadequate Accounting standards and regulatory requirements in some areas, and mismatch between the remuneration systems and strategy and risk appetite of the company. Most of the multilateral agencies and financial regulators have now increased focus on building a more resilient financial framework including developing new standards for addressing the above challenges. Like any real life crisis, the present turmoil in the financial sector provides an opportunity to learn from the financial world’s mistakes and overzealousness. This gives us the opportunity to look back and see what went wrong and structure our own financial houses so that this does not happen to us, or so severely affect the world again. In this regard I feel the most significant lesson that we have learnt from recent events is the importance of fundamentals in risk management. For instance there is a basic rule since inception of banks which says “do not put all your eggs in one basket”. Had this simple rule been followed, many institutions could have avoided huge losses. The challenges posed by the Global Financial Crisis have impacted leaders of all major businesses. Elevating corporate governance should not be confined to banks, but commercial concerns must also do the same. We all know the pace of globalization has accelerated, resulting in increased domestic and global economic integration. Today we cannot just shrug off failures within a particular sector or sometimes even a single entity if it has global linkages. Gone are the days when a financial or political crisis in one country could be contained to that country; now there are several contagion effects at different levels. BIS central bankers’ speeches So how do we address these challenges for a country like ours that is subject to exogenous shocks and maintain steady economic and social growth? Our visionary business and political leaders must be alert to the challenges they face now and are likely to face in the future due to developments in other parts of the globe. On the domestic front, we need to manage our macro-economic fundamentals. Both our economic and political leadership is faced with multiple challenges of trade imbalance, inflation, unemployment, power crises and security situation. The challenges for making good decisions on these fronts requires political will and a clear long term vision. There are no shortcuts to sustained economic development. We need to develop the right strategies and then translate these strategies into action. Similarly the challenges for business leaders, though at a micro level, are by no means less critical. These challenges range from the survival of businesses in a stagnant business environment to developing strategies for further growth through developing new business models, new products or restructuring and re-engineering. We need to understand the issues and accept that in implementation we will make mistakes, but in the long run with continuous improvement we can be on the road to recovery. This is by no means an easy task. It is important to recognize the true nature of any problem, and develop workable solutions to these problems in a timely manner. Leaders with perseverance and vision will tackle these issues successfully and emerge as the business leaders of today. Effective leadership must also include skills to manage people and teams. Management of human resources is extremely critical to the success of any business across the globe. An important challenge during difficult times is to ensure employees’ performance is maintained at a high standard. Owing a crisis, institutions must recognize they still need to retain their critical workforce. Here I would like to underscore the importance of women representation in the work force. Women represent almost half of the population of Pakistan and a significant talent pool that is ignored. How can we as a nation progress if 50% of our work force is in a non-productive capacity. Given Globalization and the crises we all face, let’s recap the traits of effective leadership that are universally applicable. Leaders must be visionary to see future trends, anticipate institutional bottlenecks, remain competitive and be able to adapt rapidly to changes. They should be continuous learners, a necessity for enhancing leadership skills. Leaders need also to take into account their corporate social responsibility so that profit seeking is balanced against the objective of social service and well being of society. Leadership success requires strong conviction and belief. Yet having humility and recognizing the need to reinvent and inspire their organization to adapt to new challenges remain an integral part of successful leaders. This is vital if businesses want to remain at the forefront of new innovations, critical for longterm competitiveness. All these and more comprise the necessary characteristics for dynamic leaders that push the frontiers of excellence. Such corporate leaders fuel the drive towards long-term growth and stability. In conclusion, the challenge is; have we learned from our past mistakes and prepared ourselves for taking advantage of expected opportunities? I would like to quote here what Nelson Mandela said about leadership “It is better to lead from behind and to put others in front, especially when you celebrate victory when nice things occur. You take the front line when there is danger. Then people will appreciate your leadership”. So it’s the time for all business leaders and managers to take the lead. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,011 | 12 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the PAF Air War College, Karachi, 21 December 2011. | Yaseen Anwar: Role of financial institutions and capital markets in Pakistan’s economy Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the PAF Air War College, Karachi, 21 December 2011. * * * The Commandant PAF Air War College, Members of the Faculty and the Future Leaders of the Armed Forces I am delighted to be invited by the PAF Air War College which is one of our premier institutions of the armed forces of Pakistan, to share my views on the Role of Financial Institutions and Capital Markets in the Pakistan Economy. The importance of Financial Institutions (FIs) cannot be overemphasized. FIs perform the vital function of intermediation between providers of investable funds (depositors, securities holders etc) and the users of such funds (namely businesses). No economy can progress unless its financial sector facilitates its business activity consistently, and in the case of a developing country like Pakistan, these FIs act as a necessary catalyst for economic growth as well. The State Bank of Pakistan, as the central bank of a developing country, has played two very critical roles with respect to the financial sector. Firstly it ensures soundness of banks and DFIs through prudential oversight with a view to maintain financial stability; secondly it pursues a developmental objective under which it facilitates financial markets developments and enhancement of access to finance. Over the years much has been accomplished, yet a lot more is yet to be achieved. The banking system, which constitutes 88 percent share of the total financial sector, is comprised of 34 commercial banks and 4 specialized banks. The share of non-bank financial institutions is approximately 12 percent, and includes leasing companies, Mudarabas, insurance companies, investment banks, housing finance companies, venture capital companies, and mutual funds. The Banking sector of an economy is generally the most significant player and performs three primary functions which include the facilitation of the payment system, mobilization of savings, and allocation of loanable funds. By virtue of its pivotal role, the banking sector can exert its positive influence on various other segments of the economy. During the course of my speech, I would be giving you a historical perspective of the development of financial sector in Pakistan, followed by a discussion of challenges and opportunities of present scenario. Finally, I would like to share with you our priorities related to the banking sector for the future to come. Historical perspective The current structure of the financial sector in Pakistan is the result of several policy shifts and developments. The eras of financial sector developments in Pakistan can broadly be segregated into 1947–70, 1971–90 and 1991 to date period. Prior to 1971, the primary focus was on developing commercial banks in the private sector and creating development finance institutions backed by the government. The private sector development, however, almost clogged during the period 1971–1990, owing to the nationalization policy of the government. During this period, the banking sector came under the government’s control. Since 1990s, more liberal and market-based reforms have been followed. BIS central bankers’ speeches Period of 1947 to 1970 At the time of independence in 1947 the banks services were adversely affected and by June 30, 1948, the number of branches of scheduled banks came down to only 81 in the territories now comprising Pakistan. However, commercial banking made tremendous progress and achieved phenomenal growth since independence as by December 31, 1973 i.e., before nationalization, there were 14 scheduled Pakistani commercial banks with 3,323 branches all over Pakistan and 74 branches in foreign countries. Development Finance Institutions (DFIs) played a significant role in the early industrial development of Pakistan from the sixties up to about the mid eighties. These DFIs were major channels for routing development funds to the private manufacturing sector and achieving socio-economic objectives such as encouragement of new entrepreneurs, setting up of industries in less developed areas and wider diffusion of industrial ownership. However in the 1980s and 1990s many DFIs ran into problems stemming basically from poor management, excessive bad loans, withdrawal of incentives or resource constraints, and considerable losses to the point of their financial ruin. They were also unable to compete with the increasingly nimble banking sector of the 1990s which was able to capture substantial investment banking business. Period of 1971 to 1990 As you may be aware, all 14 Pakistani commercial banks were nationalized and merged into 5 banks from January 01, 1974, and the financial landscape of the country changed significantly. One of the rationales given for nationalization was the fact that private banks were likely to neglect small borrowers and other priority areas, and it was thought that with nationalization, the government could direct credit to desired sectors. Consequently, various steps were taken, which included commencement of subsidized credit schemes, introduction of a complex system of credit ceilings, and the imposition of controls on interest rates. The experiment of nationalization, however failed to give the desired results, as political interference in lending decision and also in the appointment of the boards and chief executives marred the operations of these banks. The efficiency of the banks was affected severely, and by the end of 1980s, the banking sector in Pakistan had become unsuitable for adequately meeting the growing financial needs of the country. Period of 1991 to date Realizing the inherent weaknesses in Pakistan’s financial system, a broad based program of reforms was framed for the financial sector in the early 1990s. The reform agenda included, among others, financial liberalization and deregulation measures which were: privatization of NCBs, removal of restrictions on opening‐up of private banks, phasing out of subsidized and mandatory credit schemes, removal of caps on deposit and lending rates of banks, abolishment of the system of credit ceiling, and switching towards a market based approach of credit distribution, etc. These measures were implemented over time with gradual improvement that continues today. The State Bank of Pakistan played a pioneering role in these reforms, and has championed the developments in the financial sector. A brief summary of some of the major steps taken under these reforms are as follows: For privatization of nationalized commercial banks, the Government injected Rs. 30.7 billion to offset the losses incurred by these banks and recapitalized them. Professional bankers were appointed as Chief Executives and persons from the private sector enjoying a reputation of competence and integrity were nominated on the Board of Directors and ultimately the banks were privatized. Besides the privatization, fresh licenses were also issued to private sector sponsors to set up new commercial banks. These new banks provided the necessary competitive stimulus in the BIS central bankers’ speeches system, and have contributed to the enhancement of banking services in Pakistan. Resultantly the overall share of private sector owned commercial banks in the banking sector assets increased from almost negligible in 1991 to about 80 percent by June 2004. The legal and regulatory framework was strengthened significantly, and State Bank powers under the Banking Companies Ordinance were enhanced in order to make it an effective regulator. Here I would like to emphasis that strengthening of the framework is a dynamic process, and as recently as in April 2011, the amendments in the BCO were carried out which further reinforced SBP’s role as regulator of the banking sector. The prudential regulations and various guidelines issued by SBP provided the essential impetus for prudent operations of the banks and DFIs. Under the regulatory framework, corporate governance, and risk management standards have improved significantly across the industry. These regulations also aim to enhance the quality of oversight of the Board of Directors of banks, mainly by (a) ensuring that only reputable and competent persons sit on these boards and (b) requiring that the members fulfill their responsibilities towards policy making for their respective banks. Foreign direct investment in the banking sector was made more viable; and since liberalization, large numbers of reputable foreign shareholders have invested in locally incorporated Pakistani banks. At the same time several foreign banks have opted to operate in Pakistan in branch mode as well. One of the most recent positive development is the entry of largest Chinese bank ICBC in Pakistan that started operations earlier this year. Since capital of a bank provides the buffer against unexpected losses, it is essential for any bank to have adequate capital to survive the ups and downs of a business cycle and to bear exogenous shocks successfully. The Capitalization of the banks has been enhanced steadily over the years. The minimum paid up capital (net of losses) was set at Rs.1 billion in 2003, increased to Rs2.0 billion by 2005, Rs6.0 billion by 2009, and Rs.10 billion to be achieved by 2013. In addition to Minimum Capital Requirement (MCR), SBP also adopted internationally accepted solvency standard of Basel I in 1997; and the revised standard of Basel II has been enforced since 2008. Under this regime, banks have to maintain a Capital Adequacy ratio of 10%. The ratio is calculated keeping in view the risk profile of a bank’s assets, with an ultimate objective to ensure that banks carrying higher risk assets should be required to hold more capital. Over the years the monitoring of banks and DFIs has also improved. The on-site inspection and off-site surveillance has increased the level of supervision of SBP. Electronic information gathering has made oversight timely and consequently more effective. The SBP also undertook massive capacity building during the late 1990s and early 2000s to upgrade the level of expertise of its officers. Merit-based recruitment, competency-enhancing training, performance-linked promotion, and induction of skilled human resources are now regular feature of SBP’s corporate strategy. The IMF and World Bank in their banking sector assessment of 2004 state Quote: “far reaching reforms have resulted in a more efficient and competitive financial system. In particular, the pre-dominantly state-owned banking system has been transformed into one that is predominantly under the control of the private sector. The legislative framework and the State Bank of Pakistan’s supervisory capacity have been improved substantially. As a result, the financial sector is sounder and exhibits an increased resilience to shocks”. Unquote. Present day scenario Before I discuss the present day challenges and opportunities, let me first identify the key performance figures of the current banking sector. Total assets of our banks amount to Rs7.7 trillion as of end June 2011. The deposits stand at Rs6.0 trillion, while Advances and BIS central bankers’ speeches Investments of the sector are Rs3.8 trillion and Rs2.6 trillion respectively. In spite of the economic slowdown, the pretax profit of the banking sector for year 2010 was Rs105 billion and for the first six month of 2011 it was Rs77 billion. The banks stand at a healthy Capital Adequacy Ratio (CAR) of over 14 percent and have shown a steady increase in capital even in absolute terms, and equity of the banks is now Rs722 billion (June 2011). While the picture appears quite stable, the key challenge comes from the word I used just now “economic slowdown”. We have witnessed the impact of an economic slowdown through rising credit risk in the banks. The gross non-performing loans which were low in 2007 (7.6%) are now at 15.3% as of June 2011. Thanks to our conservative provisioning regime, the net NPLs are still at a reasonable level at 5.5%, but we are aware that unless an economic turnaround is achieved within a reasonable time, the impact of high credit risk can cause serious problems, at least for some banks. Since FY07, banks in Pakistan have been able to withstand the headwinds from weakening macroeconomic fundamentals. While they have remained largely insulated from the first round of shocks from the global financial crisis, we cannot ignore the adverse trends that have risen since then. The Global Financial Crisis (GFC) has continued despite the recovery efforts of advanced economies and has morphed from a financial crisis to a sovereign credit crisis with serious political implications. The crisis brought forth the realization that organizations which are not just too-big-to-fail but also too-interconnected-to-fail are the major source of systemic risk. It reinforced the fact that complete reliance on mathematical model-based risk management systems is insufficient in assessing the wide array of risks faced by the financial sector, some of which need more qualitative analysis and judgment. Most importantly, it showed how its protracted duration severely impaired the basic function of the financial sector i.e. efficient allocation of resources in the process of financial intermediation. The regulatory focus in Pakistan has strived to prevent and mitigate the occurrence of these factors as the financial sector continues to evolve and progress. The silver lining from the GFC is the fact that the emerging markets are gaining more focus. The contribution of BRIC and other emerging economies in world economic growth is on the rise. The relatively less sophistication of their financial markets has been a blessing in disguise, as they did not face the brunt of the GFC and the growth continued at an even faster pace. It will be unfortunate if Pakistan is unable to take advantage of this shift in the growth paradigm. We are facing several domestic issues that limit our ability to fully attain our potential. Our financial institutions and businesses must become more competitive and innovative, regulators like SBP and SECP must actively facilitate financial markets, and the Government should step up its function of providing infrastructure for growth, most crucially to meet the Energy demand of productive sectors. As is true in most cases, the challenges provide opportunities as well. As banking regulator, the big challenge arises from a two-pronged dilemma. We want our banks to be sound, profitable and efficient users of their funds, yet we also want them to increase financial service penetration into unbanked segments of the economy. Interestingly this challenge is the biggest stimulus for technological innovation. There is a huge surge among the banks to upgrade their technology and on-line banking services. The ATM network has been expanding and on June 2011 there were approximately 5200 ATMs operating throughout the country. Progress in creating automated or on-line branches of banks has been significant so far and it is expected that 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. The country’s payment system infrastructure has been strengthened to provide convenience in transfer of payments to the customers. The concept of branchless banking has opened a new avenue for efficient channeling of funds. It has the potential of changing lives of those people who are still unbanked and BIS central bankers’ speeches without any financial services and opened new vistas for the entrepreneurs and households of those areas; particularly with the increasing ease of mobile phone usages, it is a preferred channel of choice for those customers for transfer of funds. Keeping in view its importance, the State Bank took the lead and introduced Branchless Banking Regulations in 2008. These were the first of its kind regulatory initiative and since then other jurisdictions have replicated them for development of the branchless banking. Since 2008, Branchless Banking has expanded steadily with increased participation of stronger as well as new players. At present, the agent network under the umbrella of branchless banking exceeds 20,000 that facilitate around 53 million transactions amounting to Rs196 billion (Sep-11). Notwithstanding this progress, overall financial penetration in Pakistan remains quite low. The number of borrowers of 3.8 million constituted only 2.3% of the population on December 2010. Recognizing the overwhelming size and intensity of financial exclusion in Pakistan, SBP is pursuing the second generation reforms for the financial services industry and has placed high priority on developing and implementing an effective strategy for financial inclusion. Enabling regulatory environment has been provided for lending to SME, Agricultural and microfinance; thus banks and financial institutions are encouraged and enabled to expand their scope of lending and customer outreach. Licensing and prudential norms for micro finance institutions have been designed with particular emphasis on facilitating growth of these institutions and expanding their outreach to the poor and vulnerable segments of the population. In 2010 & 11 Consecutively, Pakistan has been ranked First in a sample of 55 countries in the category of “overall regulatory framework and practices for Microfinance” by The Economist Intelligence Unit (EIU) of The Economist Magazine. The customer base of MFBs (Microfinance banks) has crossed 700,000 whereas that of MFIs has exceeded 1,300,000 in June 2011. At present 8 MFBs are operating in Pakistan, with total assets of Rs21.4 billion. Moreover, SBP is engaged in collaborative efforts with civil society institutions, especially involving large NGOs and RSPs in providing complementary services, such as social intermediation and capacity building. The regulatory regime adopted by SBP for the microfinance sector is that of a facilitator, guide and problem solver. We do not prescribe for Micro Finance Banks the same onerous regulations that prevail for other financial institutions. We have a Consultative Group drawn from the representatives of stakeholders, who guide us in the development of our regulations and prudential norms. 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. There exists strong evidence that SME expansion boosts employment more than Large Firm growth because SMEs are more labor intensive. We realize the fundamental importance of the SME sector in the economic development of the country. While SME prudential regulations have been in place for years, we are in the process of reviewing and revising the same to make them more conducive for this sector. The economic slowdown has hit them particularly hard. The advances to SME sector declined from Rs.383 billion in Dec 2008 to Rs.292.5 billion in June 2011. The loan infection ratio of SME sector has also risen and is around 16.8 percent. Clearly we need to come up with sound solutions for revival of this sector. In March 2010, SBP came up with the Credit Guarantee scheme for small and rural enterprises with the assistance of GOP and donor agencies that aims to motivate the banks to lend to borrowers, who otherwise would not have access to credit under normal circumstances. Several other initiatives are also underway. Pakistan introduced the Islamic banking system in 2003 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 now have the opportunity to invest in trade and businesses by availing of loans from Islamic banks and thus expand economic activity BIS central bankers’ speeches and employment. The total Islamic banking assets stand at Rs.560 billion (June 2011) which is 7.3% of total assets of the banking sector. More importantly, this sector has shown more accelerated growth as compared to other segments. Deposits grew by 15.9 percent while the overall deposit growth was 9.4 percent (June 2011 data). We are very optimistic about the prospects of IB system. Now I would like to touch upon the role and importance of Capital markets that mainly consists of Stock (equity) and Debt markets. The capital market provides an avenue for raising long-term financing needs of businesses through equity and long term debt by attracting investors with a long term investment horizon. Both the banks as well as capital markets are vital in ensuring the desired level of liquidity in the system, facilitating efficient price discovery and allocation of credit and diversifying risks in the economy. However at present the level of development varies considerably in each market. While banks take the lion’s share of the overall financial sector as dominant players in money and foreign exchange markets, the capital market has yet to develop and still requires nurturing to reach its true potential. Even within capital market, the corporate debt market is truly at nascent stage. While equity markets typically tend to develop earlier than the debt markets in most developing countries, Pakistan’s economy and financial sector are now at a stage where they can support and benefit from a vibrant and efficient debt market. The size of Private debt, or Term Finance Certificates (TFCs) in Pakistan, remained around Rs. 74 billion (0.5% of GDP) which is paltry compared to the outstanding domestic government debt of PKR 4.64 trillion (31.4% of GDP). There is clearly underexploited capacity available to support economic growth. Banks continue to be the main provider of debt in the system. In the absence of an active capital markets, the commercial entities fail to procure long term debt financing, and rely on short and medium term loans from banks. Consequently banks carry sizable maturity mismatches on their balance sheets as they fund their advances through short term deposits. Since banks tend to lend to only larger borrowers, their portfolio is highly skewed towards large sized loan. In recent years, with rising NPLs, and increased borrowing by the government, the growth in private sector credit has become stagnant. Banks are trying to limit their credit risk and it has become more challenging to raise private debt for a business. While some credit uptake may take place in the future, it is unlikely that banks will be keen to finance new long term projects anytime soon. There is a need for coordinated efforts and support of the Government as well as of regulators (SBP & SECP) and banks for the development of a fixed income market that is necessary to diversify the financial sector which in turn would enhance its role in supporting economic growth. Future priorities for the banking sector The future is obviously not isolated from the progress made so far. We have unambiguously designated our future path that includes three main priorities (a) to make our banking sector more resilient against exogenous shocks through our macro (systemic) and micro prudential framework, (b) actively encourage technological solutions for financial access and an efficient payment system, and (c) address the development needs of the financial markets and broaden the array of product and services as well as outreach. We would like to see our banks operating at world class standards and synergistically reinforcing the real economy. We are actively working at a pace to achieve this goal, and despite the current economic challenges, we are confident that we will succeed. BIS central bankers’ speeches | state bank of pakistan | 2,011 | 12 |
Introductory remarks by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, on the occasion of the 18th Zahid Husain Memorial Lecture, Karachi, 22 December 2011. | Yaseen Anwar: Micro-credit and the financing of small businesses Introductory remarks by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, on the occasion of the 18th Zahid Husain Memorial Lecture, Karachi, 22 December 2011. * * * Honorable Chief Guest, learned Guest Speaker, distinguished guests, ladies and gentlemen! 1. It is my honor to offer these introductory remarks on the occasion of the Zahid Husain Memorial Lecture. These lectures, as you know, are organized as our tribute to Mr. Zahid Husain – the first Governor of the State Bank of Pakistan. Before introducing our Chief Guest and Lecturer for the day, I would like to briefly dwell upon the personality that was, and the splendid role played by, Mr. Zahid Husain. You may have heard on this topic earlier but it is always heartening to recall stories of success, particularly those that tell of victories achieved while overcoming daunting problems and of the hardships of passing through difficult paths. 2. A close aide of Quad-e-Azam Muhammad Ali Jinnah, Mr. Zahid Husain was a man who possessed abundant amounts of talent and repute. His illustrious career started from British India and culminated in Pakistan, by serving the country at the highest levels of its hierarchy. He taught at Aligarh Muslim University, he was Pakistan’s first High Commissioner to India, the first Chairman of Taxation Inquiry Committee, and the first Chairman of the Planning Commission Board, thereby authoring the first Five-year Plan for Pakistan. 3. Another feather in his cap was his appointment as the first Governor of the State Bank of Pakistan, which was formally declared open by Quaid-e-Azam Muhammad Ali Jinnah on 1st July, 1948. As the skipper of the country’s Central Bank, which was described by Quaid-e-Azam as the symbol of the country’s financial sovereignty, Mr. Zahid Husain aptly displayed his potential as an economic administrator. 4. In addition, he anticipated the prevailing as well as future economic problems for Pakistan and the importance of economists for their resolution. Accordingly, he made efforts to equip the Bank with the adequate expertise so as to effectively manage the economic development of the country. His efforts, in this regard, bore fruit and he was able to recruit a stellar group of economists at State Bank of Pakistan. 5. It is a testament to Mr. Zahid Husain’s ability to recognize and recruit talent that many of these economists served the nation as key policymakers and also displayed their brilliance at international financial institutions. One of these economists was Dr. Mahbub ul Haq whose work and achievements are exemplary. Besides being an excellent economist, he has been described as “the most articulate and persuasive spokesman” for the developing world. He is famous for his pioneering work in Human Development Theory, for the invention of Human Development Index, for the creation of Human Development Report, and for the establishment of Human Development Centre in Pakistan. He served as Pakistan’s Minister of Finance, Planning and Commerce during 1982–88, besides serving as the Director of Policy Planning at the World Bank and Special Advisor to the United Nations. The respect that he commanded at the international level could be gauged when Mr. Kofi Annan, the then Secretary General of the U.N., said of his demise that “Mahbub ul Haq’s untimely death is a loss to the world ...”. 6. There are other professionals too who started out under the patronage of Mr. Zahid Husain and reached respectable positions in international financial institutions such as Dr. Pervez Hasan, etc. It is a matter of pride for me that the example set by the first Governor of SBP has been followed by his successors. A number of SBP economists have served the IMF and reached its highest echelons. One such economist was Dr. Muhammad Yaqub, who spearheaded the Central Bank during one of the most challenging times in the country’s BIS central bankers’ speeches history and Mr. Muhammad Ashraf Janjua, who was a former Deputy Governor of the State Bank of Pakistan. This is in addition to a considerable number of non-economist professionals from the State Bank of Pakistan who have served their respective professions on the national as well as on the international stage. 7. Those of us witnessing Pakistan’s current progress may find it hard to imagine the challenging times that the country bore shortly after its birth and through its infancy stages. Without quoting specific examples here, it is suffice to say that those were really very testing times. Although resources available to the nation then were quite low, the courage and passions of our founding fathers pulled the country through. They devoted their body, soul and personal resources, in entirety, during the journey from scratch to sky-scraper. Mr. Zahid Husain was amongst those great personalities. 8. He never hesitated in accepting the challenging tasks and, in the same spirit, led the Central Bank successfully in those testing periods of our country’s history. The nation also recognized his commendable efforts and has tried to repay her debt to him for the meritorious services rendered for the country. Accordingly, on the occasion of the Silver Jubilee of State Bank of Pakistan in 1973, it was decided to institute an annual series of lectures and to name the series in commemoration of Mr. Zahid Husain. 9. Since then, we have organized 17 lectures in the series and invited eminent economists and financial experts from around the globe as Guest Speakers. The latest one took place in the year 2010 wherein Mr. Kent Mathews, Sir Julian Hodge Professor of Banking and Finance, Cardiff Business School, United Kingdom shared his thoughts with the audience on “Banking Efficiency in Emerging Market Economies”. These lectures provided an excellent opportunity for the participants to share ideas on issues of topical importance. 10. Before moving forward, I would like to express my sincere gratitude to Justice (Retired) Nasir Aslam Zahid – the son of Mr. Zahid Husain – for his attendance. He scarcely needs an introduction. He is one of the most prominent personalities of the country – not only due to his status and accomplishments in the judiciary but also for his postretirement service to the nation. He served all of the judiciary’s vital organs – he was the Chief Justice of Sindh High Court, then a judge of the Federal Shariah Court, before finally serving the Supreme Court of Pakistan. He enjoys an untarnished reputation within and outside the judicial circle. Even after retirement, he has continued serving the nation with his involvement in human rights issues and education. He is currently the Dean, Faculty of Legal Studies and the Head of the Hamdard School of Law at the Hamdard University, Karachi. I am thankful that he has very kindly accepted our invitation and spared the time to grace the occasion with his presence today. 11. Now, before introducing our speaker for the day, allow me to humbly add a few words about the role played by State Bank of Pakistan with regard to today’s subject – “Micro-Credit and Financing of Small Business”. First, our own research department has been engaged in documenting, through national surveys, the workings of the product, labor and credit markets of the informal sector – with a particular focus on the manufacturing sector. The results of these surveys have started to trickle down. Secondly, you may remember that the 5th Pakistan Microfinance Country Forum was recently held in Karachi on 2nd December, 2011. Some details concerning the issue were given in my Inaugural Address at that Forum. Since there has been hardly any change in factual position since then, I would like to avoid repetition as much as possible and limit myself to a few words about the developmental role of State Bank of Pakistan. 12. As you are aware, Central Banks of developing countries are supposed to perform both traditional as well as developmental functions, in order to achieve macroeconomic goals; and SBP is no exception. The nontraditional or promotional functions, performed by the State Bank, include the development of financial frameworks, the institutionalization of savings and investment, the provision of training facilities to bankers, and the provision of credit to priority sectors. In this regard, SBP has always endeavored to meet the genuine BIS central bankers’ speeches credit needs of different sectors of the economy, thereby serving as a catalyst to the process of economic development. As I have mentioned earlier in my speeches, efforts to bring Microfinance into the mainstream formal financial system started in 2000 & 2001 in the aftermath of the promulgation of the Microfinance Ordinance and, since then, we have witnessed the establishment of new microfinance banks, the transformations of large microfinance institutions, the diversification of funding sources, the development of inclusive financial services, the emergence of alternative delivery channels, and the piloting of “Microfinance – Credit Information Bureau” (MCIB). Against this backdrop, a Small & Medium Enterprise (SME) Finance Department was established in State Bank of Pakistan in July 2008 to focus on providing an enabling regulatory framework for SMEs, assessing their credit needs, capacity development of Banks and DFIs and for building awareness through seminars and conferences, along with the promotion of financial services for export-led industrial growth. 13. Regarding the regulatory approach of SBP, I would like to quote short excerpts here from my speech at the Pakistan Microfinance Country Forum: “In developing regulations for microfinance, the State Bank has pursued a bottom-up approach, along with use of strong analytical and problem solving skills and industry consultation. Since the inception of microfinance banking in Pakistan, our goal has been to determine the proportionality of a regulation before it is put in place. Hence, the regulatory approach has remained gradual and in line with the evolution of the sector…” “In the new Microfinance Strategic framework 2011–15, SBP has laid out a detailed strategy to promote sustainable growth of the sector. The strategy’s effectiveness and success hinges on growth dynamism fundamentally coming from microfinance operators themselves. The role of SBP is to develop the banking infrastructure, to encourage the use of successful global practices, and to provide the regulatory and supervisory mechanism that enable MFBs to develop viable business models”. 14. We shall soon have the pleasure of hearing our distinguished speaker, Professor Banerjee’s, thoughts on this subject. I am sure his lecture today will introduce us with something special on the topic, not only because of his extensive research on the subject but also because of candidness of his approach. Perhaps, not many of us will have witnessed this openness and honesty of thoughts earlier – the kind that is evident from the last sentence of the concluding chapter of his most recent book titled “Poor Economics”. Let me quote that very sentence for you: “At least we can stop pretending that there is some solution at hand and instead join hands with millions of well-intentioned people across the world – elected officials and bureaucrats, teachers and NGO workers, academics and entrepreneurs – in the quest for the many ideas, big and small, that will eventually take us to that world where no one has to live on 99 cents per day”. 15. Now let’s turn to our guest speaker himself. Ladies and gentlemen, we are honoured to have with us, Dr. Abhijit Vinayak Banerjee, the Ford Foundation International Professor of Economics at the Massachusetts Institute of Technology, USA. His teaching and research have won him accolades the world over and he stands as a giant in his profession. Just to introduce him to our guests here, Dr. Banerjee has attended the University of Calcutta, Jawaharlal Nehru University and Harvard University, successfully earning his Ph.D from the latter. 16. During 1988 to 1992, he taught as an Assistant Professor of Economics at Princeton University. He moved to Harvard University in 1992 as Assistant Professor of Economics, before joining the M.I.T. in 1993 as Pentti J.K. Kouri Career Development Associate Professor of Economics. He became Associate Professor of Economics in 1994 and then Professor of Economics in 1996. He is the co-founder of Abdul Latif Jameel Poverty Action Lab (J-PAL) at M.I.T, which runs field experiments aimed at measuring different ways to save the world. In 2009, J-PAL won the BBVA Foundation “Frontier of Knowledge” Award in the development cooperation category. BIS central bankers’ speeches 17. Professor Banerjee’s general research areas include economic development, information theory, theory of income distribution, and macroeconomics. 18. As you know, an economist’s caliber – particularly an academic one’s – is primarily judged by the quality of his publications; and to date Dr Banerjee has published no less than 60 papers in the world’s leading economic journals. The important lesson from this volume of research is that it has focused on real world issues with real world solutions. His latest research is based on studying economic interventions on the basis of “randomized controlled trials.” The idea is simple enough – to compare groups of people with and without policy intervention over a period of time; akin to the trials of new drugs. 19. In addition to his scholarly work, he has authored three books, including his recent one called “Poor Economics”, which has received the attention of scholars across the globe. And this is not the all; he is an ex-president of the Bureau for the Research in the Economic Analysis of Development, a Research Associate of the NBER, a CEPR research fellow, an International Research Fellow of the Kiel Institute, a fellow of the American Academy of Arts and Sciences and the Econometric Society and has been a Guggenheim Fellow and an Alfred P. Sloan Fellow. He has also been a recipient of the Infosys Prize 2009 in Social Sciences and Economics. 20. Dr. Banerjee and his colleagues at J-PAL have worked with a global network of researchers to conduct experiments in the poorest places of the world and have derived conclusions that are believed to have challenged economists’ and policy makers’ thoughts about impoverished areas. Their findings have concluded beyond broad generalizations to show that the poor do not always act in ways that conform to the views and programs of wellmeaning relief agencies, revealing a portrait of poverty as complex as the movements of financial markets. 21. Professor Banerjee will be delivering his lecture today on the topic of “Micro-Credit and Financing of Small Business”. Needless to emphasize that it is an important topic, particularly when seen in the backdrop of the challenges faced by the poor in gaining access to formal financial services. Although much has been done in this regard, the stage of absolute resolution has yet to be reached. 22. Here, we should not forget to mention the names of Dr. Akhtar Hameed Khan in Pakistan and Professor Muhammad Yunus in Bangladesh for their pioneering work in the subject area – providing a substantial source of assistance to the poor community – and their efforts for the alleviation of poverty and increases in the standard of living. 23. I would like to avail this opportunity to thank Dr. Banerjee on behalf of this forum for taking out the time from his extremely busy schedule and taking the trouble to fly from USA to join us here in Pakistan. 24. Before I conclude my remarks, I would also like to thank you all for joining us here and for participating in today’s knowledge-sharing event. I am sure that Professor Banerjee’s lecture today will be of immense utility for the audience, since it will enlighten us with the latest thoughts, developments and trends regarding the subject. 25. It gives me immense pleasure to introduce and invite Professor Banerjee. BIS central bankers’ speeches | state bank of pakistan | 2,011 | 12 |
Keynote speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Launching Ceremony of the National Financial Literacy Program, Karachi, 20 January 2012. | Yaseen Anwar: Role of financial institutions and capital markets in Pakistan’s economy Keynote speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Launching Ceremony of the National Financial Literacy Program, Karachi, 20 January 2012. * * * Distinguished Guests, Ladies and Gentlemen! It gives me great pleasure to launch the first ever National Financial Literacy initiative in Pakistan. The program will initially impart basic financial literacy to poor and marginalized people of Pakistan. It is my firm belief that the initiative will work towards improving financial inclusion and also serve the interests of all financial sector stakeholders. Therefore, I would like to thank and congratulate our partners including the Asian Development Bank, Pakistan Banks’ Association, Pakistan Microfinance Network, Pakistan Poverty Alleviation Fund and Bearing Point for their support and collaboration to make financial literacy a key priority. To set the stage, I would like to begin with a workable definition of financial literacy as developed by the Organization for Economic Cooperation and Development’s (OECD) International Network for Financial Education (INFE): “Financial literacy is the combination of consumers’ / investors’ understanding of financial products and concepts and their ability and confidence to appreciate financial risks and opportunities, to make informed choices, to know where to go for help, and to take other effective actions to improve their financial well-being.” The definition highlights four key aspects: First, financial literacy is about educating consumers so that they are knowledgeable about financial services and enables them to use this knowledge to evaluate products and make informed decisions. Therefore, financial education must aim to build consumers’ awareness and knowledge of financial terms and calculations; Second, for poor and rich alike, financial literacy is about empowering consumers through developing money management skills to enable them to make the most of their resources, and reducing vulnerability to overzealous retailers or fraudulent schemes. Therefore, financial literacy must enable people to make better financial decisions, to appreciate their rights and responsibilities as consumers of financial products, and to understand and manage risk; Third, there is increasing evidence that those who are financially less literate are more likely to have problems with debt, are less likely to save, are more likely to engage in high-cost credit, and are less likely to plan for the future. Therefore, for regulators of financial services, it is necessary to develop programs to promote public awareness for helping people to make informed financial decisions and maintain market confidence; and Finally, financial literacy program adds the missing demand-side dimension to financial inclusion strategies. Therefore, financial literacy can be a very effective tool to tackle the psychological, emotional and cultural barriers that prevent people from being financially included. Many poor and non-poor people do not have a bank account and very few of them understand why this puts them at a disadvantage when it comes to their personal financial management. According to Pakistan Access to Finance Survey (A2FS), only 12 percent of the population has access to formal financial services. Whereas of the remaining 88 percent, only 32 percent are informally served and 56 percent are completely excluded. Moreover, according to the A2FS analysis, about 40 percent of the financially excluded population reported lack of understanding of financial products as the main reason for financial BIS central bankers’ speeches exclusion. This clearly identifies the need for financial education as a systemic area to be addressed to tackle financial exclusion in a big way. Allow me to very briefly share the various conventional and non-conventional measures adopted by SBP to boost financial inclusion: SBP introduced Basic Banking Account (BBA), a simplified financial product for low income consumers. BBA aims to reduce costs for consumers by removing more expensive facilities and requires no minimum balance, and neither does it have complex terms and conditions thereby reducing administrative and management costs. SBP introduced Microfinance Banking Regulations in 2001 to specifically meet the demands of low income consumers. These regulations have been improved to a world class microfinance regulatory framework, ranked number one for the last two years in a row by “the Economic Intelligence Unit” of UK’s “The Economist” magazine. SBP has adopted innovative solutions to overcome geographical barriers, including branchless banking through retail agents and harnessing technology via mobile-phone banking. The Branchless Banking Regulations were introduced in 2008, clearing the way for development of branchless and mobile phone banking services in Pakistan. The retail network of banks has overwhelmingly multiplied due to agents and mobile phone channels. In less than three years, there are now 18,000 branchless banking outlets, augmenting and surpassing the 10,000+ conventional bank branches. In addition to these policy and regulatory measures, SBP has been managing various market interventions funded by donors including GOP, UKAID, and ADB. I would like to especially thank ADB and UKAID for actively supporting financial inclusion in Pakistan. Under the programs sponsored by these donors, a number of market interventions are managed by SBP including: The Institutional Strengthening Fund (ISF) providing grant funding to Microfinance (MF) providers to top and middle tier Microfinance Banks (MFBs) and Microfinance Institutions (MFIs) for key investments in HR, IT, product development, risk management systems, business plans and branchless banking development. The Microfinance Credit Guarantee Facility to link microfinance with financial markets for mobilization of wholesale commercial funding through partial guarantees. Similarly, the Financial Innovation Challenge Fund (FICF) for grants to innovative projects and testing new markets to lower cost of delivery, enable systems and procedures to be more efficient and provide new ways of meeting the larger demand for financial services. And the Improving Access to Financial Services Fund which is supporting today’s program. These are mostly supply side interventions aiming to increase financial services by removing bottlenecks and have raised financial inclusion to a certain extent. However, what has been missing is a demand side solution – a program to impart financial education and awareness to consumers. This recognises that the very low level of financial awareness and confidence of financially excluded groups remains a strong barrier to their access and use of financial services. In addition, there are risks involved in creating new opportunities for consumers if the consumers are not proficient at making financial decisions. Therefore, going forward, SBP considers financial literacy as an integral part of the financial inclusion strategy. Financial literacy has assumed greater importance in recent years for both developed and developing countries, therefore, best practices in this area are still evolving. However, synthesizing from the OECD’s high level principles for financial education, some best practices are: First, the financial education program must involve key players from the beginning. This may take a lot of time and effort due to slow decision making process but will ensure success of the program in the long-run. In particular, the consumers must be consulted to understand BIS central bankers’ speeches their preferences and identify appropriate curriculum and dissemination channels and tools. Therefore, financial education surveys must be conducted to appropriately identify the needs and to set a baseline for program monitoring. This will also help identify teachable moments for low income groups that may typically occur around the receipt of money, the need for credit etc. Second, it is better to implement and earn quick wins to generate positive energy such as starting from a pilot launch initially before going national to gain the buy-in of all the stakeholders. Third, the program design should be flexible enough to enable diverse stakeholders to join-in and create synergies. This will also give the program high visibility and help partners achieve their own goals. However, due care must be exercised that messages are product and institution neutral and can be used by all partners to create a multiplier effect. Finally, the program must enjoy ownership by leadership from participating institutions that increases the interest of the topic with stakeholders, politics and media. The National Financial Literacy Program (NFLP) is broadly in line with these guiding principles. NFLP pilot will impart financial education and awareness on six personal finance themes namely budgeting, savings, investments, debt management, financial products, branchless banking and consumer rights & responsibilities to about 50,000 beneficiaries from low income strata. We should not ignore the important peer effects of the direct beneficiaries which is very likely to be spread around a community. Those who have received education can pass on their knowledge to friends and family, thereby increasing the impact of the education. The program has been developed after the Financial Literacy Gap Assessment Survey of beneficiaries. The survey has been helpful in development and adaptation of curriculum and dissemination strategy. The curriculum will also be translated into national and main regional languages including Urdu, Sindhi, Punjabi, Pushto and Balochi. The Program is financed under the ADB-funded Improving Access to Financial Services Fund (IAFSF) and implemented under the oversight of the IAFSF Committee which has representation from SBP, Pakistan Banks’ Association, Pakistan Poverty Alleviation Fund, Pakistan Microfinance Network, education sector, and the ADB. Upon completion of the pilot phase, an impact assessment of the pilot will be conducted by a third party. Based on the experience and assessment of the pilot, the program will be scaled-up to target more than half a million beneficiaries all over the country. In addition to focused training sessions of beneficiaries, the dissemination strategy involves street theatres, board games, comic strips, activity-based competitions, website and media campaigns to reach out the masses on a larger scale. The training sessions will be sourced from banks, MFBs and MFIs based on their interest and pre-defined qualification criteria. In order to encourage and incentivize participation from partners, professional fees and out of pocket expenses of partners will be reimbursed from the program budget. Besides involvement of local institutions, the project has formed partnerships with international financial education programs including Microfinance Opportunities, Finmark Trust, Association of Microfinance Institutions of Uganda (AMFIU), Sewa Bank, Microfinance Innovation Centre for Resource and Alternatives (MICRA), World Bank Institute, Aflatoun, and others. Conclusion: I would like to conclude with the thought that consumer protection and financial education should be vital components of any financial inclusion initiative. It is now clear that policies which focus entirely on changing the supply of financial products and services can leave consumers ill-informed, vulnerable and not willing to participate in financial markets. Moreover, the focus of financial literacy program should be broader than financial inclusion. It BIS central bankers’ speeches should aim to increase consumer awareness about their rights, obligations and mechanisms for recourse to build a fair, inclusive and robust financial sector. In addition, I would like to encourage financial service providers to partner in the NFLP rollout and exercise proportionate level of accountability and responsibility to act in the best interest of their clients. Intermediaries should fully disclose their terms and conditions to clients before selling them a product or service. Finally, I would like to thank all of you for coming together to show your commitment to promoting financial literacy in Pakistan. ************** BIS central bankers’ speeches | state bank of pakistan | 2,012 | 2 |
Keynote address by Yaseen Anwar, Governor of the State Bank of Pakistan, at the 5th International Conference on "Mobile banking in Pakistan", Karachi, 15 March 2012. | Yaseen Anwar: Mobile banking in Pakistan Keynote address by Yaseen Anwar, Governor of the State Bank of Pakistan, at the 5th International Conference on “Mobile banking in Pakistan”, Karachi, 15 March 2012. * * * Distinguished Guests, Ladies and Gentlemen! I feel privileged to be here today at the 5th International Conference on Mobile Commerce in Pakistan and share my thoughts on the development of Mobile banking. At the outset, let me congratulate the organizers for bringing together relevant stakeholders to this very innovative value-creation opportunity ushered by the mobile commerce era. The State Bank sees this as a great opportunity for safe, faster, and efficient provision of financial services to the un-served segments of the society through mobile technology and agent banking. First I would like to briefly talk about the significance of Mobile Commerce and then move on to the subject of mobile banking for promoting financial inclusion. From the business perspective, the M-Commerce encompasses technologies, applications and services that involve several stakeholders like infrastructure equipment vendors, software vendors, content providers (including advertisers), content aggregators, Mobile Network Operators, mobile device manufacturers and of course financial institutions. Therefore, Mobile Commerce is generally characterized by a variety of business partnerships often involving a large number of organizations, from content providers to financial institutions to mobile network operators. Over the past few years, Mobile Commerce has been used as an alternative channel for delivery of various services in developed countries, whereas in the developing countries attempts are being made to leapfrog and use M-commerce as a main channel due to the limited outreach through conventional channels. I firmly believe that usage of innovative and unconventional channels will overshadow the conventional means of business and communication. To substantiate my optimism, currently the growth in number of mobile phones is far greater than the growth in the number of Fixed Lines across the globe, particularly in developing countries. Global mobile phone subscriptions have reached 6 billion, almost equivalent to 90 percent of the world’s population. In Pakistan, the number of mobile phone subscribers has reached 112 million and growth continues apace. The current subscription rate is as high as 100 million which roughly is around 62 percent of the total population. We should acknowledge the role played by the Government, PTA and the Mobile Operators for achieving this high level of penetration, especially under our existing socioeconomic conditions. Turning now to the use of mobile technology to promote financial access, there is an emerging consensus amongst policy makers around the world to improve access to financial services for poor people, through supporting the safe and sound spread of new modes of financial service delivery capable of reaching the poor. G-20 leaders in their last summit in Toronto in 2011 adopted 9 Principles for Innovative Financial Inclusion which includes promoting technological and institutional innovation as a means to expand financial system access and usage, including by addressing infrastructure weaknesses. These principles aim to help create an enabling policy and regulatory environment for innovative financial inclusion. The enabling environment will critically determine the speed at which the financial services access gap will close for the more than two billion people currently excluded. They are the financially excluded in a world where access to financial services can mean the difference between surviving or thriving. BIS central bankers’ speeches Innovative modes of financial services delivery can have a transformative effect on poor households. We know how greater access to even small amounts of credit can dramatically improve welfare – such as women being able to buy a sewing machine and establish a small business. Awareness is growing that access to a wider set of financial services provides poor people with capacity to increase or stabilize their income, build assets and have much greater resilience to economic shocks. Appropriate and affordable savings products, payment and money transfer services (both domestic and international) as well as insurance are all important. At the same time, One billion people with mobile phones in the world do not have even a basic bank account. As the cost of information and communications technology shrink, the time is ripe for using technology to address financial exclusion. Technological innovation changes the cost and access equation – making it economically viable for financial service providers, often in partnership, to reach poor people, with a wider range of products and services. Innovation also extends to new institutional approaches. Increasing numbers of countries with large unbanked populations are pioneering policy and regulatory innovations that open space for “banking beyond branches” and similar new approaches to the delivery of formal financial services. This is allowing previously excluded customers access to an increasing range of basic financial services. Pakistan has one of the lowest financial penetration levels in the world with 56% of the adult population totally excluded, and another 32% informally served. We are a country with a population of 180 million living in geographically diverse areas. Mobile phone subscription has seen explosive growth in Pakistan – total subscription now reaches 112 million across customers in all income segments, and growth continues rapidly. In contrast, banking accounts are owned by approximately 25 million customers largely belonging to high income segments. And there are about 7 million borrowers. With a network of 10,000 bank branches, Pakistan has the highest number of people per bank branch in the region. Until now, the lack of a sizable distribution network had been a major challenge in broadening access to financial services. As a result, a large segment of the population, particularly those living in rural and remote areas have remained deprived of banking services. An important implication of this exclusion is that this large proportion of population has been overwhelmingly reliant on cashbased transactions, thus causing a negative impact on documentation of the economy, the tax-base, efficiency of economic transactions, etc. Developing bricks and mortar branches is a costly proposition. To encourage FIs to develop alternative delivery channels, SBP in 2008, introduced Branchless Banking (BB) Regulations. The Regulations are applicable to all Commercial Banks, Islamic Banks and Microfinance Banks in Pakistan. These Regulations have actually catalyzed a number of branchless banking deployments with dual advantages: First, there is enormous scope for expanding outreach, especially to hard-to-reach rural areas. The emerging models relying on “banking agents” will greatly extend the distribution of financial services to the poor and marginalized segments. Second, alternative delivery channels promise significant cost reduction to institutions. Due to these benefits, the expansion in the retail network of microfinance has arisen overwhelmingly from agents and mobile phone channels. Mobile phone banking is now the new market niche for both banks and Mobile Network Operators (MNOs), and many of them are preparing to enter in this exciting market in a big way. In almost 2 years, the branchless banking deployments with 22,500 agents offering lowcost services all over the country, including in the hitherto neglected areas, have surpassed the 10,000 branch network of banks. The fast mobile penetration and its continuing strong growth fuels expectations that transformational branchless banking models would prove a game-changer in improving access to finance in Pakistan. BIS central bankers’ speeches The State Bank of Pakistan always welcomes innovative products and desires to work with development partners in the promotion of such products that offer choices for Banking or Payment Services in terms of cost, risk, and convenience. Certainly, benefits of such initiatives for the economy are overwhelming. I strongly believe that where conventional banking has its limitations, the Electronic Payments and Mobile Banking products should fill the Gap. In particular, the challenge is to extend these services to “Unbanked” or the Underserved segments of the population, that mostly reside in far flung rural areas. In this respect a small Retail Store in a remote part of the country could serve as an Agent to help solve everyday problems of a farmer, who is generally required to travel long distances and incurs high costs for utilizing the necessary financial services. As a forward-looking regulator of the Banking Industry, the State Bank has played an effective role in providing an enabling regulatory environment for the banks to leverage their full potential of technology, mobile operators’ penetration, and other available delivery channels to provide financial services to all segments of the population. Until recently, banks were largely focusing on conventional banking, but with the introduction of Branchless Banking Regulations in 2008, banks are now getting fast into action by exploiting Information and Communication Technologies (ICT) to offer more innovative products and services. These Regulations have now enabled our banks to diversify their geographic footprint in areas where conventional branch banking was either inadequate or totally absent. Today, we have two fully functional Branchless Banking deployments with over 22,000 Access Points with a geographic dispersion in over 600 cities across the country. These deployments are serving more than 1 million accountholders and millions of Over-theCounter customers. So far around 80 million Branchless Banking transactions of Rs.300 billion have been executed in Pakistan. In addition to the above, a number of banks are already in the Pilot Phase with others approaching SBP to initiate Branchless Banking business. It also gives me immense pleasure to share that one of the largest mobile operators in the country and the largest private sector banks is already flexing its muscles to enter into the Branchless Banking arena. With the influx of new entrants, I am expecting a surge in the number of Access Points to over 50,000 very soon. Our achievements in the Branchless Banking Services have put Pakistan at the Global Centre Stage of Financial Inclusion and innovation. CGAP, in its recent study has also recognized Pakistan as one of the fastest developing markets for Branchless Banking. According to the recent data from SBP’s Branchless Banking Newsletter, a large segment of the previously unbanked population has started entering into a new arena of branchless banking (BB). Total volume (number) of transactions has jumped to 20.6 million during the Oct-Dec 2011 quarter. Thus, the average daily transactions have increased to 228,855. Value of transactions during the last quarter reached Rs 79,410 million. Total number of branchless banking accounts have increased to 929,184. Branchless banking deposits have grown to Rs 503 million. The average size of branchless banking transactions is Rs 3,855 (US$ 43) which shows that mobile phone technology and agentbased banking are helping access to financial services by the hitherto unbanked poor. Early uptake of mobile banking is also beset with challenges. The existing agents network needs to be further capacitated to generate new demand; handle and service even larger volumes of transactions to establish the business viability of BB operations. Going forward, SBP will be initiating actionable research on the supply and demand side in collaboration with the Branchless Banking ecosystem for further development of such services in Pakistan. The study will focus on opportunities such as: BIS central bankers’ speeches i. Estimation and Development of a Retail Payments System Strategy: The initial BB business is based on handling large volumes of transactions. Therefore payments services such as bulk G2P, B2B, B2P payments and retail P2P payments are a necessity for survival in its infancy phase. Identification and preparation of a matrix of these payments will be helpful in highlighting the volumes in payments services and opportunities for future development and partnerships for establishing the business case/viability and promotion of branchless banking in Pakistan. ii. Research into agents’ economics and business case and identification of key bottlenecks including public policy issues such as taxation of BB services etc. iii. Research into agents’ selection and management for identification of challenges, particularly in the management of liquidity at agents’ outlets, quality of service for maintaining minimum service standards, Security systems & controls for fraud prevention and detection, complaint handling and redress mechanism, and Agent disqualification and delisting mechanism etc. Interventions will be launched to enhance the agent’s credibility. iv. Research on BB Technologies: there is a need for understanding of BB technologies for adoption of common standards and platforms for promotion of financial inclusion on a massive scale. Therefore, a study on BB technologies would be conducted for understanding existing technologies along with development of some common standards. These will also be helpful in getting one step nearer to the interoperability of the technological solutions and agent networks. v. Likewise demand side field research into the experience of current users and nonusers of branchless banking will be conducted. The survey would help in identification and understanding the top financing needs of the low income clients and help BB providers tailor their products to satisfy the unmet demand for such services. Similarly the survey will also provide insights on financial literacy and consumer protection issues. Branchless Banking has also proved to be an effective instrument for channelizing the Government to Persons (G2P) Payments in trying times like serving the Internally Displaced Persons (IDPs), during the devastating floods over the last three years. Further, BISP beneficiaries are also being served very effectively through the same mechanism as well. In the coming days, this channel is expected to continue playing an important role towards the promotion of financial inclusion and the management of Government to Person (G2P) Programs like Salaries Disbursements, Pensions, BISP, Watan Cards, Pakistan Cards and Tax Collections Services, etc. We are confident that the Branchless Banking deployments can cater to the needs of over 10 million potential beneficiaries of G2P Payments in Pakistan. The State Bank will continue to play its role in promoting an environment which is conducive for financial innovation. At the macro level, we will continue to work with the industry and the other regulators to promote a sound, safe, efficient and inclusive Mobile Commerce Ecosystem. Our aim is to provide at least basic Banking Services to every adult and bankable citizen. Today, as a large portion of our populations has access to mobile phones, we feel that if a workable partnership between the Banking and Telecom Sectors continue, we shall see our dreams come true. On this front, we are already working closely with Pakistan Telecommunication Authority and have also signed an MOU for enabling the Interoperability Framework where all banks and telcos can join hands to serve the customers. We are also in the final stages of formulating the Regulatory Framework for Interoperable Mobile Banking System. Interoperable systems are essential to mass adoption of mobile commerce. At present, financial institutions and telcos can choose whatever business model suits their needs i.e. One-to-One or One-to-Many; however, I can foresee that in future, only interoperable solutions shall fasten both scalability and viability. Here, let me assure that all BIS central bankers’ speeches the existing and the prospective One-to-One or One-to-Many arrangements between banks and the Telcos would not be affected with the proposed regulatory framework. I must acknowledge the efforts and initiatives adopted by Ministry of Information Technology and the PTA towards the promotion and development of Mobile Banking in the country. It is heartening to see that PTA is playing an important role by encouraging its regulatees to play their due part in the provision of smooth and efficient Branchless Banking Services. For banking and telecom industries, it should be a matter of great comfort and satisfaction that their regulators i.e. SBP and PTA share the vision and are working in tandem to provide an enabling regulatory environment for the provision of Mobile Banking Services. This cooperation between the regulators; will create much desired synergy in both the banking as well as telecom industries. Going forward, much still needs to be done. SBP is keen to work with different stakeholders, including but not limited to financial institutions, different regulators, private sector, application developers and telcos to provide an enabling environment for the creation of Mobile Commerce Ecosystem in the country. We have only seen the start of it but the rest is yet to come. However, the common challenge is to ensure that all banking transactions, irrespective of the technology platform, are cost effective, efficient, and pose a lowest risk for the consumers. This requires close coordination among the stakeholders in the area of regulations especially monitoring, licensing, provision of technological infrastructure and ensuring maximum benefits for consumers. I trust today’s conference will help us understand the issues relating to Mobile Commerce and the importance of Mobile Banking in the development of an inclusive Mobile Commerce Ecosystem. This conference will help to increase the General Awareness among participants about Mobile Commerce and the evolving trends in Mobile Banking for which Total Communications deserves to be applauded. Thank you all for being part of this forum and I look forward to your productive participation in today’s event. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 3 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the second meeting of the Financial Stability Board (FSB) Regional Consultative Group for Asia, Kuala Lumpur, 14 May 2012. | Yaseen Anwar: Managing Systemically Important Financial Institutions (SIFIs) Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the second meeting of the Financial Stability Board (FSB) Regional Consultative Group for Asia, Kuala Lumpur, 14 May 2012. * * * Ladies and gentlemen, Good evening. It is indeed a pleasure to be here in Kuala Lumpur again, and I am grateful to Governor Zeti for inviting me as a lead discussant on one of the key challenges of regulatory reform agenda – “Managing Systemically Important Financial Institutions”. In these few minutes, I will cover the need for specific regulations for SIFIs, progress made so far in designing the policy framework, perspectives of emerging markets in general and Pakistan in particular, regulatory challenges faced by supervisory authorities, and what remains to be done. In the aftermath of the Global Financial Crisis (GFC) 2007–08, the entire supervisory perspective towards financial institutions regulation has taken a U-turn. In the pre crisis era, supervisory authorities, mainly in advanced countries, chose to rely on market discipline and favored somewhat self regulation by the financial industry. The approach stemmed from the perception that financial institutions are in the best position to understand the market and risk associated with financial products. Overly prescriptive regulations were thought to stifle innovation and diversification – both across borders and across activities. The prevailing version of international accord on capital and liquidity standards, Basel II, further reinforced this practice. Most frameworks relied on banks’ own assessment of risks. However the GFC, particularly the collapse of Lehman Brothers in the fall of 2008, triggered problems throughout the financial system across the world and changed supervisory perspective towards financial industry regulations, particularly the so called “Systemically Important Financial institutions (SIFIS1)”. The Lehman bankruptcy with ensuing financial instability and loss of real output brought forth several shortcomings of the international financial architecture that exposed risks resulting from a lack of a policy framework for dealing with SIFIs. In the pre-GFC era it was precisely these institutions that were deemed quite invincible. However, the huge costs of implicit government guarantees of not letting a SIFI to fail and their adverse impact on global financial stability, raised serious concerns on “Too Big to fail” (TBTF) status of SIFIs. Post crisis era witnesses increased discussion on changing TBTF status of SIFIs and for devising a resolution regime as well as safe exit mechanisms for these entities. Resultantly, immediately after the Lehman failure, we saw international financial authorities placing financial sector reforms as their top priority agenda. Over the last few years, we have seen increased realization among financial authorities that diversification may be beneficial for a large bank against idiosyncratic risk, but similar patterns of diversification by many global banks across the world had actually contributed towards building up of systemic risk. Further, it has also been recognized that the prevailing regulatory framework and polices are not sufficient to address the “negative externalities” that large financial firms create. Supervisory authorities have arrived at a consensus that SIFI DEFINITION: An institution, market or instrument is considered systemically important if its failure or malfunction causes widespread distress, either as a direct impact or as a trigger for broader contagion. The interpretation, however, is nuanced in that some authorities focus on the impact on the financial system, while others consider the ultimate impact on the real economy as key (Financial Stability Board (2009)). Negative externalities are associated with institutions as they are perceived not being allowed to fail due to their size, interconnectedness, complexity key criterion to identify SIFIs. BIS central bankers’ speeches SIFIs require enhanced supervisory focus on account of their relative size, interconnectedness with market(s) and complexity. To reduce the probability of failure of such institution and minimize the risk to financial stability and the real economy, it is imperative to strengthen the regulatory framework and enhance supervisory capacity for dealing with SIFIs. Before expressing my views on the regulatory framework for SIFIs, I would like to appreciate the commendable work done and progress made by the FSB, BCBS and other multilateral agencies on the financial reforms agenda over the last few years. Enhanced international accord on capital and liquidity standards; i.e. BASEL III, has set forth the most critical reforms agenda for improving the solvency and resilience of financial institutions. A number of other policy measures supplement Basel III, which among others, included framework for dealing with global SIFIs (G-SIFIs). Starting from initial “Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments: Initial Considerations” issued in November, 2009 jointly by the IMF, FSB and BIS, substantial progress has been made in tackling the SIFIs challenge. A key development took place in November, 2011, when G-20 leaders at the Cannes Summit endorsed the policy framework on systemically important financial institutions (G-SIFIs). A multipronged strategy was adopted for addressing the G-SIFIs comprising of a new international standard for resolution regimes, more intensive and effective supervision, and requirements for cross-border cooperation and recovery and resolution planning. One of the key issues concerning the SIFIs is their identification. The method used for identification of SIFIs varies widely – from complex models to simple indicators (see Box 1 for discussion on methods to identify SIFIs). To facilitate the process, FSB and BCBS have been assigned to determine the G-SIFIs to which the resolution planning and additional loss absorption requirements will apply based on the methodology developed by the BCBS. Accordingly, FSB and BCBS have identified 29 systemically important banks on a global level2 out of a sample of 73 banks. These include 25 banks in the USA and Western European block, 3 in Japan and 1 in China. FSB will update the above list annually based on its assessment which will be publically disclosed. Box 1: SIFIs can be identified either using model based approaches such as contribution, participation and bottom up approach or using a set of simple indicators such as bank size, interbank lending, interbank borrowing. A BIS article “Systemic Importance: Some Simple Indicators (2011)” empirically tested and found that simple indicators are reliable proxies for model-based measures of systemic importance. Alternatively FSB has proposed three key indicators for identifying SIFIs. These are size, interconnectedness and complexity. Whereas the five indicators used for designating Global-SIFIs by FSB are: size, interconnectedness, complexity, and substitutability and cross jurisdiction activity. To address the greater risk posed by the G-SIFIs, intensive regulatory approach is being prescribed for them. They are required to meet the additional loss absorbency requirements ranging from 1% to 2.5% of Risk Weighted Assets (RWA). These requirements will be applicable in phases starting January 2016 with full implementation by January 2019. As per FSB and BCBS assessment, long term economic benefits in terms of greater resilience of these institutions from additional loss absorbency requirements far exceed the modest temporary decline of GDP over the implementation horizon. Another positive development on this front is that some of the countries, notably Switzerland, United Kingdom and Sweden have already taken action to implement higher capital requirements for banks that are deemed systemically important at the national level. Recently, Financial Stability Oversight Council (FSOC) in the USA proposed guidance on the See Annexure 1 for a list of G-SIFIs by FSB BIS central bankers’ speeches process and the factors that it will use to designate Non-Bank Financial Institutions as SIFIs. Some jurisdictions have already adopted legislation to improve their resolution regimes like Germany, where supervisory powers have been significantly extended to restructure and resolve banks. On the other hand, many institutions have actively lobbied against being identified as a SIFI, because of the additional and significant regulatory requirements that SIFIs will endure. Emerging markets Emerging economies financial systems remained fairly resilient in the face of recent crisis. It was possible firstly because financial systems in emerging economies have primarily domestically active FIs. This argument can be supported by the fact that out of 29 designated G-SIFIs3 only one bank from Asia; “the Bank of China” could make it on the list. Secondly, financial systems in emerging economies remain relatively conservative – activities are mainly centered on more traditional banking businesses while capital markets and other financial institutions remain relatively underdeveloped. The difference between financial structures and business models of developed and emerging economies have raised concerns regarding relevance of the reforms – which mainly addresses causes of GFC – for emerging economies. Moreover, since the Asian financial crisis of 1997–98, financial authorities have not only carried out extensive reforms but are very keen in continuously monitoring and adapting to the changing market conditions. Nonetheless, it is a common understanding that supervisory authorities around the world need to give special attention to SIFIs by focusing on the development of specific, relevant and appropriate regulatory standards. In this regard, Asian economies are quite well aware of the issues involving implementation of such a framework. Firstly, emerging Asia is now at the center of global economic growth. To sustain such growth, the need for financial intermediation is also likely to increase. While there is a global consensus on the use of public funds for resolution of SIFIs as a last resort, there can also be circumstances in which use of public funds may be less costly to the economy than excessively “taxing” of the banking system. Asian economies must weigh the cost of new regulations on institutions, against the perceived benefits that those regulations have for the economy and society. Secondly, international standards must be customized according to Asian economies business models. The regulatory and supervisory regime must target well-defined risks that could have systemic implications. Pakistan’s perspective on SIFIs Pakistan is a small, open economy, with domestically an active financial sector. In terms of banking concentration, top 5 banks (all locally incorporated) account for 51% of industry assets; while foreign assets of the system are 10.4% of total assets. Moreover locallyincorporated banks and most foreign branches don’t have significant exposures to the complex financial assets that caused financial meltdown in the U.S. and Europe. Apart from the conservative financial structure, i.e. less risky assets on banks’ balance sheets, SBP has always required banks to meet higher capital and liquidity standards, exceeding international norms in several areas. More importantly, we have a strong legal framework, which has been tested for effectiveness during the last decade and a half. SBP has successfully restructured a number of banks successfully demonstrating the problem bank resolution regime. We already practice enhanced supervision of the most significant financial institutions, identified 17 are from Europe, 8 from US and in Asia 3 from Japan and 1 from China. The initial sample of 73 banks include from Australia, Belgium, Brazil, Canada, China, France, Germany, India, Italy, Japan, Korea, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States. BIS central bankers’ speeches by size. The supervisory framework includes quarterly reviews of individual banks for off-site surveillance, periodical and special on-site inspections and regular interactions with banks’ aimed at reducing the probability of failure of these institutions. The multi-pronged strategy has proved quite effective so far. SBP has ensured that adequate safeguards are in place to limit the direct impact of externals shocks. Not surprisingly, Pakistan’s financial system withstood the global financial crisis reasonably well. SBP is vigilant towards the changing market dynamics, both locally and abroad, and is already in the process of reviewing Pakistan’s banking industry vis-a-vis Basel III capital and liquidity standards. Regarding dealing with SIFIs, high-frequent monitoring and more in-depth supervision are our main tools for dealing with large banks, which are essentially the so-called SIFIs for us. However, we are looking forward to the development of a framework to identify and deal with domestic SIFIs (D-SIFIs) by FBS, BIS, and IMF. Till such time the framework for global SIFIs may be a useful starting point for countries like ours for dealing with domestic SIFIs. In view of that, we have already initiated an assessment process. Recently, we have conducted an in-house study based on simple indicators approach to assess possibility of domestic SIFIs in Pakistan; our initial assessment suggests that banks with the largest market share in terms of assets – are the most systemically important banks. These findings endorse the earlier held belief regarding the significance of asset size in Pakistan’s banking industry. Regulatory challenges There are multiple challenges faced by regulatory authorities to design and implement the framework for SIFIs identification, implementation and cross border resolution – to accelerate reforms of domestic resolution regimes and tools and of frameworks for cross-border enforcement of resolution actions. One of the major issues highlighted by the crisis has been gaps in the legal framework for dealing with failing financial institutions. Though capital buffers will help build up the resilience, however, it cannot avoid failures. Therefore gaps in legal frameworks must be addressed so that SIFIs, too, must be able to exit the market in an orderly manner without exposing taxpayers to the risk of loss. Emerging economies need to be cautious while adopting the regulatory framework being proposed for SIFIs. A detailed assessment on the possible legal, regulatory and economic implications is imperative before adopting and customizing the SIFI regulatory framework to one’s own financial structure. An important challenge for regulators is to develop a framework that allows financial sector to grow, innovate, and support the needs of the economy, without compromising on the stability of the financial system. Nonetheless, an effective framework for dealing with SIFIs would include a combination of stronger market discipline; capital buffers; comprehensive recovery and resolution arrangements; and a strengthened market infrastructure to reduce probability of failure. Going forward In the near future we expect to see further developments in the areas of managing SIFIs, particularly the D-SIFIs. As highlighted above, FSB is already working with the Basel Committee for extending the framework to D-SIFIs. The selection criteria is expected to resemble that for the G-SIFIs, with institutions placed in different “buckets” according to their size, interconnectedness, and lack of substitutability. Once the framework is introduced in November this year, we expect to have detailed deliberation on implementation of the new framework in emerging and developing economies. Development of a resolution regime will remain a key element of the D-SIFIs framework, making sure that the critical functions of these financial institutions continue in the event of failure. Given that it will involve legislative processes, the move towards development of a BIS central bankers’ speeches resolution regime may be somewhat slow. Therefore, emerging markets and developing economies (EMDE), taking lead from the proposed framework for G-SIFIs, need to start work on the development of a resolution regime now rather than wait for a final D-SIFIs framework. Another important issue for the emerging market economies from a stability perspective is on account of the presence of foreign financial institutions. The regulators of emerging markets may not be fully equipped to understand the risk profile of a globally active institution operating in their countries. Risks also arise due to financial interlinkages between emerging and foreign financial markets. For the host emerging economy, an important issue is possible market disruption through an adverse impact on local lending decisions and depositors safeguard as a result of problems at the parent institution level. Regulatory colleges should therefore be encouraged by the home regulators across the regions. The practice of conducting regulatory colleges for systemically important institutions would assist regulators in dealing with the global issues in a coordinated manner. I would like to point out that regulation and monitoring of SIFIs is just one of the aspects in overall macro-prudential regulations. In order to implement a complete reform agenda, SIFIs framework needs to be dovetailed with other initiatives of financial stability. These may include an elaborate crisis management framework, work on countercyclical measures, framework for effective resolution of problem institutions, legal cover for enforcement etc. Increased coordination among authorities both at top level as well as operational level is critical for successful implementation of a global financial agenda. For the purpose, there is a need to establish working committees under the Regional Consultative Group terms of reference. I therefore propose the establishment of working level committees to be involved in the development of policy level documents on financial stability related issues from the EMDEs perspective. Thank you for your attention! BIS central bankers’ speeches Annexure 1 The list 29 G-SIFIs is as follows: U.S. Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, J.P. Morgan (JPM), Morgan Stanley, State Street and Wells Fargo U.K. Royal Bank of Scotland, Lloyds Banking Group, Barclays, HSBC Holdings; France: Credit Agricole, BNP Paribas, Banque Populaire, Societe Generale Germany: Deutsche Bank, Commerzbank Italy: Unicredit Group Switzerland: UBS, Credit Suisse Belgium: Dexia Netherlands: ING Groep Spain: Banco Santander Sweden: Nordea Japan: Mitsubishi, Mizuho, Sumitomo Mitsui China: Bank of China Chronology of developments regarding SIFIs, 30 April 2012 The report and background paper respond to a request made by the G20 Leaders in April 2009 to develop guidance for national authorities to assess the systemic importance of financial institutions, markets and instruments. IMF, BIS, FSB, “Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments: Initial Considerations” (7 Nov 2009), available at http://www.bis.org/publ/othp07.htm FSB Recommendations and Time Lines FSB, “Reducing the moral hazard posed by systemically important financial institutions” (20 OCT 2010), available at http://www.financialstabilityboard.org/publications/r_101111a.pdf A final framework issued by the Basel Committee on Banking Supervision for the additional capital required of G-SIFIs that are banks, or G-SIBs. The framework also includes the methodology for deciding which global banks will be considered G-SIBs. BCBS, “Global systemically important banks: assessment methodology and the additional loss absorbency requirement – Rules text and Cover note” (Nov. 2011), available at http://www.bis.org/publ/bcbs207.htm. A final policy framework for supervising SIFIs. FSB, “Intensity and Effectiveness of SIFI Supervision: Progress report on implementing the recommendations on enhanced supervision” (27 October 2011), available at http://www.financialstabilityboard.org/publications/r_111104ee.pdf. The list of the 29 global banking companies in the initial group of G-SIFIs. FSB, “Annex to Policy Measures to Address Systemically Important Financial Institutions” (4 Nov. 2011), available at http://www.financialstabilityboard.org/publications/ r_111104bb.pdf. A final policy framework on resolution regimes (“Key Attributes”) that G20 countries are required to implement in order to resolve SIFIs effectively. BIS central bankers’ speeches FSB, “Key Attributes of Effective Resolution Regimes for Financial Institutions” (4 Nov. 2011), available at http://www.financialstabilityboard.org/publications/r_111104cc.pdf. Extending the G-SIFI Framework to domestic systemically important banks. The framework is still in development stages FSB, A Progress Report submitted to G-20 Ministers and Governors on April 2012. http://www.financialstabilityboard.org/publications/ r_120420b.pdf BIS central bankers’ speeches | state bank of pakistan | 2,012 | 6 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 9th Islamic Financial Services Board (IFSB) Summit, hosted by the Central Bank of the Republic of Turkey, Istanbul, 16 May 2012. | Yaseen Anwar: International regulatory initiatives to enhance global financial stability Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 9th Islamic Financial Services Board (IFSB) Summit, hosted by the Central Bank of the Republic of Turkey, Istanbul, 16 May 2012. * * * Mr. Chairman, the Secretary General IFSB, Distinguished Guests, Ladies and Gentlemen! It is a pleasure and an honor to join you at this 9th IFSB Summit. I am greatful to IFSB for inviting me to share my views on “international regulatory initiatives to enhance global financial stability” with this esteemed audience. In my remarks today I will briefly discuss the events that lead to recent reforms, importance of regulatory initiative introduced so far and Pakistan’s standing. The crises that hit the global financial landscape during 2007 remains the worst since the great depression of 1930s. Though originating from financial markets and innovative “opaque” financial products, it impacted virtually every aspect of the world economy with consequences affecting the masses. The instruments that were meant to disperse financial risks instead allowed financial institutions in general and the banking system in particular to become highly leveraged that ultimately lead to financial meltdown. As a result, it not only put the innovations in the financial markets under the spotlight, but also singled-out regulatory and supervisory weaknesses in assessing the risks associated with financial institutions, markets and innovative financial products. The Euro region still faces the effects of the financial turbulence in the form of sovereign debt crisis. The fragile GDP growth and the unemployment data in the UK, USA and other crisis hit advanced economies still falls short of the pre-crisis level. On a positive note, the financial crisis provided valuable lessons for improving the effectiveness of financial system regulation and supervision. To policymakers, it reminded that the present state of the international financial system requires a complete overhaul of the functioning of the markets and institutions. From supervisory perspectives, it showed that the available prudential regulations are simply not effective and prudent enough to ensure financial system stability. The lessons learnt from the financial crisis signify the far-reaching changes in the structure and functioning of the financial systems and institutions. The international regulatory bodies including Financial Stability Board (FSB), IMF and BIS along with national supervisory bodies have developed a set of regulatory and supervisory reforms that aim at increasing the effectiveness of financial sector supervision. Furthermore, the G-20 leaders at various Summits have endorsed the policy framework recommended by FSB and BCBS, which has made countries reach a consensus on the selection of a reforms agenda. Much of the focus of the reforms is on improving the soundness of the banking system, addressing the Systemically Important Financial Institutions (SIFIs), developing macroprudential policy tools, strengthening accounting standards, disclosure requirements and crisis resolution framework. We know that excessive leveraging by the banking sector, particularly in advanced countries was one of the key reasons that lead to the recent crisis. Banks took excessive on and offbalance sheet exposures while maintaining an inferior quality of capital base with insufficient liquidity buffers. In order to avoid such situations in the future, the Basel Committee on Banking Supervision (BCBS) introduced fundamental reforms in the Basel II capital adequacy regime by issuing a number of reforms and enhancements of the existing the Basel framework. These enhancements commonly referred to as Basel III are aimed at BIS central bankers’ speeches raising the level and quality of capital, introduction of leverage ratio, capital conservation buffer, counter cyclical capital buffer and liquidity coverage and net stable funding ratios. Similarly, in order to facilitate the national supervisory authorities and small and medium sized banks and to avoid a sudden credit crunch in already fragile economies, the BCBS also set a rather relaxed timeline from 2013 to 2019 for the adoption of Basel III. It is therefore expected that increased capital requirements and further consolidation in international banking will prove to be a major step towards promoting financial stability. However since Basel III only affects banks, the regulators of other financial sectors such as insurance are expected to encourage the implementation of solvency II for insurance companies in order to reduce the presence of shadow banking and restrict the risk to move towards less regulated entities or creating regulatory arbitrage. In recent times, an important reforms measure being pursued is to improve regulation and oversight of Shadow Institutions, so as to limit arbitrage opportunities, arising from the transfer of risk to relatively less regulated areas/sectors. The regulators therefore, are now focusing on minimizing the regulatory gaps in the shadow banking framework. To bridge this gap, the Financial Stability Board (FSB) is working closely on the development of an effective regulatory regime for shadow banking system that would largely focus on a) mitigating any spill-over between regular and shadow banking as banks are part of the intermediation chain of the shadow banking sector, b) reducing buildup of leverage in shadow banking through securitization, c) assessing systemic risk posed by shadow banking, d) reducing procyclicality incentives posed by secured lending (REPOs) and e) reducing vulnerability of Money Market funds to possible runs. While focusing on improving the soundness of financial institutions, the reforms emphasized heavily on the global and national Systemically Important Financial Institutions (SIFIs) and the moral hazards they pose while being vulnerable. Since the initiation of reforms, there has been considerable debate on the identification of SIFIs and the institutions that have the capacity to become SIFIs. Factors such as institution size, suitability and interconnectedness including “time varying judgment based assessments” have been prescribed for identification of SIFIs. Under the new reforms agenda, emphasis is on changing Too Big To Fail (TBTF) status of SIFIs and for devising a resolution regime as well as a safe exit mechanism for these entities. Further, supervisory authorities are focusing on enhanced supervision of SIFIs to mitigate the financial risks propagated by them through interconnectedness with other institutions that cause system-wide distress. Similarly a multipronged strategy has been adopted for addressing the risks posed by G-SIFIs (Global SIFIs) that comprise development of a new international standard for resolution regimes, more intensive and effective supervision, and requirements for cross-border cooperation, recovery, and resolution planning. The reforms also impose a cost on the SIFIs in the form of increased capital requirements ranging from 1% to 2.5% of Risk Weighted Assets for enjoying economies of scale and scope and to have higher loss absorbing capacity. As per FSB and BCBS assessment, the long term economic benefits of this additional capital requirement in terms of greater resilience of these institutions far exceed the modest temporary decline of GDP over the implementation horizon. Another significant regulatory initiative in the post-crisis period has been greater focus on adopting a macroprudential framework along with traditional inflation targeting and monetary policy models. Central banks and regulatory bodies who traditionally have been using microprudential tools to ensure financial system stability are now increasingly using macroprudential tools along with traditional microprudential tools to ensure the soundness and stability of the financial system. The scope of the macroprudential policy framework is very broad and includes (a) identifying, monitoring and limiting systemic risks, (b) designing and calibrating instruments for executing macroprudential policies and (c) building institutional and governance arrangements. BIS central bankers’ speeches Though at initial stage, the macroprudential framework has already started delivering key results including broader coverage of central bank financial stability analysis and monitoring of systemic risks. Furthermore, much work is done in closing data gaps and coming up with techniques to assess systemic risks and development of new macroprudential tools that have the capacity to identify systemic risk in a forward-looking way. The stress testing frameworks have also been redesigned by the regulators that incorporate extreme shocks (tail risk) to capture systemic risk and to identify the effects of macroeconomic vulnerabilities on individual institutions as well as on the overall financial system. However, the challenging task of building institutional and governance arrangements call for additional debate among policy makers. The post crisis reforms also stress the need to improve and bring uniformity in international accounting standards. In this regard, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) initiated a convergence project of their accounting standards and practices. The FSB made recommendations for converged accounting standards of IASB and FASB in four areas including lending activities, impairment of financial assets, addressing valuation uncertainty in fair value measurement guidance and offsetting/netting of financial instruments. Accordingly, the IASB and the FASB are jointly developing a common impairment model to assess and record the impairment in the value of financial assets/instruments. Both Boards have also agreed to expand the scope of their joint project of financial instruments to address netting financial assets and liabilities on the statement of financial position. Furthermore, disclosure requirements have also been revisited in the reforms agenda. Much of the focus has been on improved disclosures on structured credit products, instruments and exposures taken in Special Purpose Entities (SPEs), and on- and off- balance sheet items of banks. Similarly, Basel III also improved its disclosure requirements for exposures in securitization, off-balance sheet exposures and exposures in asset-backed papers and mortgage-backed securities. In a recent survey organized by the FSB it was found that the disclosure recommendations have improved the disclosure practices in certain OECD countries. However, it is felt that the disclosure on SPE securitization and exposure before and after hedging need certain improvements. The financial crisis resolution framework has also been revisited in the post-crisis period and its scope has been enhanced to an integrated crisis management and resolution framework. Similarly, the FSB has put forward the principles for cross-border cooperation on crisis management that includes effective coordination amongst the national supervisory agencies, central banks and government finance ministries for making advanced preparations for managing the financial crises. In the backdrop of the recent Global Financial Crises, the remuneration of Directors and Executives of banks and financial institutions have lately come under scrutiny around the globe. In order to put things in the right direction, there has been a growing effort globally to address the issues related to rationalization of compensation in the financial sector. Institutions like BIS, FSB and many national regulators like FSA, APRA and HKMA, among others, have made purposeful attempts to bring the issue of excessive remunerations to the forefront and make it more transparent and fair, not only by making enhanced disclosure requirements, but also drawing a detailed structure of requirements and guidelines for determining the remuneration and compensation of executives. FSB issued “Principles for Sound Compensation Practices” in April 2009 and relevant “Implementation Standards” in September 2009. Both these documents were later adopted in a consolidated form by the Basel Committee on Banking Supervision in January 2010. Pakistan is a small, open economy, with domestically an active financial sector with limited interconnectedness with advanced economies. Like many other developing countries, it did not face the direct impact of the crisis on its banking system and financial markets. In terms of banking concentration, top 5 banks (all locally incorporated) account for 51% of industry BIS central bankers’ speeches assets; while foreign assets of the system are 10.4% of total assets. Moreover locallyincorporated banks and most foreign branches don’t have significant exposures to the complex financial assets that caused the financial meltdown in the U.S. and Europe. SBP has always required banks to meet higher capital and liquidity standards, exceeding international norms in several areas. More importantly, we have a strong legal framework, which has been tested for effectiveness during the last decade and half. SBP has successfully restructured a number of banks, successfully demonstrating the problem bank resolution regime. SBP being the regulator of the banking sector, has introduced and implemented key regulatory reforms and prudential measures to ensure financial system stability. Further, in order to align its regulatory framework with international regulatory standards and best practices, it regularly reviews and evaluates the standards issued by them for their possible implementation keeping in view our own local legal, regulatory and economic environment. Similarly, SBP has taken steps to improve the effectiveness of macroprudential supervision by revising its prudential regulations like rationalization of loan classification and loan loss provisioning requirements whereby the loan loss provisioning framework was made more stringent during economic booms and relaxed during stressed economic conditions. In addition, SBP has devised a stress testing mechanism that not only stress tests the solvency and liquidity profile of the banking system under various extreme scenarios but also conducts macroeconomic stress testing under which macroeconomic indicators are set to influence the financials and solvency and liquidity profile of the banks. We are also working on the subject of Consolidated Supervision of Conglomerates having direct or indirect holdings or influence on banks through shareholdings as well as large exposures. A legal framework is being formulated in consultation and coordination with the regulator of the non-banking sector i.e., Securities and Exchange Commission. We believe that this framework will provide an overarching supervisory control over the major stakeholders of the financial services. Additionally, the disclosure standards for banks are being revised to make performance of the banks more transparent and management of the banks more accountable. While the regulatory reforms agenda being pursued vigorously by policy makers and regulatory bodies across the globe is likely to strengthen the financial system and may possibly be instrumental in preventing financial crisis in the foreseeable future, history says that reforms initiated after each crisis could not prevent the next crisis and each time the nature and dimension of the crisis was different from the earlier ones. This suggests that there may be fundamental and structural problems with the financial system like risk transfer rather than risk sharing, development of speculative products in the name of risk management instruments (derivatives), allowing unprecedented growth of the financial sector without any comparable growth in the real sector etc. Incidentally, these are some of the key features and principles of Islamic Finance as it believes in risk sharing, encourages growth of the financial sector in tandem with the real sector and prohibits investment in speculative activities. I would thus suggest that national and international supervisory authorities to objectively evaluate the potential of Islamic Finance principles in mitigating the existential risks faced by the financial system. I would also request Islamic Finance scholars and practitioners to reach out to their conventional counterparts to highlight the potential of the Islamic Finance system addressing the issues faced by the financial system. Finally, I will reiterate that every crisis brings an opportunity, and it is upon us how we benefit from it. Let this crisis be the one whose lessons help us in improving the soundness and stability of international and domestic financial systems. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 6 |
Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SAARCFINANCE seminar on "Monetary policy framework in the SAARC (South Asian Association for Regional Cooperation) region", Islamabad, 14-16 June 2012. | Yaseen Anwar: Monetary policy framework in the SAARC region Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SAARCFINANCE seminar on “Monetary policy framework in the SAARC (South Asian Association for Regional Cooperation) region”, Islamabad, 14–16 June 2012. * * * Distinguished speakers, honored guests and fellow colleagues, allow me to welcome you, on behalf of the State Bank of Pakistan, to Islamabad for the seminar on “Monetary Policy Frameworks in the SAARC region”. The seminar, as you all know, has been organized under the auspices of the SAARCFINANCE banner. The SAARCFINANCE initiative, now more than 14 years old, has been instrumental in providing a platform that enables knowledge-sharing across the SAARC region and allows for discussion and debate amongst the region’s premier economic decision makers. Let’s move on to the subject of the seminar now. Central banks are often synonymous with monetary policy. And why shouldn’t they be? After all, monetary policy is any central bank’s premier policy tool to achieve its objectives. Strictly academically, the monetary policy framework consists of an institutional arrangement, which provides an anchor to identify monetary policy objectives and describes how the policy is implemented through a set of instruments and their intermediate and operating targets. Wow, that was quite a mouthful! Let’s make it simple. In essence, monetary policy has its means (i.e. the framework) and its ends (i.e. macroeconomic objectives). When those two are congruent, the monetary policy framework is considered well-defined. Let’s go backwards here and have a look at the ends first. The universal aim of monetary policy is achieving price stability; a secondary aim of monetary policy may be growth. For instance, the preamble to The State Bank Act states that the bank is supposed to “regulate the monetary and credit system of Pakistan… with a view to securing monetary stability and fuller utilization of the country’s productive resources”. Therefore, SBP is concerned with not just inflation and price stability, but also with economic growth. That was the easy part. The tough part is actually finding and calibrating the tools that are required to achieve these ends. Broadly speaking, central banks tend to target one or more of monetary aggregates, inflation or exchange rates. All three of these have an impact on the real economy and have implications for price stability. In the recent past, countries have moved towards inflation targeting regimes. However, such a regime requires that the central bank’s policies remain independent of the fiscal authority, have market credibility and are time-consistent. Given that conditions in developing countries may not allow for such freedoms, inflation targeting may prove to be ineffective in such economies. Indeed, these are interesting times to be an economist; and in such times, we must occasionally toss conventional prescriptions aside and seek customized solutions. But for that it is necessary to fully understand our individual economies. The Greeks may not be going through the best of times right now, but it was a Greek philosopher who first advised “know thyself”. And, analogous to this, any competent policymaker must know his or her own economy inside out. He must know what makes the economy tick; how the linkages in the economy interact with each other; how signals and information gets transmitted through these linkages; and what each of the knobs and dials on his dashboard does to calibrate the economy. The process of self-discovery is as relevant for the individual as it is for the economy. The process of improving the economy starts after the process of understanding. BIS central bankers’ speeches For instance, monetary policy may be transmitted through a variety of different channels. Most commonly, the real interest channel is used to influence aggregate demand and fine-tune the economy. But we must take a step back and ask ourselves: do the linkages hold as strongly in the actual economy as they do in theory, especially given the high level of inflation and the high frequency of price changes that most developing economies face? Monetary policy may also be transmitted through the balance sheets of banks and firms. Once again, we must know how bank lending and pricing behavior changes in response to changes in the policy rate. Then, there’s also the exchange rate channel and finally, the expectations channel, which I shall discuss in a bit more detail later. But they key idea here is that a thorough understanding of all these transmission channels is needed in order to calibrate an effective monetary policy framework. Know thy economy! Allow me to share my understanding regarding the workings of these channels in Pakistan. As I pointed our earlier, the real interest channel is extremely weak in times of frequent prices changes and high inflation. A recent survey carried out by the Research Department revealed that prices are revised roughly every quarter in the economy. Coupled with the fact that we have had, more or less, double-digit inflation for the past 4 years now, prices are very quick to adjust. Therefore, the impact on aggregate demand through the real interest channel is muted. On the contrary, we have observed that the lending channel via the banks is quite robust. In fact, the transmission of monetary shocks through the lending channel is asymmetrically distributed; smaller banks, which have a higher cost of funds, tend to amplify monetary shocks for smaller borrowers. In fact, the bank lending channel is the primary channel through which monetary policy is transmitted to the real economy in Pakistan. On a related side-note, it’s important to mention that Pakistan has moved away from credit allocation policies and now let’s the market decide both the quantity and the price of credit to various sectors. The country has also liberalized its foreign exchange markets and lets the forces of demand and supply dictate the rupee exchange rate. While this is an important step towards greater global integration, it has meant that the exchange rate channel is particularly relevant now – especially due to the implications that it has for inflation. Given the influence that full exchange rate pass-through has, SBP monitors the foreign exchange market very closely. Finally, monetary policy may also influence inflation through the expectations channel. I can think of no better example to illustrate the mechanism of the expectations channel than Paul Volcker’s time at the helm of the Fed. Having credibly committed to tackling inflation, Volcker raised rates drastically and managed to weed out the inflationary expectations that had taken root in the American economy after the oil shocks of the 70s. In my opinion, the two decades of low inflation that the American economy enjoyed following Volcker can at least be partially attributed to the suppression of inflation expectations. In fact, I also believe that a large part of the persistence of inflation in Pakistan’s economy is due to the sustained period of high inflation, which has allowed inflationary expectations to incubate. The transition from understanding these channels to developing the proper mechanisms to impact our objectives may not be smooth. After all, we should concede that there are some things that we have absolutely no control over in the short-run. Similarly, a certain policy measure may also produce conflicting outcomes, such as a reduction in inflation but a rise in current and fiscal accounts; how should we proceed then? We need to stay abreast of a very steep learning curve and constantly keep checking if the relationships that we have assumed, while developing our models, still hold. The economy is a living, evolving organism. Relationships between variables break down ever so often. This only adds to the excitement of being a policymaker, ladies and gentlemen! The complexity and the uniqueness of our economy only emphasize the need to develop a thorough grass-roots understanding of the economy, and a customized toolbox to deal with the multiples challenges along the way. Far too often have we relied on conventional BIS central bankers’ speeches prescriptions without fully understanding the symptoms. I challenge you all to question the assumptions that you have based your frameworks on; let’s take nothing as a given and let’s make our policy directives as unique as the economies they target. I’m in a room full of central bankers here and it is probably unnecessary to say this, but, at the end of the day and despite our best efforts, even seemingly seamless plans may fail and our policy instruments may let us down. Yes, it is tough to map out the behavior of an informal sector that is probably the size of the formal economy; yes, it is difficult to impose fiscal discipline; yes, it is almost impossible to control the international prices of fuels and grains; and yes, our textbooks seem to be clueless when it comes to tackling today’s economic problems. But this only underscores the need – no, the necessity – to fully understand the nature of our economies. Know thy economy, ladies and gentlemen! And now I invite you all to share your ideas and experiences with the rest of us. Tell us about the nature of your economies; tell us about your toolkits; and tell us how they have fared with time. I can tell you that we, at the State Bank, have come a long way from the days of rationalized credit and strict controls on exchange rate. We have moved towards a better understanding of our economy and we’ve made some significant progress towards discovering the impact that our monetary policy has on the real economy. I hope that you will get a chance to share your thoughts with us and lead our minds to previously unexplored territories. The SAARCFINANCE seminar series was meant to facilitate the transfer of ideas and experiences. Today, I am excited about what we may learn from each other over the next few days. On that note, ladies and gentlemen, let us share our insights regarding monetary policy frameworks; and let’s get to know our economies. Thank you for your time and I wish you all an amazing stay in Islamabad! BIS central bankers’ speeches | state bank of pakistan | 2,012 | 7 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Chartered Financial Analyst (CFA) Convention and Excellence Awards ceremony, Karachi, 4 July 2012. | Yaseen Anwar: Ethics, corporate governance and financial inclusion Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Chartered Financial Analyst (CFA) Convention and Excellence Awards ceremony, Karachi, 4 July 2012. * * * Messrs Jawaid Iqbal, Ashraf Bajwa, Governing Board of the CFA Association of Pakistan, Ladies and gentlemen: It is indeed an honor to be invited at this annual CFA convention – a gathering of the country’s finest analysts, investment and risk managers and the banking industry professionals. I also appreciate the efforts of CFA Association of Pakistan for arranging this convention at a very significant time in terms of both domestic and international economic perspectives. The progress CFA Association of Pakistan has made in raising the educational skills and ethical standards for investment analysts is highly commendable. I am delighted to learn that the association’s Charter membership of the Pakistan chapter is continuously increasing and its members are playing a significant role towards advancing professionalism in our financial institutions. Taking benefit of this opportunity, I feel it is appropriate to discuss the importance of ethics in financial businesses, and the role of corporate governance in a highly dynamic financial world and the constantly and rapidly evolving regulatory regimes. I will also briefly touch upon recent initiatives taken for promoting financial inclusion and literacy in the country. A key issue in finance and investment management is the understanding and practice of ethical norms. If we closely analyze the recent financial turmoil, we will certainly find misconduct of ethical norms by a few leading market participants that ultimately translated into market panic and subsequently crashes. This implies that a few individuals benefited at the expense of the entire society. It is due to that huge cost to society that we have seen increased focus on ethics and in this regard, the CFA curriculum places due emphasis on the code of ethics and professional conduct for financial analysts and investment professionals. With the growing number of chartered financial analysts, the markets are expected to be better-off from their high ethical standards and improved knowledge of the financial markets, instruments and associated risks. We all agree to the notion that businesses need to be governed by a set of rules that protect the interests of all stakeholders. The codes of best practices and principles were in force internationally by the regulators and supervisors of various economic segments including the financial sector even before the events that led to the recent financial crises. But many of these standards were not adhered to effectively because they were either too general or perhaps the regulators had limited autonomy to implement the codes in its true spirit. We all know what led to the 2007/2008 crisis. Those opaque derivative products led to an asset bubble and the sub-prime mortgage sector was simply the catalyst that popped that asset bubble. Essentially, it was a mispricing of those risk assets. The current events unfolding in the international economic environment are both challenging as well as unique. Though substantial progress was made to limit the effects of the financial crisis, the vulnerability still persists in the shape and size not imagined earlier. Few would have thought that the effects of the sub-prime crisis will question the survival of the Euro Currency and would threaten the entire European region to fall into a severe recession. Meanwhile, in our domestic economy though, we have largely been successful in mitigating the effects of exogenous shocks and contagion risks of the international crisis. But we still face challenges of our own, and ensuring conservative and prudent policies, should enable us to remain resilient from exogenous shocks. BIS central bankers’ speeches Among many other factors, the global financial crisis and domestic turbulence can also be attributed to failures in corporate ethics and underlying weaknesses in how corporate governance is practiced. Internationally, the prevailing corporate governance practices failed to safeguard against excessive risks taken by leading financial institutions. The market players exhibited herd behavior and deviated from the ethical norms by engaging in speculative activities for self-gain. Hence, it can be argued that for efficient and wellfunctioning markets, a responsible and ethical behavior of the participants is a pre-requisite apart from an enabling environment, proper infrastructure, skills and knowledge. Similarly, domestically it behooves us to upgrade our corporate governance practices at all institutions to strengthen our pace of economic recovery and make the environment more challenging and productive for corporates and private institutions. One key lesson policy makers and regulators learned from the recent sub-prime crisis is that among many other factors, weak corporate governance practices in leading financial institutions played a crucial role in creating the asset price bubble and misallocation of financial resources. As a result, policy makers in the post-crisis period are placing more emphasis on improving market transparency and Corporate Disclosure. Similarly, regulators have also placed heavy emphasis on imposing stricter regulatory regimes and hands-on approach towards ensuring sound corporate governance practices. These measures have encouraged the Boards and management of financial institutions to improve their governance practices and eliminate knowledge gaps. The regulators also require the Boards to develop their capacity to assess the nature of risks keeping in view the size and complexity of the institutions on an ongoing basis. Similarly, the misaligned incentives and the remuneration of Directors and Executives of banks and financial institutions also came under scrutiny in the post-crisis reforms. This led to growing efforts for rationalization of compensation practices in the financial sector, with a focus on medium to longer term goals to avoid undue risk-taking and promoting transparency and meeting proper disclosure requirements. Though corporate governance is important for every institution and business, I consider it more critical for the banks as they are the custodians of household and business sector deposits and their intermediary role is only possible when the society has full confidence in its banking system. And, this is where the role of the central bank and other regulators of the financial system comes in. The corporate governance revolves around three basic principles of fairness, transparency and accountability. SBP has been on the forefront in promoting sound corporate governance practices and fair competition in the banking sector by introducing various reforms and prudential regulations. The SBP has implemented a comprehensive corporate governance regime for the banks, which is supported by a robust legal and regulatory framework, riskbased supervision and detailed banking sector reforms, notably, privatization, liberalization and consolidation of banks. The measures taken by SBP have enabled the corporate governance regime for banks and its different elements are not only compatible with international best principles but are also parallel with most other emerging economies. Central Banks are vital in instilling confidence in the economy. They are key towards the promotion of trust and confidence in the financial sector. Interested groups on the other hand may attempt to disrupt the regulatory framework and in turn confidence in the institution. Accordingly, we must provide constant reassurance to the public of the confidence in the Central Bank. Cognizant of the international regulatory developments, the SBP regularly reviews the international regulatory standards and best practices issued by the Financial Stability Board (FSB), Bank for International Settlements (BIS) and other multilateral agencies and standard setting bodies and assesses them for their possible implementation in its banking system. The SBP’s regulatory approach towards promoting and strengthening of corporate governance has been successful in inducing a positive change in the corporate governance BIS central bankers’ speeches culture in the banking sector that has transformed them into healthy and profitable financial institutions. It also positively impacted the solvency profile of the banking system, that has enhanced their market value and attracted substantial foreign investment in the banking sector during the 2004–2009 period. I am pleased to state that, the World Bank’s country review of Pakistan based on OECD Principles on Corporate Governance (Report on Observance of Standards and Codes) rated Pakistan above average on most of the Principles1. Further, in a survey, the World Bank rated Pakistan as the leader on the robustness of corporate governance standards and practices in South Asia. Adoption of ethical standards in dealing with bank customers is an important attribute of corporate ethics, which improves the standing of the financial institutions. Effective treatment of banks’ customers, ensuring provision of services to prospective customers and their proper education are key traits necessary for providing strength to the institution. While banks are continuously trying to provide best services to their customers, SBP has been playing its part in improving financial literacy, enhancing depth and reach of financial services, and resolving issues faced by the bank customers. For the purpose, the SBP has not only embarked upon providing a conducive regulatory framework for financial inclusion encompassing promotion of microfinance banking and alternate delivery channels like mobile banking. The SBP has recently launched a Nationwide Financial Literacy Program (NFLP) with the collaboration of multilateral agencies including Asian Development Bank (ADB) and local private partners including Pakistan Banks Association (PBA), Pakistan Microfinance Network (PMN), Pakistan Poverty Alleviation Fund (PPAF) and Bearing Point. This first-ever financial literacy initiative is expected to impart financial knowledge covering basic concepts such as budgeting, savings, investments, debt management, financial products and branchless banking among the masses. Our branchless banking regulatory framework has been ranked number 1 by the Economist magazine. The fast growing network of BB agents has now reached over 26,000 as of March 31st, 2012 and total volume of transactions have increased to 25.3 million (up 23%). Deposits have grown by 18% to Rs 594 million. This fits well into our Financial Inclusion strategy. In fact, Central Bank should have an expanded mandate to include those sectors of Financial Exclusion. This adds to overall growth of the economy and women should be an important component to this effort. I have always stated that how can we as an economy grow when 50% of our population is in a non-productive capacity. On the issue of consumer protection, availability of an effective redressal system adds to the confidence of the financial system and ensures that customers are being served without any discrimination. Consumer protection is primarily based on institutional arrangements that include a formal set of disclosure requirement and addressing grievance mechanisms. Besides, customers also desire proper handling and maintenance of their accounts, and privacy of their personal financial information. For cost effective and quick redressal, SBP has issued necessary guidelines to the banks regarding complaint handling along with institutionalization of the Banking Mohtasib Pakistan. The State Bank has also taken considerable interest in enhancing the capacity of its own human resource as well as that of the banking sector that is an important element for ensuring the effective implementation of the regulatory requirements. SBP through its subsidiary, NIBAF, is providing world class training and arranging specialized courses in banking, economics and finance. Further, SBP also encourages its employees to gain international certifications like the CFA, to boost their professional capacity. I am confident that the steps taken by the SBP to promote financial literacy and inclusion and capacity building of the banking sector professionals will be highly useful in creating a professional, sound and vibrant financial culture. Similarly, the regulations to promote corporate governance are also expected to promote corporate ethics in the banking sector. It BIS central bankers’ speeches is now up to the young generation – like many of you to improve the skill-set and take keen interest in striving for excellence and maintaining professionalism. The State Bank looks forward to working with you and the whole community towards achieving our shared goals of economic growth and social prosperity. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 7 |
Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, on the 65th Independence Day, Karachi, 14 August 2012. | Yaseen Anwar: Main challenges for the State Bank of Pakistan Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, on the 65th Independence Day, Karachi, 14 August 2012. * * * Dear Colleagues, Ladies and Gentlemen, Assalam-o-Alakum! I am delighted to be here with you today to celebrate the 65th Independence Day of our beloved country. Today reminds us of our great leaders and forefathers who fought for independence of our nation with a vision to form a country for the welfare of its people. Allow me to quote from Quaid-e-Azam Muhammad Ali Jinnah’s famous address at the inauguration of Pakistan Constituent Assembly on 14th August 1947 at Karachi; “It will be our constant endeavor to work for the welfare and wellbeing of all the communities in Pakistan, and I hope that everyone would be inspired by the idea of public service, and they will be imbued with the spirit of co-operation and will excel in their political and civic virtues which go to make a great nation and help to advance its greatness.” These words reflect the statesmanship, wisdom and vision of our great Quaid, under whose inspiring leadership, the first ideological state of the world came into being. The leaders and workers of the Pakistan Movement also deserve our rich tributes. It is now our duty to transform this country into a truly developed state, as envisioned by our Quaid. I am sure that by following the guidance of our founding fathers, we can easily overcome our main challenges. The Quaid, while inaugurating State Bank of Pakistan on 1st July 1948, from this very podium, said in his address that “State Bank of Pakistan symbolises the sovereignty of our State in the financial sphere” and had set some high goals for our institution and I quote; “I need hardly dilate on the important role that the State Bank will have to play in regulating the economic life of our country. The monetary policy of the bank will have a direct bearing on our trade and commerce, both inside Pakistan as well as with the outside world and it is only to be desired that your policy should encourage maximum production and a free flow of trade.” Today, the State Bank has been striving to fulfill the twin objectives of monetary policy i.e., maximizing production/employment while ensuring price stability. Pakistan has a well developed banking sector and financial infrastructure which helps in meeting the credit demand of our productive sectors and transmitting the monetary policy. The banking system is largely responsive to the needs of the growing economy. In addition, our banks are considered safe, relative to some of the advanced nations, where confidence in financial institutions has dwindled as a result of the recent financial crises. People still feel safe to keep their hard earned savings in banks here. Likewise, banks have been performing well in attracting new equity with their high ROE which is unmatched in the region. State Bank has also been working to increase the welfare of all communities in line with the Quaid’s vision for Pakistan. Financial inclusion is a core component of SBP’s financial sector development strategy. It envisages transforming the financial market into an equitable system with efficient market based financial services to the otherwise excluded poor and marginalized population including women and young people. In addition, inclusive finance recognizes that a continuum of financial services providers work within their comparative BIS central bankers’ speeches advantages to serve the poor and low-income people, as well as micro and small enterprises. Therefore, in order to further build the linkages of the banking sector to promote access to finance for the poor and marginalized segments of the population, the State Bank has been promoting financial inclusion through innovative approaches. SBP has been actively supporting microfinance in Pakistan to make major breakthroughs in reaching out to millions of underserved people who require a wide variety of financial services. Presently, nine MFBs are operating in Pakistan. The success of microfinance in Pakistan is widely acknowledged by the international community. Our microfinance regulatory framework has been ranked globally at the top in 2010 and 2011 by the independent “the Economic Intelligence Unit” of UK’s “The Economist” Magazine. Moreover, a unique opportunity for the financial sector in Pakistan are the branchless banking regulations that have catalyzed a number of branchless banking deployments with dual advantages: First, there is enormous scope for expanding outreach, especially to hard-to-reach rural areas. Second, alternative delivery channels promise significant cost reduction to institutions. Due to these benefits, the expansion in the retail network of microfinance has arisen overwhelmingly from agents and mobile phone channels. In a little over 2 years, the branchless banking deployments with 26,954 active agents offering low-cost services all over the country, including in the hitherto neglected areas, have surpassed the 10,000+ branch network of banks. As a result of these low-cost, efficient financial services being offered at convenient locations the quarterly volume of transactions has reached to 28 million totaling Rs.115 billion. The average size of these transactions is Rs.4,000 which shows that technology is reaching out to the previously unbanked, marginalized segments of the society. The years ahead are expected to see continued expansion in the market – new players, innovative distribution channels, market segmentation, price reductions etc. Moreover, a number of initiatives have been taken to promote access to finance in the SMEs, agriculture, and housing sectors that largely focus on creating an enabling environment by addressing regulatory barriers, market failures and industry bottlenecks, as well as to ensuring consumer protection. Despite having in place internationally acclaimed regulations, innovative delivery channels, industry-wide market development initiatives, the growth in financial access leaves much to be desired. This partly explains why Pakistan has one of the lowest financial penetration levels in the world with 56% of the adult population totally excluded, and another 32% informally served. Here, I would like to recognize that part of the challenge may be lying on the demand side of the equation. Therefore, initiatives such as the National Financial Literacy Program (NFLP) have been rolled out by the State Bank along with stakeholders to address the lack of financial literacy. The program focuses on different themes such as savings, budgeting, debt management, investment, consumer protection and branchless banking to impart awareness and understanding of basic financial concepts to the low-income and unbanked population. In conclusion, it’s true that our economy is going through testing times; but let me just assure you that Pakistan holds enormous potential for economic growth. The State Bank will keep on working with all stakeholders to ensure that the financial system is well positioned to meet the growing needs of the economy and for achieving our shared goals of economic growth and prosperity. This momentous occasion compels me to urge upon all employees of the State Bank to continue to stride for transforming this prestigious institution into the best central bank of the region. Let me conclude with these words of our Quaid, and I quote “Let us on this day, humbly thank God for his bounty and pray that we might be able to prove that we are worthy of it.” Happy Independence Day! Thank you Pakistan Paindabad BIS central bankers’ speeches | state bank of pakistan | 2,012 | 9 |
Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the 6th SME Banking Conference, Karachi, 5 September 2012. | Kazi Abdul Muktadir: Engaging the SMEs to stabilize economy Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the 6th SME Banking Conference, Karachi, 5 September 2012. * * * Ladies and gentlemen, it’s my pleasure to address the delegates and speakers at this Conference, arranged by Shamrock Conferences International, on “Engaging the SMEs to stabilize Economy”. Through this Conference, all the stakeholders in the SME sector have been brought together that will generate valuable debate on the issues confronting the sector and look at the various strategies being developed at the regulatory and policy level, to support this very important sector of our economy. It is particularly in this context that this Conference is really a timely initiative. There exists strong evidence that SMEs expansion boosts employment more than large firm growth due to the fact that SMEs are normally more labour intensive. In Pakistan, the SME sector contributes 30 percent towards the country’s GDP, employ more than 70 percent of the non-agricultural workforce, accounts for 35 percent of the value added in the manufacturing industry and generates 25 percent in the export earnings. The sector has huge potential in generating employment and alleviation of poverty in the country. Today, most big industrial establishments depend on SMEs for their value addition. In most emerging markets, SMEs have played dominating role in the economy especially in reducing the poverty levels. Emphasis has been placed on pro-poor growth led by the private sector especially through SMEs. Sectors such as agriculture, services, manufacturing with heavy content of labor-intensive activities have received much support by the Governments because of their potential for reducing poverty. These countries have also successfully integrated their SMEs with the large corporate sector through subcontracting which has proved to be an extremely useful and efficient way of integration across the size and scale. The sustained and long-term growth of SME sector in Pakistan remains constrained by a number of factors on both demand and supply side. Most SMEs are sole proprietorships or family businesses that are managed rather informally, and therefore, face issues such as lack of formal business management skill, poor maintenance of accounts, lack of business planning, etc. They often do not have adequate collateral to meet banks’ requirements, and have little awareness about available financing options. Further, reliable research data on important SME segments is also not available for use of banks. At the same time, on the supply side, one of the primary issues seems to be dearth of appropriate skills to evaluate SMEs’ credibility on non-traditional parameters. This is reflected in the lack of innovation in product design and in marketing of financial products for SMEs. A sustainable solution requires that we take a more holistic view of this problem. A large number of players have to be involved in contributing to the success of SMEs. There are number of different stakeholders who have to work together in a coordinated and cohesive manner to ensure sustainable growth of SMEs especially removing the hurdles in the way of their easy access to finance. Important stakeholders are the Government, State Bank, Commercial Banks, SMEDA and various chambers and SME Associations. First of all, the Government and State Bank of Pakistan need to provide a conducive and enabling environment for SMEs to operate. This requires that the macroe conomic policies are sound, the regulatory regime is supportive and the legal system is able to enforce contracts and property rights. BIS central bankers’ speeches Secondly, organizations such as SMEDA have to play a critical role in the business developments support, advisory services and managerial training of SMEs. For example, most small enterprises do not maintain proper accounting of their operation and do not have a trained accountant on their staff. This impedes their ability to access credit from commercial banks. SMEDA can organize training courses in this and many other important areas. SME Associations also need to come forward and launch awareness programs for their members on the opportunities that are already available, assist them in linking up with the appropriate support institutions, listen to the genuine difficulties and problems faced by their members and communicate these to the concerned quarters. As far SBP’s role is concerned, it has been taking various important measures for improving the business environment for the sector, and addressing financing needs of SMEs. Keeping in view the specific business dynamics of the sector, SBP issued specific Prudential Regulations (PRs) for SMEs in 2003 that greatly helped banks to focus on SME Financing and accordingly align their business strategies. These Prudential Regulations for SMEs do not make it mandatory for banks to require collateral but allow them to take cash flow generation as the basis for loan approval. We have always been open to any suggestion from the sector for further improvement and strengthening of these regulations. Further, SBP has introduced various Refinance Schemes for SMEs. These schemes carry concessional rates for the end-users, in order to meet both short-term and long-term needs of different SME segments. Of special mention in these schemes are the Schemes for Modernization of SMEs, for developing alternate energy resources and establishing silos and storage houses. The maximum use of these schemes by SMEs can benefit the sector in a big way with resultant positive impact on the economy. SBP has also launched a Credit Guarantee Scheme for Small and Rural Enterprises that shares credit losses of banks, to the extent of 40 percent on loans to the Small Enterprises, under a UKAID-supported financial inclusion program. This Scheme has been highly successful and the latest figures show that 64% of the guarantee limits allocated to banks have been utilized by them. Discussions are underway to further enhance the size of this facility so that a larger number of Small Enterprises are accommodated under the Scheme. Additionally, SBP, in collaboration with IFC, is assisting banks in their capacity building efforts, focusing on the areas of Strategy Formulation, Product Development, Risk Management, HR Development and Marketing Area. Initially, Bank Al Falah has been selected for its capacity building, while many other mid-tier banks have been lined up for the subject consultancy project. This project will revitalize the SME lending by the participating financial institutions and will be a prototype for other financial institutions who could see financing to SMEs as profitable business ventures. Keeping in view the absence of credible research data on SME clusters, SBP has been undertaking cluster development surveys, in partnership with IFC and LUMS, that will greatly help stakeholders, and especially banks, in coming up with cluster-specific products and tailored SME banking strategies. So far, 11 clusters have been covered whose survey profiles are available on the SBP Web, while surveys of 10 more SME clusters are underway, that will soon be completed for the use of relevant stakeholders. Lastly, I would emphasize the role of banks that is crucial for the development of SMEs, given their critical positioning and greater capacity in terms of their outreach and availability of funds. The actual statistics for lending to SMEs are not satisfactory in recent years. Bank credit to SMEs has declined over the last 4 years from Rs 437 billion in 2007 to Rs 248 billion on June, 2012. With this decline, the SMEs’ loan proportion to the total advances of banks has also decreased from 16 percent in 2007 to less than 8% percent in 2012. BIS central bankers’ speeches Although, this decline can partly be attributed to adverse economic conditions during the period and growing NPLs, however, a more risk-averse posture of banks remains a major factor responsible for their low exposure to SMEs. In the recent years, banks have increasingly invested in safer havens – opting for government paper and increased financing for commodity operations, rather than supporting the fragile private sector which is the main driver of economic activity. I would stress the financial industry to break-out of the tendency of lending to conventionally profitable and relatively safer sectors, and rather move towards promoting SMEs through prudent banking solutions. The banks should formulate strategies to overcome the challenges presented by the market as well as by the cyclicality in economic conditions. Banks need to shift from traditional banking approach towards SMEs to the provision of more customized and differentiated financial products and services to suit different SME segments. They also need to develop and implement appropriate credit evaluation techniques used globally such as credit scoring, cash flow based lending, and program based lending. A strategic shift in focus for SMEs would greatly benefit the financial institutions themselves as SMEs will grow into larger corporations, resulting in increased business opportunities for them. Banks need to remember that their industry is only as strong as the underlying economy. Let me conclude by restating the fact that SMEs will continue to play a very important and vital role in our economy where the twin problems of unemployment and poverty constitute major development challenge. Well targeted government intervention in this sector and effective coordination among the stakeholders remain indispensable for the true development of the sector and its sustainability. Given the quality of participants in the conference, I am convinced that useful policy recommendations will emerge at the end of different sessions. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 9 |
Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Islamic Finance news (IFN) Roadshow 2012, Karachi, 4 September 2012. | Kazi Abdul Muktadir: Islamic finance developments in Pakistan Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Islamic Finance news (IFN) Roadshow 2012, Karachi, 4 September 2012. * * * Distinguished guests, ladies and gentlemen! Assalam-u-alikum and a very good morning. It is my great pleasure to welcome you all in this IFN road show. I would like to congratulate and thank Redmoney for organizing the show in Pakistan, which is one of the fastest growing Islamic finance markets across the globe. Such events not only enhance Islamic finance awareness and stimulate its demand but also provide a platform to Islamic finance stakeholders to share their experiences and insights about this fast emerging segment of the financial system. I hope that today’s discussions and deliberations would help in addressing the key challenges being faced by the industry and contribute towards sustaining the growth momentum. Ladies & Gentlemen! Since the inception of modern Islamic finance in 1960’s, Islamic banking has evolved from its relatively modest size to a vibrant industry with an increasing global footprint. With a size of US$1.35 trillion (according to Global Islamic Finance Report 2012) and annual growth rate of more than 20 percent, the Islamic financial industry now comprises 430 Islamic banks and financial institutions and around 191 conventional banks having Islamic banking windows operating in more than 75 countries. The relative resilience and stability of the industry during the financial crisis and its flexibility and responsiveness to changing business needs has helped the industry to establish itself as a viable financial system. The tremors and aftershocks of the financial crisis are still on either in the form of European debt crisis and/or weakening global economic outlook and the policy makers are still looking for answers to fix these issues. Islamic finance, with its roots in a moral economic model that supports productive economic activity and discourages excessive leveraging and imprudent risk taking, can play an important role in rebuilding the financial system. I believe that this is high time for Islamic economists and scholars to highlight the inherent strengths and potential of Islamic finance in addressing the existential challenges faced by the global financial and economic systems. Ladies & Gentlemen! The evolution of Islamic finance industry in Pakistan has followed the same trajectory as global Islamic financial industry; with growth mainly intensifying over the last decade. Despite having introduced landmark changes during 1980s including amendment in the Banking Companies Ordinance, enactment of Mudaraba Companies and Mudarabas (Floatation and Control) Ordinance etc, efforts for transformation of financial system to Shariah Compliant met with limited success only. This was primarily due to unavailability of adequate infrastructure and lack of trained human resources. Learning from past experience, Islamic banking was re-launched in 2002 with a more practical and gradual approach that allowed Islamic banks to operate in parallel with conventional banks. This time we also introduced a comprehensive Shariah compliance framework to ensure that the operations of Islamic banks are in conformity with the Shariah principles; this was necessary to give confidence to the consumers about Shariah permissibility of Islamic banks’ business and operations. The approach has proved a mega success as the industry growing from scratch in 2002 now constitutes over 8 percent of the country’s banking system with a network of 964 branches and over 500 windows across the country. The future outlook is also positive; the Islamic finance industry with its rapidly growing acceptability both amongst the providers and users of financial services, is likely to increase its share in the banking system to 15 percent during next five years. Encouragingly, the sustained growth of Islamic banking in the country during the last decade has also started catalyzing growth and development of Islamic capital markets, Mutual funds and Takaful companies etc; presently we have 5 Takaful operators, about 30 Islamic mutual BIS central bankers’ speeches funds. We have an effective coordination mechanism with SECP – the capital markets and NBFIs’ regulator – and I am sure that the non-banking Islamic financial services industry would also be growing in tandem with the Islamic banking industry. Ladies & Gentlemen! The State Bank of Pakistan fully owns the Islamic banking industry and has been taking a number of initiatives to strengthen the legal, regulatory and Shariah compliance framework, create awareness amongst the masses and build the industry’s HR capacity. I will share a few with this audience today. The development and issuance of sovereign Sukuk for the domestic market, which is an important liquidity management instrument was a long outstanding demand of the industry. The SBP in collaboration with the industry and the Federal Government developed sovereign Sukuk and you would be pleased to know that during last two years sovereign Sukuk of Rs.369 billion (USD 4 billion approx) have been issued that has largely addressed the liquidity management issue of the industry. The regular issuance of the Sukuk, almost on quarterly basis, has improved market confidence and tradability of the Sukuk. To improve transparency and bring standardization in IBIs’ profit distribution and pool management practices, we have developed a comprehensive profit distribution and pool management framework in consultation with the industry. The framework will be issued most probably within this month and will be instrumental in improving public confidence in Islamic banking generally and profit distribution policies and practices of IBIs particularly. Similarly to further strengthen the Shariah governance in IBIs, we are in the process of developing a comprehensive Shariah Governance framework. The framework will explicitly define the roles and responsibilities of different organs of IBIs including the Board of Directors, Shariah Advisors/Committees and Executive Management for ensuring Shariah compliance. Presently Shariah compliance is perceived to be the responsibility of the Shariah Advisors only whereas Board of Directors and Executive Management assume no such responsibility. This we believe is contrary to the corporate governance principles as unless the BOD and management are not fully aware of the Shariah non-compliance risk, it would be difficult for the Shariah Advisor to develop an effective Shariah compliance mechanism in IBIs. The proposed framework will fix these and other similar issues. Further, the SBP, in collaboration with the industry, will also be developing the strategic plan for the industry for the next five years ie 2013–2017. The plan will make a detailed assessment of the earlier plan (2007–2012) as well as the existing environment and will set the strategic direction for the industry. This is an important project which would define the strategies and action plans to move the industry to the next level of growth and SBP would expect active and meaningful involvement of the industry in development of the plan. Ladies & Gentlemen! As you all know that SBP has been at the forefront of the initiatives and programs for creating awareness. Being the host of today’s program is a part of its efforts to improve public understanding of Islamic banking and minimize their apprehensions and confusions. While seminars, conferences, workshops are being organized across the country on regular basis, we will soon be launching a mass media campaign to create awareness about Islamic banking. The campaign we believe will be instrumental in enhancing public awareness and allaying their apprehensions and confusions about Islamic finance and thus would give further boost to the growth momentum. Lastly, I would reiterate my optimism about the growth prospects of the industry; I believe the growth momentum will not only be sustained but will gather further strength as we will see some more key players entering the market with aggressive expansion plans in very near future. The challenge will however be to develop suitably qualified and trained HR to man this growth; while SBP will be further intensifying its efforts to build the industry’s HR capacity through its regular and specialized training programs, the IBIs would also have to significantly increase their investment in HR development. Another challenge would be diversification of assets mix and taping non-traditional sectors like agriculture and SMEs to deploy the growing deposit base in productive avenues. Presently the IBIs’ exposure in these BIS central bankers’ speeches sectors is nominal that needs to be increased significantly, which would not only improve their repute amongst the masses but would also provide them an attractive avenue to develop and expand their assets portfolios. SBP would be willing to provide necessary support to IBIs to build portfolios in these non-traditional but strategically important sectors. My thanks and appreciation again to Redmoney for organizing this event and I hope such collaborations will continue in future. I wish all the foreign delegates to have pleasant stay in Karachi and a safe journey back home. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 9 |
Speech by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the launch of Easypaisa Khushaal, Karachi, 16 October 2012. | Kazi Abdul Muktadir: Promoting deposit mobilization and financial inclusion in Pakistan Speech by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the launch of Easypaisa Khushaal, Karachi, 16 October 2012. * * * Distinguished guests, ladies and gentlemen! A very good afternoon, I am delighted to be part of this launching ceremony of Easypaisa Khushaal and I would have to congratulate Tameer Microfinance Bank and its key partner Telenor on designing another innovative product which will go a long way in promoting deposit mobilization and motivating other microfinance sector players to move in this direction. 1. Due to slow progress in deposit mobilization, Microfinance Banks have not yet become fully sustainable in generating substantial internal funding. Such type of innovations in product designing will not only attract small savings to generate internal funding of Microfinance Banks but will also provide savers a feeling of safety and security in terms of insurance embodied with the product. Now the time is only of demand driven innovative products, through which MFBs can easily handle the challenges like scarcity of funding and financial exclusion. 2. Since inception, Government and the State Bank of Pakistan have been supporting the microfinance sector to reach out to the millions of unserved low-income people. This growth is facilitated by several factors, including an enabling policy framework, institutional reforms, technology initiatives, regulatory flexibility, tax incentives and technical support through different programs and projects. State Bank of Pakistan has also issued a Strategic Framework for Sustainable Microfinance in Pakistan which mainly focuses promoting use of alternative delivery channels to enhance financial services to people without access to finance which is recognized as one of the fundamental constraints in achieving sustainable economic growth in many developing countries. 3. SBP has always been encouraging innovations in products and delivery channels in order to promote financial inclusion. For the reason, SBP has also launched a “Financial Innovation Challenge Fund” under its DFID-funded Financial Inclusion Program (FIP) to support innovation in product and delivery channels in microfinance which will give further impetus to branchless banking. 4. With our all assertive efforts, our financial sector is now going through a dynamic transition, led by increasing uptake of technology solutions. This transition can be seen in recent branchless banking data, with a transactional volume of nearly 30 million valuing Rs. 115 billion during a single quarter of April–June, 2012 by only two players. We are delighted that the active players have registered more than 1,447,381 mWallet accounts of previously un-banked and under-banked to operatio of the economy. 5. With the entry of new players and scaling-up of the existing institutions the present growth momentum will further build. Our Tele density also highlights the inherent potential for mobile banking in Pakistan. Achievements in the Branchless Banking Services have put Pakistan at the Global Centre Stage of Financial Inclusion and innovation. World Bank’s Consultative Group to Assist the Poor (CGAP), in its recent study has also recognized Pakistan as one of the fastest growing branchless banking market in the World. BIS central bankers’ speeches 6. State Bank of Pakistan as a supervisor and regulator of the banking industry, is trying to make banking services available at the door step of the people. Promoting access to banking services is the corner stone of State Bank of Pakistan’s policy framework. As opening of physical branches, entails substantial costs and is time consuming, SBP has always been encouraging adoption of alternate delivery channels for providing financial services to clients by the banks. 7. Access to Branch banking is limited by time. The availability of Automated Teller Machines (ATMs) is a convenient and efficient tool to access accounts by clients for cash withdrawals and other related services on a 24 hour 7 day basis. In developed countries, there are three ATMS against one bank branch; however, being a developing economy, the availability of ATMs in Pakistan is low. Presently we have only 5600 ATMs across Pakistan, just about one ATM against two bank branches. Therefore, there was a strong need for the Central Bank to come up with some policy initiative to improve this position. As such, SBP has recently issued policy instructions to all banks binding them to expand their ATM network in a phased manner so as to achieve a target level of one ATM for each bank branch. Once this target is achieved, we have plans to gradually raise the bar so as to come close to the international levels. 8. Ladies and Gentlemen, the banking industry of Pakistan has tremendous growth potential and can deliver a lot more than what it is delivering right now. The driving force behind the efficiency and dynamism of the banking business today is the use of technology. The significance of e-banking and e-commerce cannot be overemphasized because of the fact that both have brought about remarkable changes in the ways people think and do their banking business today. 9. The outcome of e-banking in Pakistan will be gradual but the trends towards adoption of information technology are quite encouraging. Transformation from traditional banking modes to modern ways of banking is taking place at a fast pace. A number of alternate delivery channels for provision of banking services like ATMs, Credit Cards, POS (Point of Sale) terminals, Internet Banking, Debit Cards already exist in our country to benefit the masses. Currently, 93% of the total bank branches are offering Real-Time Online services. 10. I would like to acknowledge the efforts of Tameer Bank and Telenor towards financial inclusion and deposit mobilization. It will not only bring economic prosperity but also help alleviate poverty and improve living standards of the people of Pakistan. State Bank of Pakistan looks forward to the success and positive outcomes of Easypaisa Khushaal and expects more innovative products from Tameer Microfinance for promoting deposit mobilization and financial inclusion agenda. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 10 |
Speech by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Karachi Press Club, Karachi, 9 October 2012. | Kazi Abdul Muktadir: Branchless banking in Pakistan Speech by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Karachi Press Club, Karachi, 9 October 2012. * * * Ladies and Gentlemen! Assalam o Alaikum! Let me first thank the organizers for inviting me to share my thoughts with the distinguished guests at the opening of ATM being installed by Summit Bank at the Karachi Press Club. It is an opportune moment for me to be here amongst an august gathering of Writers and Journalists. I would like to place on record my appreciation to the important role played by the members of the Karachi Press Club in the struggle for freedom of expression in the country. Karachi Press Club and the media have always tried to uphold their professional integrity, strength and commitment despite facing a lot of challenges. Their untiring effort to provide latest news and write ups and opinions on current issues is the prime responsibility of Journalists and in my experience the thirst of media somehow always seems to be unquenched and remains unfulfilled. This in turn has contributed to information explosion and mass awareness that is one of the basis of active democracy. Ladies and Gentlemen! As press is the part of service sector, banking is also a service provider of financial produces. Banking thrives on standards and service rendered by it. Standard and consumer protection have to be regulated in order to ensure quality. As banks operate on commercial considerations; their branch expansion has traditionally been skewed towards big cities and commercial centers. Therefore, SBP under its Branch Licensing Policy has made it compulsory for banks to open at least 20% of their new branches in rural localities and under-served areas. These regulatory measures are bearing fruit and branch penetration in rural areas has started to improve. State Bank of Pakistan as a supervisor and regulator of the banking industry, is trying to make banking services available at the door step of the people. Promoting access to banking services is the corner stone of State Bank of Pakistan’s policy framework. As opening of physical branches, entails substantial costs and is time consuming, SBP has always been encouraging adoption of alternate delivery channels for providing financial services to clients by the banks. Access to Branch banking is limited by time. The availability of Automated Teller Machines (ATMs) is a convenient and efficient tool to access accounts by clients for cash withdrawals and other related services on a 24 hour 7 day basis. In developed countries, there are three ATMS against one bank branch; however, being a developing economy, the availability of ATMs in Pakistan is low. Presently we have only 5600 ATMs across Pakistan, just about one ATM against two bank branches. Therefore, there was a strong need for the Central Bank to come up with some policy initiative to improve this position. As such, SBP has recently issued policy instructions to all banks binding them to expand their ATM network in a phased manner so as to achieve a target level of one ATM for each bank branch. Once this target is achieved, we have plans to gradually raise the bar so as to come close to the international levels. Ladies and Gentlemen, the banking industry of Pakistan has tremendous growth potential and can deliver a lot more than what it is delivering right now. The driving force behind the efficiency and dynamism of the banking business today is the use of technology. The significance of e-banking and e-commerce cannot be overemphasized because of the BIS central bankers’ speeches fact that both have brought about remarkable changes in the ways people think and do their banking business today. The outcome of e-banking in Pakistan will be gradual but the trends towards adoption of information technology are quite encouraging. Transformation from traditional banking modes to modern ways of banking is taking place at a fast pace. A number of alternate delivery channels for provision of banking services like ATMs, Credit Cards, POS (Point of Sale) terminals, Internet Banking, Debit Cards already exist in our country to benefit the masses. Currently, 93% of the total bank branches are offering Real-Time Online services. Ladies and Gentlemen, we are now leveraging the mobile phone technology and agents network, that has resulted in the development of branchless banking to a higher tier of accessibility and resource utilization. Branchless Banking is now helping in reaching out to the low income groups and unbanked people through more than 30,000 access points across the country. Following trends are noteworthy: • Nearly 30 million transactions worth Rs.115 billion have been processed through branchless banking during the fourth quarter of last fiscal year. • The average daily transactions have been reported to be 315,178. • Total number of branchless banking accounts have also increased to over 1.7 million. According to the World Bank’s Consultative Group to Assist the Poor (CGAP), Pakistan is the fastest growing branchless banking market in the world. The banking architecture for such services is being developed in a robust manner in collaboration with the telco industry that is not only helping its growth but also ensuring quality of services and connectivity. While we seek to encourage the introduction of innovative instruments for payments, we are also mindful of the need to ensure that high levels of service standards that are required to be maintained for safety, security and cost effectiveness with adequate levels for protection of consumers’ interests. In conclusion, let me re-emphasize on the need for an efficient and thriving banking system that guarantees superior services with enhanced access with higher returns to the stakeholders and also create both forward and backward linkages with the rest of the economy. As a financial regulator, State Bank is open to provide an enabling regulatory environment to all financial institutions for advancing and promoting financial inclusion in the country. Providing people with access to finance is a challenging task, not just for the central bank but for all the stakeholders. I believe that with the concerted efforts of all, we will be able to achieve the desired goal of “Banking for All”. With the opening of ATM at the Karachi Press Club, I am sure all members would be facilitated with access to banking from within the Club’s premises. My best wishes to you all. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 10 |
Chief guest/keynote speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 4th CEO Summit and Book Launch of "100 Business Leaders of Pakistan", Karachi, 8 November 2012. | Yaseen Anwar: Developing leadership skills and vision for Pakistan’s economic growth and prosperity Chief guest/keynote speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 4th CEO Summit and Book Launch of “100 Business Leaders of Pakistan”, Karachi, 8 November 2012. * * * Good morning ladies and gentlemen, and thank you for inviting me to this prestigious gathering! As I look around here, I can see some of the most talented individuals that Pakistan has ever produced. Each success story is as unique as it is brilliant. Ladies and gentlemen, I do not need to tell you this, but you have arrived! The successes of Pakistani CEOs are a collection of stories about fearless leadership, in the face of adversity. Let’s admit it: the business environment in this country could be better. We may have numerous problems, but a lack of entrepreneurial spirit and drive is not one of them. What have you, as entrepreneurs and managers, not faced in this environment? You have faced changes in governments and policies; you have faced high inflation; you have faced the depreciation in the value of the currency; you have faced shortages of electricity and energy; you have faced multiple security issues and a constant threat to both life and property; in fact, we haven’t made your job any easier by keeping interest rates on the higher side! But you have persevered and persisted, committed and dedicated your energies to your businesses and workers. And now your success stands in front of you. You have created corporate empires within Pakistan – ones that now provide essential goods and services to the economy, ones that are the engine of growth for this economy. This is why, ladies and gentlemen, you have arrived! And this is why I would like to applaud your success. But there is one thing that concerns me. And let me throw it out as a challenge. You have conquered the Pakistani market it would seem. Yes, the local market holds tremendous potential for growth, but I think the time has come for you to lead Pakistan forward, beyond our borders. Yes, I challenge you, to take the wonderful skills that you have acquired here in the face of adversity, and build up your presence in the world. Companies from the developing world have a unique advantage over their peers in industrialized economies. They are survivors in the face of challenges that your peers in the developed world have not had to face. They learn to adapt in the harshest of environments, and can take that nimbleness in their ventures abroad. The last two decades, in particular, have seen the rise of EMNCs – emerging multinational companies. Our corporate sector has survived in perhaps one of the most challenging environments, and yet it has flourished. There are challenges to expanding abroad – challenges that our companies may not have encountered previously. But I, for one, would like to see more of our corporate sector aggressively targeting the regional and global market. I challenge you to dream larger than ever before. This is where the role of visionary leadership comes in. Can a Pakistani multinational be recognized as a regional or global powerhouse? Our peers in the developing world have been surging forward here. Jaguar, the icon of British royalty, was recently bought by Tata motors. Mittal Steel acquired the European company Arcelor, and Arcelor-Mittal is now the world’s largest steel maker. Russia’s Gazprom surpassed Microsoft in 2006 to become the world’s third most valuable company. China Mobile’s market capitalization has now surpassed that of Vodafone’s. Orascom of Egypt led Europe’s largest ever leveraged buyout. It is apparent we are in the middle of a paradigm shift – let’s not get left behind. The path to internationalization of any corporate is slow and gradual. There is a steep learning curve, lots of false starts, and constant feedback loops. I may not be the best person to deliver a lecture on expanding overseas, but I am convinced that the lessons BIS central bankers’ speeches learned here, can easily be applied in other economies, where companies from more developed countries may not be able to adapt as quickly. So let us expand into other developing countries first. Let us expand into other countries in South Asia for instance. The African market is another possible destination as well. Let us develop a regional presence before we can take on the markets in industrialized nations. Let us also not forget that the millions of Pakistanis abroad will give you an edge as you venture abroad. They will be familiar with your brands, and with the quality of your products. They may just hold the key to giving you a foothold in international markets. But for all this to happen, we need your vision and your leadership. At the State Bank, we are concerned about the current state of Foreign Direct Investment or FDI. We are concerned for a good reason. Most of the time, it is a very good indication of the health of the economy. The reasoning is something like this: if the economy is doing well, companies abroad will want to invest in the country. But we’re not living in normal times. Most companies in the west are themselves struggling with their domestic markets. Would they then consider investing abroad in another country and assume all the risk that entails, especially in times like these? As business leaders, you know the answer better than I do. So where does this leave us? The market opportunities in developing nations are still there. But FDI flows from industrialized nations have been falling. That is where EMNCs have emerged to fill in that vacuum. And that is where our companies should expand. It’s time for reverse capital flows. Outward FDI (OFDI) is a metric that has been largely forgotten and relegated to just a number in most developing countries’ balance of payments two decades ago. Now, it is increasingly becoming a measure that signifies the health of the country’s corporations and their competitiveness abroad. Last fiscal year that number was $63 million for Pakistan. That is very small by any standard and it is a challenge we should undertake to change. I have also noticed that there seems to be some apprehension surrounding outward FDI in Pakistan. We have fallen prey to a mindset where inward FDI is good, and outward FDI is bad. From a strictly balance of payments perspective, that is very true; and it is my job to be concerned about that and at the same time to manage it in a prudent and disciplined manner. The flows of FDI, both inward and outward, reflect something deeper. Inward FDI reflects the potential in the domestic economy. Outward FDI reflects the willingness and ability of domestic corporations to compete in the international market. The two are not inversely proportional. One of more does not imply less of the other. There is another distinction to be made here. FDI does not include investments in financial assets, such as investments in stock or bond markets. FDI is investment in tangible assets in the real sector. That means that money and capital flows through FDI are not very volatile. And it is the volatility in such flows that keeps any central banker awake at night. Let me digress here. The point that I hope to communicate is that our economy should move away from a persisting fascination with inward FDI as a metric of the economy’s health and, at least, give OFDI the attention it deserves. Again it is your leadership and vision in taking your corporations to the next frontier that will take us forward into this new paradigm. Your corporations are the engines of this economy, and our economy needs a paradigm shift. I have noted that a few of our corporations have tentatively started venturing into foreign markets. The United Arab Emirates has been a particularly favored destination. I’ve seen many of our brands there, particularly from the textile industry. One of our conglomerates recently acquired a company in the North American market. We know a couple of our banks are extremely keen on entering the Indian market. So yes, a few of our more daring enterprises have ventured outside their comfort zone, and I respect them for that. BIS central bankers’ speeches But there is a great deal more that needs to be done. And there is a great deal more that can be done. The current breed of Pakistani CEOs is the street-smart entrepreneur, who will learn to adapt to any environment. That is going to be our competitive advantage in the global market. Once again the challenge is to put your skills to the test on the global stage. I am confident that you will create a new success story with each challenge. I would certainly be remiss in not pointing out that the world today is passing through a turbulent phase that requires a realignment of our leadership approach to managing businesses. Today’s business leader is faced with a multitude of challenges, both on external and internal fronts. The complexities arising in the eco-system of any business may arise in the shape of macro economic imbalances that include sagging demand, inflation, volatility in financial markets, etc. While demanding situations on the internal front arise from personnel management, investment ambiguity that there are always complex matrices linking external challenges with internal ones and therefore, successful business leaders will never make internal business decisions in isolation. An uniformed business leader is a leader without a vision and quite likely without any success. Like any real life crisis, the present turmoil in the financial sector provides an opportunity to learn from the financial world’s mistakes and overzealousness. This gives us the opportunity to look back and see what went wrong and structure our own financial houses so that this does not happen to us, or so severely affect the world again. In this regard I feel the most significant lesson that we have learnt from recent events is the importance of fundamentals in risk management. For instance there is a basic rule since inception of banks which says “do not put all your eggs in one basket”. Had this simple rule been followed, many institutions could have avoided huge losses. The challenges posed by the Global Financial Crisis have impacted leaders of all major businesses. Elevating corporate governance should not be confined to banks, but commercial concerns must also do the same. We all know the pace of globalization has accelerated, resulting in increased domestic and global economic integration. Today we cannot just shrug off failures within a particular sector or sometimes even a single entity if it has global linkages. Gone are the days when a financial or political crisis in one country could be contained to that country; now there are several contagion effects at different levels. That is why emphasis on good corporate governance regimes cannot be underscored more as it creates an attractive investment climate necessary to maintain investors’ confidence, resulting in positive impact on the share price and creating possibilities for raising low cost Capital. It is imperative that we develop and implement good governance practices in order to provide impetus to economic growth. Given Globalization and the crisis we all face, let me highlight the traits of effective leadership that are universally applicable and that I have cited in earlier talks. Leaders must be visionary to see the future trends, anticipate institutional bottlenecks, remain competitive and be able to adap rapidly to changes. They should be continuous learners, a necessity for enhancing leadership skills. Leaders need also to take into account their corporate social responsibility so that profit seeking is balanced against the objective of social service and well being of society. Leadership success requires strong conviction and belief. Yet having humility and recognizing the need to reinvent and inspire their organization to adapt to new challenges remain an integral part of successful leaders. This is vital if businesses want to remain at the forefront of new innovations, critical for long term competitiveness. All these and more comprise the necessary characteristics for dynamic leaders that push the frontiers of excellence. Such corporate leaders fuel the drive towards long-term growth and stability. I’ll conclude my thoughts with a small personal aspiration. Twenty years from now, I would like to hear the story of how a Pakistani corporation entered the global market, the challenges it faced and overcame, and became the first Pakistani company to be BIS central bankers’ speeches consistently featured in the Fortune Global 500 list of companies. I look forward to being in an audience of thousands, listening to that story. That is my final challenge to you. So, ladies and gentlemen, you have arrived. But there is, as I have said in my talk, that other frontier that still needs to be conquered. And I am confident that your leadership skills and your vision are more than sufficient to achieve that ambitious but reachable goal. After all, a man’s reach should exceed his grasp or what’s a Heaven for. That is what will usher this country into a new age of economic growth and prosperity. Thank you! BIS central bankers’ speeches | state bank of pakistan | 2,012 | 11 |
Chief guest address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Branchless Banking Commercial Launch of Waseela Microfinance Bank Limited, Karachi, 12 November 2012. | Kazi Abdul Muktadir: Tackling financial exclusion in Pakistan through branchless banking Chief guest address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Branchless Banking Commercial Launch of Waseela Microfinance Bank Limited, Karachi, 12 November 2012. * * * Mr. Ghazanfar Azzam, President & CEO of Waseela MFB, Mr. Rashid Khan, CEO Mobilink Distinguished guests, ladies and gentlemen! Assalam-o-Alaikum and Good Morning, I am extremely delighted to join you on the occasion of this commercial launch of branchless banking by Waseela MFB. I would like to congratulate the sponsors, management, and staff of Waseela Microfinance Bank Limited on this special occasion and believe that the launch of Waseela will not only help in catalyzing market development especially in areas of agent development but also the use of technology would rapidly scale up mobile financial services to the vastly underserved segments of society all over Pakistan. I have been told that the number of mobile phone subscribers in Pakistan is around 120 million and Mobilink has the largest share of over 36 million subscribers. The current tele-density is above 72% which is much higher than the level of financial access that hovers around 12 percent. This factor alone highlights the immense potential for mobile banking in the country. The role played by the Government, PTA and the Mobile Operators for achieving this high level of penetration, especially under our existing socio-economic conditions, is highly commendable. Ladies and Gentlemen! There is an emerging consensus amongst policy makers around the world that mobile financial services is a safe and sound way to rapidly improve access to financial services for poor people. G-20 leaders in their last summit held at Toronto in 2011 adopted 9 Principles for Innovative Financial Inclusion that include promoting technological and institutional innovation as a means to expand formal financial system access and its usage. These principles aim to help the creation of an enabling policy and regulatory environment for innovative financial inclusion. Such enabling environment will assist and determine the speed at which the financial services will be made available to the more than two billion people who are currently excluded, where access to financial services can make the difference between surviving and thriving. Innovative modes of financial services delivery can have a transformative effect on poor households. We know that access to even small amounts of credit can dramatically improve the welfare of the excluded population both in urban and rural areas. Awareness is growing that access to a wider set of financial services provides poor people with capacity to increase or stabilize their income, build assets and have much greater resilience to economic shocks. Appropriate and affordable savings products, payment and money transfer services (both domestic and international) as well as insurance are all important. Gender discrimination has excluded women who have toiled to provide and support financial needs through enterprising means but were stymied due to negligible access from the formal financial sector. BIS central bankers’ speeches At the same time, one billion people with mobile phones in the world do not even have a basic bank account. As the costs of information and communications technology shrink, the time is ripe to extend this technology to address financial exclusion. Technological innovation impacts the cost and access equation – making it economically viable for financial service providers, to reach poor people, with a wider range of products and services. Innovation also extends to new institutional approaches. Increasing numbers of countries with large unbanked populations are pioneering policy and regulatory innovations that opens space for “banking beyond branches” with new approach to the delivery of formal financial services. This is allowing previously excluded customers the much needed access to an increasing range of basic financial services. Pakistan has one of the lowest financial penetration levels in the world with 56% of the adult population totally excluded, and another 32% informally served. We are a country with a population of 180 million living in geographically diverse areas. Mobile phone subscription has seen explosive growth in Pakistan. In contrast, banking accounts are owned by approximately 30 million customers largely belonging to high income segments of the society. With a network of a little over 10,500 bank branches, the coverage of branches is one of the lowest in the region. Developing brick and mortar branches is a costly proposition. To encourage Financial Institutions to develop alternative delivery channels, SBP in 2008, introduced Branchless Banking (BB) Regulations. The Regulations are applicable to all Commercial Banks, Islamic Banks and Microfinance Banks in Pakistan. These Regulations have actually catalyzed in the deployment of a number of branchless banking initiatives that have a dual advantages: First, there is an enormous scope for expanding outreach, especially in the hard-to-reach rural areas. The emerging models relying on “banking agents” have greatly extended the distribution of financial services to the marginalized and deprived segments. Second, alternative delivery channels promise significant cost reduction to institutions. Due to these benefits, the expansion in the retail network of microfinance has arisen overwhelmingly from agents and mobile phone channels. Recent international researches 1 and studies prove that increase in mobile penetration in developing countries is correlated with economic growth. When this technology is used to expand financial services, the benefits that accrue are: increase in savings due to incremental small savers, access to information improves, costs and time spent on traveling reduces, new employment opportunities emerge, cost and savings to financial institutions, and creation of a platform on which other businesses can also grow. Ladies & gentlemen, branchless banking is moving at a phenomenal pace in Pakistan, and it should be our endeavor to achieve maximum benefits from these developments. Encouragingly, market environment for branchless banking is widely considered globally as one of the best. SBP has been promoting innovations in products and delivery channels through policy and regulatory measures and market interventions. SBP has put in place a “Financial Innovation Challenge Fund” under the DFID-funded Financial Inclusion Program (FIP). I am glad to highlight that market has been responding actively to this stimulus. As a result, users’ adoption has started rising at an increasing rate, and is likely to change the landscape of retail banking in Pakistan in near future. This dynamic transition is endorsed by recent branchless banking data, with a transactional volume of nearly 32 million valuing (a) Waverman, L., M. Meschi, and M. Fuss.. “The Impact of Telecoms on Economic Growth in Developing Countries.” Vodafone Policy Paper Series 2 (March). http://info.worldbank.org/etools/docs/library/ 152872/Vodafone%20 Survey.pdf. (b) Qiang C., and C. Rossotto. 2009. “Economic Impacts of Broadband.” In Information and Communication for Development Report: Extending Reach and Increasing Impact, ch. 3. Washington, DC: World Bank. www.worldbank.org/ic4d. BIS central bankers’ speeches Rs. 140 billion during the single quarter of July–September, 2012 by only two players. These players have registered more than 1.8 Mobile-Wallet accounts largely of those people who have previously been un-banked and under-banked. Mobile banking is also facilitating repayment of microfinance loans and we are seeing increasing number of partnerships between Microfinance Institutions (MFIs) and branchless banking providers Achievements in the Branchless Banking Services have already put Pakistan at the global centre stage of financial inclusion and innovation. The World Bank’s Consultative Group to Assist the Poor (CGAP), in one of its studies has also recognized Pakistan as one of the fastest growing branchless banking markets in the world, and a laboratory of innovation. We hope that with the entry of new players and scaling-up of the existing institutions the present growth momentum will build up strongly and progressively. Before I close, I would like to emphasize on our broader goal i.e. to provide inclusive financial services to poor and low income groups. I firmly believe that microfinance and branchless banking are complementary to each other, and together they will bring the advantages of inclusiveness, convenience, ubiquity, and efficiency. Pakistan offers best regulatory framework and industry infrastructure for microfinance, and I hope that our MFBs will take advantage of such a favorable market environment by investing in innovative technologies and products to grow their businesses and expand access to financial services in Pakistan. Once again, I would like to congratulate Waseela Microfinance Bank Limited and Mobilink. I wish you every success, assure you of our support, and look forward to positive outcomes of this commercial launch and I hope today’s commercial launch of Waseela and its branchless banking will go a long way in tackling financial exclusion in Pakistan. Thank You. BIS central bankers’ speeches | state bank of pakistan | 2,012 | 11 |
Keynote address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at a roundtable on "SME Banking", jointly organized by the State Bank of Pakistan and the International Finance Corporation (IFC), Karachi, 16 January 2013. | Yaseen Anwar: SME banking Keynote address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at a roundtable on “SME Banking”, jointly organized by the State Bank of Pakistan and the International Finance Corporation (IFC), Karachi, 16 January 2013. * * * Mr. Kaiser Naseem & Mr. Andrew McCartney from IFC, Distinguished Presidents of commercial banks Ladies and gentlemen, Good morning! Let me extend a very warm welcome to all of you to this Roundtable on the important subject of “SME Banking”, jointly organized by State Bank of Pakistan and IFC. I would like to especially welcome and thank the SME Banking experts from IFC who have traveled from abroad to conduct this important session for the top management of the banking industry of Pakistan. This Roundtable is indeed a significant event as we have representation of all the major banks that contribute more than 90% of the total SME Lending in the country. The objective of today’s proceedings is twofold; first, to take stock of the issues confronting the SME sector, and second, to learn and deliberate on the various successful strategies and SME Banking models practiced globally by lending institutions. I am sure everyone around the table believes that SME development plays a key role in the economic development of a country. In Pakistan, the sector contributes 30 percent towards GDP, employs more than 70 percent of the non-agricultural workforce and generates 25 percent in export earnings. The sector has huge potential in generating employment and poverty alleviation in the country. Therefore, SBP is actively promoting SME finance under the broader agenda of increasing Financial Inclusion in Pakistan. The governments around the world support small scale agriculture, services and manufacturing sectors through a number of initiatives because of their labor-intensiveness and employment generation potential for poverty reduction. These countries have also successfully integrated their SMEs with the large corporate sector through sub-contracting which has proved an extremely useful way of integration across size and scale. In Pakistan, despite the immense significance of the SME sector, it remains largely financially excluded, as reflected from the declining trend in SME finance over the years, constituting only 8% of the banks’ total advances as of June 2012, down from 16% in June 2007. Unfortunately, this ratio is quite low compared to our regional peers such as in India, Sri Lanka and even Bangladesh. A closer look at the SME sector reveals that there are various issues on both demand and supply side that constrain the SME’s access to finance and other banking products and services. On the demand side, these issues can be tackled through a more systematic documentation and disclosure of information by SMEs and better business planning. On the supply side, bankers’ reluctance to lend to SMEs can be addressed through innovative credit assessment tools and techniques like credit scoring and better capacity building efforts for the financial service providers. Among various stakeholders that have to play their role for SME development, I think, State Bank of Pakistan and Commercial Banks both need to play a proactive role in improving access to finance for SMEs. As far as SBP is concerned, it has taken a number of important initiatives for improving access to credit for SME sector. These measures include a provision of specialized Prudential Regulations (PRs) for SMEs, Refinance Schemes for SMEs, Credit Guarantee Scheme for Small and Rural Enterprises and cluster development surveys. Further, SBP has been assisting banks through a holistic IFC technical assistance and capacity building initiative encompassing areas of Strategy Formulation, Product BIS central bankers’ speeches Development, Risk Management and HR Development etc. for SME lending. Presently, Bank Alfalah Ltd. is being supported for capacity building to boost SME banking, while many other mid-tier banks are being considered for similar IFC technical assistance. IFC is in direct dialogue with a number of banks. We hope that this project will revitalize SME lending by participating financial institutions and will be a prototype for other financial institutions which could see financing to SMEs as profitable business ventures. Aside from the boost SME provides to employment and overall growth to the economy, it also provides diversification to a bank’s balance sheet and in turn a stable revenue stream to support long term shareholder value. Given the huge potential for this sector, I encourage all the commercial banks to review their SME strategies and assume a greater role in SME lending. Ultimately it has to be the private sector which has to take the lead role in lending to the SME sector given their critical positioning and greater capacity in terms of their outreach and availability of funds. As I earlier mentioned, the actual statistics for lending to SMEs have not been encouraging in recent years. Banks’ credit to SMEs has declined over the last 4 years from Rs 437 billion in 2007 to Rs 248 billion in June, 2012. Although, this decline can be partly attributed to adverse economic conditions during the period and growing NPLs, a more risk-averse posture of banks remains a major factor responsible for their low exposure to SMEs. In recent years, banks have increasingly invested in safer havens – opting for government paper and increased financing for commodity operations, rather than lending to private sector that would offer better returns and is the main driver of economic activity. I would encourage the financial industry to break-out of this tendency and move towards promoting SMEs by formulating strategies to overcome the challenges presented by the market as well as by the cyclicality in economic conditions. Banks need to shift from traditional banking approach towards SMEs to the provision of more customized and differentiated financial products and services. Let me re-iterate the objective of this program i.e. to share with you the successful SME banking models and their important Building Blocks, such as Strategy Formulation, Product Development, Risk Management tools, and HR & IT requirements. We are lucky to have with us today’s lead presenter Mr. Andrew McCartney from IFC who is a renowned international expert on SME Banking. I hope this event will help top management of the banks to take critical stock of their existing approaches towards the SME sector; and, accordingly develop a more robust and focused strategy for meeting the banking needs of this important sector of economy, leading to better and improved banking solutions for their SME customers. I would hope that when you walk out after this roundtable, a voluntary commitment to increase lending to this sector will be forthcoming. This prudent decision will be in the interest of both the banking sector and the economy. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 2 |
Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at 4th the Conference on Financial Services and Consumers, Karachi, 31 January 2013. | Kazi Abdul Muktadir: Financial inclusion, consumer awareness and protection Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at 4th the Conference on Financial Services and Consumers, Karachi, 31 January 2013. * * * Mr. Kaukab Iqbal, Chairman, Consumers Association of Pakistan, Distinguished Speakers, Ladies and Gentlemen – Assalam o Allaikum wa Rahmatullah! First of all, I would like to thank the Consumers Association of Pakistan (CPA) for inviting me to address this Forum on the increasingly important issue of Financial Inclusion and consumer awareness and protection. I congratulate the organizers for holding this pertinent event which has gained special prominence in the aftermath of global financial crisis. I sincerely hope that the today’s proceedings would give further impetus to our efforts in promoting an inclusive and responsible financial sector in the country, thereby enhancing the financial sector’s stability and viability in the long-run. Ladies and Gentlemen! The importance of financial services in the development of any economy cannot be overemphasized as it promotes entrepreneurship, generates employment, fosters innovation, reduces poverty levels and enhances social equality. Therefore, SBP, as part of its financial sector development strategy is actively promoting financial inclusion. Financial Inclusion refers to the process of promoting affordable, timely and adequate access to a wide range of regulated financial products and services and broadening their use by all segments of society through the implementation of tailored and innovative approaches including financial awareness and education with a view to promote financial well-being as well as economic and social inclusion. To add further emphasis and urgency to the issue of financial inclusion, I would like to share that financial sector in Pakistan remains restricted in its outreach as the majority of population remains either excluded or informally served. This limited access is reflected in the total number of bank accounts, presently around 32 million, and the total number of borrowers, which is only 5.7 million. This high level of financial exclusion is largely attributed to two major factors. Firstly, on the supply side, there is lack of appropriate product offering by financial service providers primarily influenced by their typical hesitance towards the informal and low income segments of the population and lack of geographic presence. Secondly, on the demand side, there is lack of public awareness about availability of financial services and products. SBP is cognizant of high financial exclusion in the country and is fully committed to tackling the associated challenges in a sustainable manner. State Bank of Pakistan is pursuing a multi-pronged financial inclusion strategy through the following: 1. SBP introduced Basic Banking Account (BBA), requiring commercial banks operating in Pakistan to offer BBA to facilitate and provide basic banking facilities to the low income people in Pakistan. A typical BBA can be opened with a minimum deposit of Rs1,000 carrying no fee, no limit of minimum balance and offering full ATM facility. 2. SBP has introduced the Annual Branch Licensing Policy which 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 branch of any bank exists. BIS central bankers’ speeches 3. SBP has developed a world class regulatory framework to enable commercial microfinance and branchless banking in Pakistan. These regulations enable alternative approaches and models for delivery of pro-poor and low-income financial services and products while ensuring institutional viability, broadening access, financial integrity, and pro-consumer practices. 4. Pakistan is amongst the few countries that have a national microfinance strategy which not only identifies drivers and bottlenecks to growth but also provides an implementation plan drawn alongside with industry stakeholders to monitor progress against the identified targets. 5. SBP has partnered with the UK Department for International Development (DFID) and other donors to launch programs to increase access to finance in the country. The DFID-funded Financial Inclusion Program (FIP) aims to address financial exclusion through a variety of interventions. FIP focuses on market-based, sustainable financial services for low income people and small enterprises. In addition, FIP aims to enhance delivery of financial services through technology based branchless banking solutions, financial innovation, and remittances. FIP has provided support to a number of initiatives to enhance supply of and access to finance for SMEs, agriculture, and microfinance sectors. FIP interventions largely focus on addressing market failures and industry bottlenecks, while addressing issues of fair treatment of clients and consumer protection. Here, I would like to make specific mention of some of the breakthrough FIP initiatives on promoting responsible finance in the microfinance sector: • FIP is supporting the establishment of a separate national level Credit Information Bureau for microfinance clients. Once the MF-CIB is fully functional, it would hold the credit histories of MF borrowers addressing the fundamental issues of asymmetric information on MF clients and would also handle the issue of over indebtedness among the MF borrowers. • FIP is supporting Pakistan Microfinance Network (PMN) to introduce the Transparent Pricing Initiative in Pakistan. This initiative will make the prices for the microfinance market available for the first time in history. The MF clients will then be in a position to compare the various products to make the appropriate choice. Moreover, this initiative is expected to increase the level of competition among the MF providers and ultimately efficiency which would benefit the MF clients in the long-run, and • FIP is also supporting strengthening consumer protection under the industry-led SMART campaign that is seeking to improve client protection mechanism in the microfinance sector. 6. Finally, in line with the evidence (Access to Finance (A2F) Survey of 2008) that lack of financial literacy is a major constraint in advancing financial inclusion, SBP launched the first-ever Nationwide Financial Literacy Program (NFLP) in January 2012 to tackle this issue. The program intends to create awareness about basic financial concepts such as budgeting, savings, investments, debt management, financial products, branchless banking and rights and obligations of consumers etc. The pilot phase of the program has been concluded successfully by targeting about 50,000 beneficiaries in various provinces, regions and districts with emphasis on low income strata and its effectiveness is currently being evaluated. Following a third party independent assessment, the program will be scaled up to the national level in its next phase. Let me now briefly talk about the current overall architecture of financial Consumer Protection which anchors on: • Comprehensive Legal and supervisory framework. BIS central bankers’ speeches • Effective Institutional arrangements. • Robust dispute Resolution Mechanism. • Impactful Financial Literacy and Capability programs and initiatives. • Culture of providing responsible finance by the financial service providers. Let’s begin with Legal Framework. Ideally, there should be a Financial Consumer Protection Act at the Federal level, covering a range of issues, including transparency, confidentiality, data protection, account servicing, protection against unfair contracts, lending practices and availability of statements, etc. However, due to lack of such framework at the national level, SBP has been promoting financial consumer protection in the industry through regulatory initiatives on the basis of its powers under the BCO, 1962. These include: 1. Issuance of Prudential Regulations for Consumer Financing, which addresses a number of important issues pertaining to market conduct and consumer protection. 2. Issuance of circulars, covering key areas arising from consumer financing, including disclosure standards, business conduct, underwriting standards, complaints handling, cooling-off periods, sale of third party products, fair debt collection practices, pricing and loan documentation, etc. 3. Establishment of electronic CIB. 4. Fixation of Minimum rate of return on deposits. 5. Issuance of guidelines for Internal controls for cheque payments. 6. Issuance of guidance on Sale of Third party products. 7. Issuance of operational Guidelines for Credit card Business in Pakistan. 8. Issuance of operational Guidelines on ATMs. 9. Issuance of Guidelines on Collection of Utility Bills. 10. Issuance of Guidance on Priority to Senior Citizen and Pension Disbursement through Banks. Turning to the issue of Institutional Arrangements for strengthening of consumer protection policy and swift grievance redessal, SBP has established a Consumer Protection Department (CPD). Under the current regulatory framework, all banks are required to establish comprehensive dispute resolution mechanisms while maintaining proper records of such disputes. SBP also inspects the bank’s records and processes for resolving complaints during its annual on-site inspections. One of the most inevitable traits of financial consumer protection is consumer trust which can only be ensured through initiatives such as, financial education, appropriate disclosures & non-exploitative competition. Therefore, SBP frequently make use of print and electronic media to create awareness for the general masses regarding the probable threats of financial fraud to clients. Moreover, targeted awareness sessions are held for various groups including financial service providers, trade bodies/associations, Chamber of Commerce & Industries, Consumer Associations, NGOs, students and faculty members of universities. Last but not least, I believe that financial consumer protection could be best achieved if the financial service providers develop and adopt more responsible business practices, encompassing their entire product value chain. The responsibility should be exercised, starting from product design to the delivery of the product to the clients. Besides, they should have a swift and effective grievance handling mechanism for satisfaction of their clients. Ladies and gentlemen! In the end, let me invite stakeholders like consumer associations, trade bodies, banking ombudsman, financial and legal functionaries, banks and competition commission to come BIS central bankers’ speeches together in eradicating financial consumer malpractices for building an inclusive and stable financial sector in Pakistan. Wa Aakherun Dawana Annil Hamdolillahe Rabbil Aalamin. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 2 |
Opening remarks by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SBP Conference on Operational Risk Management organised by the State Bank of Pakistan, Karachi, 7-8 February 2013. | Yaseen Anwar: Operational risk management in Pakistan – issues and challenges Opening remarks by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SBP Conference on Operational Risk Management organised by the State Bank of Pakistan, Karachi, 7–8 February 2013. * * * Good morning ladies and gentlemen! Thanks for participating in this well timed conference on operational risk. The conference is part of SBP’s ongoing efforts to promote the culture of awareness on critical issues that demand the attention of the financial services industry. In the local context, credit market and liquidity risks have been the subjects of much discussion. Financial institutions have made significant progress in the management of these risks and Pakistani banks have considerably improved their processes for identification and management of credit and market risk exposures. By contrast, it is relatively difficult to measure the level of operational risk exposures on an enterprise wide level. The global financial crisis has also demonstrated the cost of operational risk failures. It has been observed that in several instances, the mitigation or transfer of credit and market risks actually gives rise to operational risk. Accordingly, operational risk is gaining prominence and coming close to credit risk as the foremost safety and soundness challenge to the financial institutions. It is imperative for our banks to develop requisite capacities to manage their operational risks, collect their loss data, implement risk indicators and set aside capital to cover potential operational risk losses. Operational risk is about instilling proper risk behavior at each level of an organization. Informal operational risk management frameworks have been in place in our industry. However, these informal frameworks are undocumented, lack consistency and do not provide desired level of assurance to senior management or regulators. Thus, it is necessary for risk managers to develop awareness of operational risk and effectively use the emerging management techniques. Under the traditional approach of managing operational risk, the focus has largely remained on protecting the risk of loss of capital through insurance. Banks have relied on internal controls and audit functions. The increased use of technology in executing transactions have necessitated banks to focus more on core banking solutions, IT security and business continuity programs. While the traditional approach has its own merits, there is a pressing need that banks modify their fragmented approach of operational risk management in favor of a much more comprehensive governance and management framework. A framework comprising of clearly defined roles and responsibilities along with reporting procedures. I hope that this conference will promote active discussions on this issue. Against this background, I am pleased to deliver the opening address in which I will cover three main areas. First, I will begin by offering my view on operational risk management – the issues and challenges. Next, I will discuss Basel Accord treatment of operational risk and emergence of sound principles on the topic. Finally, I will talk about some of the regulatory developments & supervisory expectations to strengthen the operational risk management within our banking sector. Operational risk has always existed as one of the core risks in banking. But what constituted operational risk was never agreed until the Basel Committee on Banking Supervision (BCBS) came up with a definition. For this reason, Basel Accord may rightly be credited for promoting BIS central bankers’ speeches the discipline of operational risk which recognized it as a significant risk and prescribed capital charge to protect against operational risk losses. The BCBS defined operational risk as – “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events”. While the definition has determined four sources of operational risk (i.e. people, processes, systems and external events), there are a number of ways in which operational risk can actually manifest itself. It could be a failure of control function, major system breakdown, rogue trading, accounting scam, regulatory penalties, internal/ external fraud, diminishing number of qualified staff, terrorist attack, floods, earth quakes etc. Since the scope of operational risk encompasses the entire organization and covers several dimensions. We, as banking professionals, need to consider the following points in defining any strategy to manage and mitigate operational risk. • The source of operational risk is from the day to day activities of a bank. For this reason, operational risk management must initiate from the business unit level. • There is misconception that operational risk management is solely about internal controls. Banks are good in minimizing high frequency low severity risk events but it is often low frequency high severity events that can jeopardize the existence of a bank. Hence we need to identify and analyze predictive key risk indicators and use scenario analysis to simulate the impact of irregular events. • Good operational risk management is about finding and correcting the real cause of the incidents and not about the effects or observed events. Thus, while maintaining the history of losses is important for capital modeling, we need to realize that two identical events may have entirely different underlying causes. As a result, every operational risk event requires deeper investigation. • Operational risk management is all about instilling proper risk behaviors. Thus changes in culture and governance needs to be institutionalized. I believe these challenges can be overcome if banks adopt a systematic approach like the one prescribed by the Basel Committee. Let me briefly talk about the spectrum of approaches offered by Basel Accord to calculate operational risk capital charge. Under the two simple approaches (i.e. Basic Indicator and Standardized Approaches), gross income is used as a proxy for the scale of business operations. This suggests that banks with higher gross incomes are relatively bigger in size and have more operational risk exposure. However, it is often argued that gross income is not always a perfect proxy for operational risk since it may fluctuate with the business/ economic cycle. Nevertheless, in the absence of any other proxy, income is being used due to its simplicity, comparability and reduced capital arbitrage opportunity. Another approach offered under Basel II is the Advanced Measurement Approach (AMA), wherein banks can develop their own internal assessment techniques. Unfortunately, the quantitative techniques for measuring operational risk are evolving and there is no broad consensus on the modeling methodologies of operational risk. Thus, it can be said that the quantitative approaches offered under Basel Accord are still in the process of refinement. However, this is all the more reason for banks to focus on qualitative requirements depending on the regulatory approach they intend to follow. In the past one decade, the awareness of operational risk has improved and resultantly the principles for sound management of operational risk have emerged. Banks need to incorporate these internationally agreed principles while implementing any operational risk management framework. These principles mainly focus on the Governance, Risk management environment, role of supervisors and business resilience. BIS central bankers’ speeches I will now outline SBP’s expectation on the integrated components of the overall framework for managing operational risk across the enterprise. Sound internal governance forms the foundation of an effective operational risk management Framework. It is necessary that those at the top of the organization should take the lead in establishing a strong risk management culture. The board of directors needs to regularly review the framework and ensure that senior management is actively monitoring the effectiveness of risk management and controls. For this purpose, the board should establish a management structure based on clear lines of responsibility, accountability and reporting. The board should set the bank’s risk appetite through the approval of operational risk management policy. SBP expects that boards should seek periodic reports from management to the monitor the operational risk profile of the bank in a proactive manner. The role of senior management is to implement the operational risk management framework as approved by the board. Senior management must ensure that all its business activities are adequately staffed having necessary experience and technical skills. The remuneration policies should also be consistent with the approved risk appetite. Managers should not be rewarded solely on the basis of profits, but audit findings and compliance status should also be considered while deciding bonuses and compensations. Sound operational risk governance practices rely mainly on the following lines of defense: i. Business line management is the first line of defense against operational risk. Business line management is responsible for identifying and managing risks in the products, activities, processes and systems for which they are accountable. It is important that clearly documented and regularly updated operating manuals are readily available to all employees. Segregation of duties needs to be ensured. It is also necessary that operational staff must have necessary skills and training so that they can fulfill their duties. ii. A separate independent operational risk management function is the second line of defense and has become a good practice. Independent operational risk management function would assist management to understand and manage operational risk. The function should be responsible to assist in establishing policies & standards and coordinate with various businesses/ risk management activities. The function assesses, monitors, and reports operational risks as a whole, and ensures that the management of operational risk in the bank is as per approved strategy/ policies. iii. Independent validation and verification is the third line of defense in the governance structure. It serves as a challenge function to the other two lines of defense. Internal audit or any independent group of qualified staff may conduct these independent reviews. Since internal audit reports to the board audit committee therefore the audit function should also provide assurance to the board regarding effectiveness of the operational risk management framework. Senior management should seriously investigate the findings of audit to set up a risk culture in the bank. The next principles focus on Risk management environment, it outlines the bank’s approach to the identification, assessment, monitoring, control and mitigation of risk. Banks need to use various tools for proactive operational risk management. These tools include audit findings, analysis of internal and external loss data, risk control and self assessments, key risk indicators, scenario analysis, comparative analysis etc. I am pleased to know that lively discussions on these tools will follow in the coming sessions. SBP is cognizant of its responsibilities with regard to sound operational risk management frameworks in banks. SBP will continue to play its role in ensuring effectiveness of established frameworks in banks. We expect each bank to develop and continuously improve its risk management and control framework depending on nature, location, size, sophistication, complexity of business operations and approved risk appetite. BIS central bankers’ speeches In order to have comprehensive and current information on operational risk, SBP will expand its existing reporting mechanism. SBP is working on a two prong strategy; one is to update the existing instructions on frauds & forgeries with the purpose to further strengthen the fraud risk management and monitoring in banks. On the second front, Guidelines on operational risk data collection will be issued to enhance the scope of loss data gathering in line with Basel II requirements and to provide the industry a minimum set of instructions for consistent recognition of losses and their reporting to a centralized data consortium. These projects are at an advanced stage of consultation with the industry. These guidelines/ instructions will help banks improve their operational risk management processes. Information security and business continuity are becoming the top supervisory concerns. Banks need to monitor IT security risks and respond to security breaches in a timely manner. Banks need to devise and test their business continuity plans to ensure they are able to operate on an ongoing basis in the event of severe business disruption. The plans must be based on different types of worst case scenarios like inaccessibility of bank’s facilities, IT infrastructure or a pandemic event. Let me sum up the key message of this address. For sound management of operational risk, we need to inculcate a risk culture within the organization with open communication channels between business lines and control functions. There is a need for close cooperation between banks and SBP. We are all on the learning curve; therefore exchange of ideas is very important in capacity building for operational risk management. I hope this conference will provide a good opportunity to exchange our thoughts on the subject and learn from each other’s experiences. Thank you very much for your attention. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 2 |
Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SECP (Securities and Exchange Commission of Pakistan) Conference on "Non-bank financial institutions", Karachi, 4 March 2013. | Yaseen Anwar: Developing non-bank financial models while addressing the risks of shadow banking Address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the SECP (Securities and Exchange Commission of Pakistan) Conference on “Non-bank financial institutions”, Karachi, 4 March 2013. * * * Mr. Muhammad Ali, Chairman, SECP, Distinguished Speakers, Ladies and Gentlemen – Good Afternoon! I would like to thank the SECP for inviting me to join you and address this very timely conference on Non-Bank Financial Institutions (NBFIs). I congratulate the organizers for holding this pertinent event which has gained special prominence in the aftermath of the global financial crisis. I sincerely hope that today’s session will give further impetus to our efforts in promoting NBFIs as an alternative source of funding for businesses and also as a separate class of assets for investors in the country, adding to the financial sector’s diversity, stability and viability in the long-run. Globally, NBFIs have gained a prominent position and role in the financial sector and economy. However, the role of this sector has recently been scrutinized for its contribution to financial sector fragility during the recent global financial crises. Therefore, at the November 2010 G20 Seoul Summit, while reviewing the new capital standards for banks (Basel III), the G20 Leaders identified some remaining issues of financial sector regulation that warranted attention. They highlighted “strengthening regulation and supervision of shadow banking” as one of these issues and requested the Financial Stability Board (FSB), in collaboration with other international standard setting bodies, develop recommendations to strengthen the oversight and regulation of the “shadow banking system”. The “shadow banking system” is defined as “the system of credit intermediation that involves entities and activities outside the regular banking system” in other words intermediation through non-banks. The term started to be used widely at the onset of the recent financial crisis. The emergence of the term reflected recognition of the increased importance of entities and activities structured outside the regular banking system that perform bank-like functions.1 The financial sector in Pakistan comprises of Commercial Banks, Development Finance Institutions (DFIs), Microfinance Banks (MFBs), Non-banking Finance Companies (NBFCs) (leasing companies, Investment Banks, Discount Houses, Housing Finance Companies, Venture Capital Companies, Mutual Funds), Modarabas, Stock Exchange and Insurance Companies. Under the prevailing legislative structure the supervisory responsibilities in case of Banks, Development Finance Institutions (DFIs), and Microfinance Banks (MFBs) falls within legal ambit of State Bank of Pakistan while the rest of the financial institutions are monitored by other authorities such as Securities and Exchange Commission and Controller of Insurance. In Pakistan, while the overall assets of the financial sector have increased from Rs. 5.202 trillion in 2005 to Rs. 11.107 trillion in 2011, the share of the financial sector in terms of GDP is very low at 57.4 percent. In 2011, Banks held 74 percent of the financial assets while the share of NBFIs was only 4.7 percent of the total financial sector assets which was around 7.6 percent in 2005. The low financial sector to GDP ratio and NBFIs Shadow Banking: Scoping the Issues: A Background Note of the Financial Stability Board, 2011. BIS central bankers’ speeches declining share in financial sector assets clearly underscores the need for financial sector development and diversification of financial sector assets to attract investors with different return expectations and risk appetite and channelize financial resources for the economic development of the country. Therefore, today’s conference is very important and we should use this opportunity to understand the key bottlenecks in the way of financial sector development and also come up with concrete measures to address these shortcomings in a sustainable manner. Alan Greenspan identified the role of NBFIs in strengthening an economy, as they provide “multiple alternatives to transform an economy’s savings into capital investment [which] act as backup facilities should the primary form of intermediation fail”.2 On the other hand, the NBFIs offer an alternative to typical commercial banking saving-investment products. However, in Pakistan, NBFIs other than Investment banks and leasing companies which offer saving and investment products on a relatively small spectrum need to develop appropriate and affordable products to increase its market share. The key negative outcome of this is that there remains limited access to funding resources and relatively higher risk avenues to earn spreads. Here I would like to briefly touch on the major constraints that the NBFI sector in Pakistan is beset with: First, although there has been an increasing effort by NBFIs to broaden the range of their business activities and product base, thereby diversifying their revenue streams, the sector is yet to make a breakthrough in this regard. Second, the sector is fragmented and each NBFI is trying to create its niche market in pursuit of establishing a sustainable revenue stream. In this regard, most companies are concentrating on financial advisory and other fee-based income segments. Unfortunately, the sector is yet to capitalize on the huge opportunities offered by previously relatively untapped areas like SMEs, Consumer, and Agriculture segments to enhance avenues for fund deployment. Third, the sector needs to develop and diversify sources of funding for sustainable growth. This would require a shift from the traditional sources such as commercial banks credit lines etc for on lending to clients. The NBFIs need to develop capital market instruments to pool funds from a diverse set of investors to ensure certainty to the source and cost of funding. Fourth, we need to strengthen the oversight and regulation of NBFIs to reduce the risks emanating from “shadow banking”. As observed by FSB, the objective of this exercise should be to ensure that shadow banking is subject to appropriate oversight and regulation to address bank-like risks to financial stability emerging outside the regular banking system while not inhibiting sustainable non-bank financing models that do not pose such risks.3 The measures articulated today adhere those very regulatory issues going forward. In conclusion, I would like to say that the financial system in Pakistan is yet to grow to its full potential and play a more meaningful role in the economic development of the country. Therefore, we definitely need to add to its diversification and depth. NBFIs can play a meaningful role in this pursuit. In light of the global financial crises, we are better informed about the various risks that the NBFIs/Shadow Banking carries with it. As regulators we need to remain vigilant to ensure that those risks are mitigated without inhibiting sustainable non-banking financing models. Thank you. FRB: Speech, Greenspan – Do efficient financial markets mitigate crises? – October 19, 1999 FSB Consultative Document: Strengthening Oversight and Regulation of Shadow Banking – An Integrated Overview of Policy Recommendations, 2012. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 3 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Pakistan Navy War College, Lahore, 5 March 2013. | Yaseen Anwar: Brief strategy for the revitalization of the Pakistani economy Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Pakistan Navy War College, Lahore, 5 March 2013. * * * Respected guests, esteemed servicemen, and students at this fine establishment, Assalamo-Alaikum! I’m glad that you could join us today and thank you for inviting me to introduce you, very briefly, to a strategy for the revitalization of the Pakistani economy. Our roles at the State Bank, and your roles in the armed forces, are not very different from each other. We are both tasked with guarding national interests and we both seek to actively mitigate threats – both from within our boundaries, and from the outside world. Today, I hope to be able to share with you, how we, at the central bank, guard and guide this economy towards a path of sustainable growth and stable prices. But before I go down that path, I would like to put some things in perspective here. For instance, I’d like to point out that we are not in the middle of an economic meltdown. In fact, we are not even close to being in an economic meltdown. That is why the topic of this lecture “A strategy to improve economic meltdown” may just have been a tad misleading. So yes, we certainly face challenges, but I assure you that they can hardly be categorized as a meltdown. Since we’re on the subject of economic catastrophes, I think it would be enlightening if we talk about a few countries that have seen their economies collapse in the past few years. Let’s start with Greece. Their latest unemployment rate is roughly 27 percent. That means that more than one in four people remain jobless. Let me reemphasize that: one out of every four individuals does not have a job! Can such a high unemployment rate be socially acceptable or sustainable? Of course not. That’s why the country was beset with riots, massive protests, political bickering and a very uncertain and bleak outlook. Youth unemployment in Greece is more than 50 percent. That means that more than half of the youth – the most productive part of any labor force – remains jobless. Can you imagine how demoralizing that is for new entrants into the workforce? If you throw this into the mix, you will have some very strong incentives for social unrest, with sharp rises in crime, hooliganism, and general despondency. It’s no surprise then that the suicide rate in the country has doubled in the past five years. 2013 will mark the sixth year of the Greek Depression. For six consecutive years, the economy has shrunk. The light at the end of the tunnel is a very, very long way off for Greece. That – ladies and gentlemen – is an economic meltdown. In fact, southern Europe has been teetering on the edge of an economic disaster for a while now. Their governments borrowed incredible sums of money when times were good in the first few years of the 21st century, and are now struggling to repay their debts. In some instances, their debts reached 200 percent of their GDP – twice the size of their entire economy’s output. It was fiscal irresponsibility at its worst. Pakistan’s national debt is 60 percent of its GDP – and that is an uncomfortable level for us. 200 percent, on the other hand, is a completely different ballgame. Now they have to balance their books once more and live within their means. And they’re discovering just how painful the process of deleveraging, or paying off their debts, can be. Their economies are facing serious difficulties, unemployment is very high, and the prospect of default looms large. Since their economies are so interconnected with the rest of Europe and indeed, with the rest of the world, they are threatening to plunge the entire world into a recession if their economic BIS central bankers’ speeches conditions deteriorate further. And if that happens, ladies and gentlemen, I will be inclined to believe that we are living in the middle of a global economic meltdown. At this point, let me walk you through a meltdown that happened quite recently in the largest economy in the world: the financial meltdown of 2008–2009 in the US. It started off with irresponsible lending by the banks, which was backed implicitly by the government, to individuals who wanted to buy property – and not just one. Investment banks then bought these loans from the banks that had originated them, and proceeded to create complex financial products anchored to these loans, which were then peddled to other investors. Some of those investors were pension funds, and state governments – funds that basically came from hardworking families’ taxes and savings. Such funds are only allowed to invest in riskless assets, ones which are considered as safe as possible. But most investors did not truly understand the nature of these products, and instead turned to rating agencies for assurance. Rating agencies, such as S&P and Moody’s, evaluate financial assets and rate them in terms of their riskiness. For reasons that should not be mentioned, these agencies decided that the toxic assets were of the highest quality, and least riskiness – equal to sovereign debt. All this while, the regulators had, more or less, gone to sleep. Eventually, they woke up to a very rude shock. Since the financial system was so interconnected, one ripple is all it needed to create a tidal wave in such an unstable scenario. Banks’ irresponsible lending meant that eventually, individuals defaulted on their mortgages. Once this cycle of defaults started, it spilled over from mortgage companies to investment banks. Of the five large investment banks in the US, one defaulted, two got sold, and two others had to be rescued by the government. The fear and panic that gripped the financial markets meant that banks were reluctant to lend to each other – markets froze completely. The regulators had to no choice but to step in, but a lot of the damage had already been done. The economy went into recession, and the next four years brought a flickering flame of economic growth – vulnerable to the next gust of wind that threatens to blow it out altogether. [Governor’s comments on the future of the US and the Euro, and their efforts to rekindle their economies after the financial meltdown…] Let me get back now to the Pakistani economy. The word that’s been used to describe our economy quite a few times has been “resilient”. I think it’s worth talking about how that word describes this economy. In 65 years, Pakistan has never gone through an episode of hyperinflation; Pakistan has never defaulted on its international and domestic debts; in fact, our economy has grown consistently, but not spectacularly, over the past six decades. Not many countries in the developing world can claim to have achieved all of that. This has been despite periods of international alienation and sanctions, three expensive wars, two hostile fronts, regular political upheaval, social unrest, sharp increases in the price of oil, and much, much more. However, it would be dishonest to say that the economy’s resilience is completely by design. Yes, regulation and strict oversight has had a part to play in it. And I’d like to briefly touch upon that here. The State Bank has always ensured that the financial system of the country remains safe and stable. We may not have always gotten things completely correct, but we have made sure that banks remain healthy and depositors’ money remains safe. We have managed to do this despite privatizing the banking system almost entirely. This means that capital is now allocated more efficiently, and private sector businesses can borrow freely for their requirements. I must add though that we are a little disappointed with the current risk aversion of the banks. The reforms process was initiated in the early 90s and focused on more private sector participation as financial intermediaries; developing a more robust regulatory framework; restructuring banks; and developing non-bank financial institutions (also known has NBFIs), BIS central bankers’ speeches as well as equity and bond markets, as alternatives to the banking system for both savers and borrowers. The financial sector was essentially given a completely new look during the course of that decade. The purpose of all these changes was to enhance competition and efficiency in the financial sector. That would mean that capital gets allocated into productive investment, which can drive future growth. Simultaneously, as banks became more efficient, savers could receive a better return on their deposits and borrowers could finance themselves at lower rates. The robustness of our financial system, is a direct consequence of the reforms process and the State Bank’s constant vigilance. There’s a lot that can be improved in our financial system – for instance, I would love to see the development of efficient debt markets, even better regulatory and reporting practices, and the broadening of the financial sector’s scope to include largely unbanked, such as agriculture, small and medium enterprises, and housing. Despite this wish-list, the fact remains that our financial system is, by design, secure and does not pose any threat to the economy as a whole. Now let’s turn to the features of this economy that have, helped the country become and remain resilient in the face of adversity. I believe that our social system in Pakistan influences why the economy remains resilient. Our family structure is a huge blessing in economic terms. Children take care of their parents, and that spares the state from the responsibility of taking care of the elderly and sick. Governments in developed economies are currently struggling to meet their social commitments, with healthcare costs surging for an aging population. Our social fabric also ensures that informal employment is always readily available in some shape or the other – relatives and family friends usually help out in providing the unemployed with some form of work, and the immediate family supports unemployed individuals financially. That spares the state from paying out unemployment benefits to such individuals. I believe that the nature of our society and the close relationships of a family-oriented society, is one of the primary reasons for Pakistan’s relatively low rate of unemployment and overall resilience to adverse conditions. I would like to clarify here that this resilience has come with a cost: the size of the informal sector. The size of Pakistan’s undocumented economy is, by some estimates, as large as the formal economy. The informal economy does not file taxes and, while it does absorb a significant chunk of the labor force, it also evades corporate and labor laws. Therefore, although close informal relationships do make the economy more resilient, they do so at a cost to the overall economy, by eroding the ambit of the regulators. Ideally, we, at the State Bank, would like to see a smaller informal economy, while society retains the structure that has made it so resilient. The second factor that has unintentionally helped the country’s resilience is the limited interconnectedness between the Pakistani and the global financial and economic system. Although the absence of such integration is by no means desirable, it has happened due to non-economic factors, and has insulated our domestic economy. It’s also the reason that our financial system and financial markets remain relatively sheltered from global events. Let me re-emphasize here, that greater integration with global markets is something that we should aspire towards. But that does not mean we should not have proper controls and mechanisms in place to safeguard our own interests. For instance, greater integration with financial markets will mean that capital will flow more quickly through our borders. It’s definitely something that will boost the national economy, but, as most East Asian countries learned in the 90s, it can be a double-edged sword. Therefore, having some capital controls in place, which reduce the volatility of capital flows, is a necessary regulation in this day and age. Personally, I believe the role of effective regulation only increases as the economy becomes more integrated and more market-oriented. Markets in themselves have no moral character. Inherently, they are neither good, nor evil. But they remain very powerful tools that distribute BIS central bankers’ speeches goods and services across the economy. Regulation is necessary because it gives markets a direction, and can govern them with a set of values, which markets do not possess innately. Less, but more effective regulation is the need of the hour for our own economy too. It’s an essential part of what is needed today to get the economy on a track for steady and sustainable growth. The government’s footprint in some sectors of the economy is very large, and quite negligible in other sectors. Such divergence is unhealthy. For instance, the government has a very large presence in our agriculture and energy markets. Those sectors are, in some ways, over-regulated. Too much regulation and red tape can breed incentives for the abuse of power, mismanagement and corruption. It also acts as a disincentive for the private sector. And we must remember here that it is always the private sector that functions as the engine of the economy. However, effective regulation is sorely lacking in other sectors. The tax machinery can be tightened considerably. One of the country’s most challenging problems today is the size of the fiscal deficit – and a large part of the solution lies in increasing our tax base by enacting regulation that encourages tax compliance, and punishes tax evasion. The link between better tax collection and faster economic growth deserves to be flushed out here. Better tax collection means that the government has to depend less on foreign support for its budgetary needs, and can decrease its fiscal deficit. More importantly, the government will not have to borrow as much from the domestic banking system to finance itself. Less borrowing from commercial banks will encourage market rates to fall and banks will lend more to the private sector. As investment picks up, the growth potential of the economy increases. Similarly, the government will need to borrow less money from the central bank as well. Borrowing from the central bank is popularly known as printing money. This is inflationary, and I don’t think I need to introduce you to the problems associated with high levels of inflation. If government borrowing from the central bank falls, inflation will follow suit. Therefore, better tax collection is a necessary condition for faster economic growth. And for that we need to have more effective tax regulation. Another problem that we desperately need to fix is our energy problem. It’s something that has been affecting every citizen of the state, and I don’t think that I need to highlight the scope of the problem here. Similarly, I think the effect on the economy of an energy shortage should be fairly straightforward: energy is one of the key inputs in any value-added production process. Less energy availability will translate into lower output. The solutions to the energy problem will take time – unfortunately, there is no magic pill here. We will need to invest in infrastructure for hydro-electricity, natural gas transportation and transmission, and more efficient power plants. Moreover, we will need to move to greater private sector participation in the energy sector. That means there will, once again, be a need for less, but more effective regulation – one that safeguards the rights of both producers and consumers, while ensuring adequate incentives for the exploitation of our natural resources The most important incentive here will be prices. Unfortunately, a large part of our energy problems today can be traced to a mispricing of fuels. Under-pricing any commodity will always lead to a shortage – that’s one of the fundamental axioms of economics. Letting the market decide the price is one way of ensuring that future shortages are averted. But remember that markets do not have morals – and that’s why we will need regulation to make sure that those markets serve and protect the interests of all stakeholders. At this point, I would also like to touch very briefly upon the State Bank’s efforts to accelerate economic growth. As you may know, any central bank’s primary policy tool is the discount rate – the basic interest rate which acts as an anchor for all other rates in the economy. Unlike most central banks, and similar to the US Federal Reserve, the State Bank has a dual mandate: it must tackle the issue of maintaining price stability, i.e. inflation, while also keeping an eye on economic growth. The preamble to the SBP Act of 1956 defines that the institution has “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 BIS central bankers’ speeches utilization of the country’s productive resources”. So at the State Bank, we need to pay close attention to both monetary stability and fuller utilization of the country’s resources. That is a tough balance to strike in the best of times. The Bank’s policy is to use any room available to cut interest rates in order to promote economic growth. After being in doubledigits almost consistently for two years, inflation has come down substantially in the past few months to single digit, because of this, the Bank decided to reduce its interest rate into single-digits. The benchmark rate now stands at 9.5 percent. We also expect that average inflation for the year will remain in the 8.50–9.50 percent range. Interest rates are reviewed, and may be revised, every two months, which allows our policy responses to be nimble and respond quickly to any changes in the economic environment. The Bank also ensures that the money market is never short of funds, which means that monetary policy signals are transmitted efficiently. Our primary constraints to faster growth, however, remain the large size of the fiscal deficit and the energy shortfall. As with most economic problems, there is no immediate solution. Both problems require systemic changes that will take time to achieve, through the implementation of effective regulation and a move towards greater private sector participation. Meanwhile, rest assured that while our current economic situation is less than optimal, it is also very far from what may be described as an economic calamity. In fact, over the years, this economy has shown an inherent resilience, and I’ve shared my thoughts about why I think our economy has the ability to navigate through choppy waters. Nevertheless, this economy remains quite far below its potential – however, the solutions to our problems regarding faster growth are an open secret. It’s only a question of implementing them. I’d like to end my talk here on that relatively optimistic note. Unlike the problems of the US and the Euro, our problems have very attainable solutions. Those economies are still trying to work out what would work best for them. We already know what we need to do. It’s only a matter of execution now. I’m excited by the economic potential that this country holds, and I encourage you all to become a part of the country’s future, by becoming a part of the solution. Thank you! BIS central bankers’ speeches | state bank of pakistan | 2,013 | 3 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Closure Ceremony of Term Sarmaya Certificate (TFC) issued by Tameer Microfinance Bank, Karachi, 24 January 2013. | Yaseen Anwar: Promoting an inclusive financial sector in Pakistan Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Closure Ceremony of Term Sarmaya Certificate (TFC) issued by Tameer Microfinance Bank, Karachi, 24 January 2013. * * * Mr. Nadeem Hussain, President/CEO of Tameer Microfinance Bank Ladies and Gentlemen – Good afternoon! It is a pleasure for me to witness the successful closure of the first ever Term Finance Certificate (TFC) issued by any microfinance bank in Pakistan. This is indeed a significant achievement for the microfinance industry and capital markets that has been made possible by collaborative efforts of the diverse stakeholders involved in such a complex transaction. As someone once said: “Coming together is a beginning, staying together is progress, and working together is success.” Therefore, I would like to congratulate Tameer Microfinance Bank, Standard Chartered Bank, IGI Investment Bank, JCR VIS, Karachi Stock Exchange, SECP, and my colleagues at SBP, for collaborating together to make this TFC issuance a success under the SBP’s Microfinance Credit Guarantee Facility. I sincerely hope that this first issuance of TFC by Tameer Bank would open up new funding avenues for microfinance providers and would give further impetus to our efforts in promoting an inclusive financial sector in the country, thereby enhancing the financial sector’s stability and viability in the long-run. The importance of financial services in the development of any economy cannot be overemphasized. There is no denial of the fact that access to finance has positive impact on economic growth as it promotes entrepreneurship, generates employment, fosters innovation, reduces poverty levels and enhances social equality. The financial sector in Pakistan remains restricted in its outreach both in terms of its depth and breadth. According to the Access to Finance Study of 2008, hardly 12% of the population has access to formal banking services and another 32% is informally served whereas 56% of the adult population is totally excluded. Similarly in Pakistan, the estimated size of the microfinance market is in the range of 25–30 million clients which indicates that the current level of microfinance access at 2.4 million clients is only 10% of the potential market. Financial Inclusion has progressively assumed greater priority in SBP’s financial sector development strategy. SBP is pursuing a multi-pronged approach to tackle the challenge of high financial exclusion in our country. In particular, SBP is aiming to develop an efficient and sustainable market-based financial structure meeting the financial needs of the marginalized population including women and young people. Let me be clear that the estimated microfinance market of 25–30 million clients may not necessarily just need credit services. It is of utmost importance that the industry should aim to provide holistic and appropriate financial services, including deposit, credit, insurance and remittance services. SBP is well aware of the fact that the industry is beset with a number of challenges in the way of achieving this high objective. SBP is actively engaged with all stakeholders to address the sector specific challenges in a sustainable manner. One of the fundamental challenges faced by microfinance providers is how to match the massive scarcity of funding to scale up microcredit services to the majority of the microfinance market. SBP had launched the Microfinance Credit Guarantee Facility (MCGF) BIS central bankers’ speeches to achieve this very objective through a sustainable market based mechanism. Prior to the MCGF launch in Dec 2008 and apart from one-off funding deals between the few MF providers and Commercial Banks, the commercial funding market was non-existent for microfinance providers. Therefore, the microfinance industry was severely handicapped and highly donor dependent for its funding needs. The MCGF was initially started with the help of the UK Department of International Development (DFID) grant amount of GBP 10 million which has been recently increased to GBP 15 million. The MCGF is a credit enhancement facility to attract long term commercial funding for microfinance providers. The objective of the facility is to incentivize commercial banks through a risk sharing mechanism to provide wholesale funds to microfinance banks and institutions for on-lending to the poor and marginalized groups. Recently, the scope of the facility has been enhanced to allow microfinance providers to mobilize non-bank financing from capital markets, further diversifying sources of financing for micro borrowers. It is heartening to see that a number of microfinance providers, including Tameer microfinance bank, while benefitting from the MCGF, has helped the facility to attain this objective. Let me briefly share with you that the facility has been instrumental in relaxing funding constraints of the microfinance sector in Pakistan: • So far, 25 guarantees have been issued under MCGF, mobilizing over Rs. 7 billion for 5 leading MF providers, enabling microcredit access to around 350,000 new micro borrowers. • The facility, due to its risk sharing structure has achieved a leverage of 3 times, mobilizing an additional Rs. 5 billion from private capital markets, establishing that microfinance may not be that risky as a business proposition, and • Most of all, the facility has engaged 16 commercial banks and recently retail investors in funding the microfinance providers. In doing so, the facility has accomplished the following key long-term development objectives: First, the Guarantee has helped build links between micro borrowers and Banks/DFIs. The familiarization of the Banks/DFIs with the client will eventually lead to mainstreaming and graduation of the micro borrower; Second, the facility has introduced microfinance business to Banks/DFIs as Banks have to evaluate the microfinance providers which must have helped them develop their own sense of the risks involved in microfinance. As a result, banks are now more willing to invest in micro banking; and Finally, and more importantly, the facility has helped microfinance providers to offer small ticket sizes for retail investors. This has offered small retail investors an alternate channel for investing their savings and earning relatively higher returns, encouraging the concept of micro-savings. I would like to conclude by saying that the MCGF has attained most of its developmental objectives. Moreover, I firmly believe that this TFC issuance will go a long way in diversifying funding for the microfinance sector. I strongly encourage all the financial market players to develop a long term vision for making the financial sector in Pakistan more inclusive. Thank you! BIS central bankers’ speeches | state bank of pakistan | 2,013 | 3 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 6th International Conference on "Mobile banking in Pakistan", Karachi, 14 March 2013. | Yaseen Anwar: Mobile banking in Pakistan Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the 6th International Conference on “Mobile banking in Pakistan”, Karachi, 14 March 2013. * * * Good Morning Ladies and Gentlemen I am indeed delighted to be here today at this Conference on mobile banking. I would like to congratulate the organizers for arranging this important conference, which has now become an annual event to showcase the developments, and measure the progress made by mobile banking in the country. Through these annual conferences, all of us have been identifying various challenges and finding new solutions, and thus transforming branchless banking into vibrant and innovative industry in Pakistan. Let me first briefly talk about the significance of Mobile Commerce and then move on to the mobile banking, its role in promoting financial inclusion, and our responsibilities to strengthen mobile banking in Pakistan. Mobile Commerce is generally characterized by a variety of business partnerships often involving a large number of organizations, from content providers to financial institutions to mobile network operators. After successful application of Mobile Commerce as an alternative channel for delivery of payment services in developed countries, the concept is now also taking roots in developing countries. The usage of innovative and unconventional channels will dominate the conventional means of business and communication, as evidenced by the high mobile phone subscription witnessed in Pakistan. The number of mobile phone subscribers has reached 120 million. Turning now to the use of mobile technology to promote financial access, there is an emerging consensus amongst policy makers around the world to improve access to financial services for poor people, through supporting the safe and sound spread of new modes of financial service delivery capable of reaching the poor. In Pakistan, Developments in branchless banking so far have been marvelous, leaving nobody in doubt about the potential of mobile phone banking to be a game-changer in banking, m-commerce, and financial inclusion. Broadly describing these recent developments, we have been witnessing transformation in customers’ needs and behaviors, increased competition, technological innovation, new business models, and regulatory proportionality. Owing to these developments, international development agencies and media have now been highlighting Pakistan for its market and institutional environment for branchless banking. In an article a few months back, The Financial Times counted branchless banking and microfinance initiatives in Pakistan among the “hidden forces of resilience offering the best hope for the country’s future”. Elaborating further, the article highlighted Pakistan “being in perpetual motion at the grassroots with ceaseless creativity as people find affordable solutions to their basic needs”. Regulatory approach has played a fundamental role in the development of branchless banking. The issuance of branchless banking regulations in 2008 was an outcome of SBP’s vision and strategy to develop a road map for financial inclusion through the use of mobile phone banking. With these regulations, SBP enabled a diverse set of players including banks, microfinance banks, mobile network operators (MNOs), retailers, and technology firms to develop partnerships and business models, while safeguarding stability of the banking and payment system, and interest of customers. In accordance with these objectives, SBP allowed only the bank-led model for undertaking branchless banking. At that time, many thought that this was a “restrictive” approach, and would not work out. They were proved wrong by the subsequent phenomenal growth of branchless banking in Pakistan. As BIS central bankers’ speeches a result of our market developments, SBP’s regulatory approach and experience was cited as an example for other countries to follow. According to a recent CGAP publication, “Pakistan serves as an example of how public and private institutions together can move a country towards a digital financially inclusive system”. The report further notes that “Government and public actors have created the enabling environment and provided seed funding, while private actors are developing the infrastructure, services and a long-term business case”. Since the issuance of branchless banking regulations in 2008, several branchless banking models have been deployed. UBL’s Omni and Tameer bank’s EasyPaisa have already gained substantial ground and have established themselves as market leaders. Two new services (MobiCash and Timepey) have just launched while two are running live pilots. Moreover, all the four mobile network operators in partnership with some of the largest banks have already launched their branchless banking services or are at the final stages of launching. As a result, the branchless banking current growth trajectory is expected to get further steeper in the years ahead. With the entrance of new and strong players, branchless banking has already seen acceleration. The number of agent network servicing branchless banking customers has reached 42, 000. Therefore, the basic financial services can now be accessed in the remotest parts of the country through any of these agents. A total of 194 million transactions have been carried out worth 813 billion rupees. More than 2 million m-wallets have been opened till date, and these numbers will improve significantly. Along with the tremendous growth in the branchless banking sector, the infrastructure of payment systems and branch network is also showing an increasing growth trend. The ATMs network has increased to 6,232 whereas branch network has reached 11,600. 94 percent of our branches are now real time on-line. Similarly, the number of plastic cards has increased to 20 million and the number of POS machines has increased to 34,000 units. This is a significant achievement, and this also demonstrates the opportunity to bring the benefits of this infrastructure to millions of the unbanked population. Branchless Banking has also proved to be an effective instrument in channelizing the Government to Persons (G2P) payments in trying times like serving Internally Displaced Persons (IDPs), and devastating floods for the last two years. The Benazir Income Support Programme beneficiaries are also being served effectively through the same mechanism. In the coming days, this channel is expected to continue playing an important role towards the promotion of financial inclusion and the management of Government to Person (G2P) Programs like Salaries Disbursements, Pensions, BISP, Watan Cards, Pakistan Cards and tax collections services, etc. The existing Branchless Banking deployments can cater to the needs of over 10 million potential beneficiaries of G2P payments in Pakistan. Branchless banking is going to dominate the retail banking landscape in the long-term. Whilst we seek to encourage the introduction of innovative instruments for payments, we also need to ensure that high levels of standards are maintained for safety, security and protection of consumers’ interests. The central policy objectives of SBP are to ensure safety, soundness and efficiency of the banking system, and to protect the interest of consumers. Since branchless banking is becoming a vital component of the national payment grid, it is prudent for all stakeholders to ensure that appropriate measures are in place to mitigate inherent risks associated with it like access by un-authorized persons/ criminals such as hackers, money launderer, terrorist financiers etc. This can only be achieved when our technologies are robust and secured, and agents are comprehensively trained and effectively monitored by the banks. In this regard, the importance of a comprehensive agent development framework cannot be ignored. I am sure that our banks would not simply jump on the bandwagon without sufficient agent development mechanisms including their hiring, on-going training and monitoring. BIS central bankers’ speeches Building public confidence on these innovative payment solutions is critical. A single failure of branchless banking deployment can erode the public’s confidence in the system which in turn may jeopardize the whole sector. Being fully cognizant of the risk factors involved in such unconventional modes of banking, SBP has been proactively monitoring developments and associated risks both at system and entity level in order to take appropriate corrective measures in a timely manner. We must acknowledge that branchless banking has gained critical mass in a short period of time. I believe that the market has to start shifting transactions from first generational services (Person-to-person/Bills payments) to second generational services (account-toaccount and inter-bank transfer). The players need to expand their product portfolio by offering new products and services for their target market. In my view, this is part of an inevitable evolution which will ensure the long-term sustainable development of the sector, encourage micro savings and help in meeting the demands for inclusive financial services of the target market. Let me mention that SBP is working closely with key stakeholders of the mobile and branchless banking industry. We have already constituted a national consultative group and its various working groups to develop a common understanding on the challenges and develop a proposal for policy actions. SBP will continue its engagement with the stakeholders to identify and undertake all necessary measures for developing an eco-system that would not only support mobile banking but would also contribute to the wider economy. I trust that today’s conference will help us understand the various issues relating to the growth of mobile banking systems and products, and m-commerce. As this conference is meant to create awareness on mobile commerce, we understand that developments in m-banking and m-commerce will lead us to connect the unbanked segment of our population to financial services, thus contributing to their empowerment. Thank you all for being part of this forum and I look forward to your productive participation today. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 3 |
Keynote address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Islamic Finance News Pakistan Roadshow, Karachi, 27 August 2013. | Yaseen Anwar: Developments of Islamic banking in Pakistan Keynote address by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Islamic Finance News Pakistan Roadshow, Karachi, 27 August 2013. * * * Thank You for inviting me to speak at today’s event. I am honored to have this opportunity of addressing such a distinguished audience. My appreciation to the organizers for once again having assembled a strong list of speakers at this year’s Islamic Finance News Road show and a warm welcome to the international delegates. With all of us gathered here at the central bank sends a strong signal about commitment and determination of the State Bank of Pakistan and the Government towards ensuring sustainable growth of the Islamic finance industry in the country. As I look around I am optimistic that the collective experience of speakers will lead to rich debates that will not only help us in understanding the key issues but will also enable us to map out the future of the industry. The Islamic finance industry has come a long way to be recognized as a viable alternate to conventional finance. Islamic financial institutions are currently offering a wide range of services catering to both Muslim and non-Muslim communities. The unprecedented growth of the Islamic finance industry can be associated to efforts of dedicated regulatory, Shariah and academic institutions along with the presence of diversified players in the field i.e. Islamic banks, investment banks, takaful companies, Islamic fund management companies, Islamic brokerage companies etc. The Introduction of Sukkuk and Islamic stock market indices have also added the necessary depth and breadth to the Islamic financial markets. In particular Sukuk; has proved to be a powerful tool in attracting investors and building their confidence in Islamic finance while fulfilling financing needs of the public and private sector in a Shariah compliant manner. Pakistan is no exception to this; rather the country has remained at the fore front in promoting Islamic finance by being a key member of International Islamic finance institutions established to develop necessary legal, regulatory, supervisory and Shariah compliance infrastructure for Islamic finance institutions. Pakistan’s active engagement with the Islamic Financial Services Board (IFSB), the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM) and collaboration with other central banks has helped the growth of the Islamic banking industry both locally and at the global level. Islamic banking in Pakistan has witnessed significant growth during the last decade and now constitutes over 10 percent of the country’s banking system with an asset base of over Rs.900 billion and a network of more than 1,100 branches. Given the interest of all stakeholders and a relatively high level of financial exclusion in the country, we believe this expansionary trend is likely to continue and the industry is well set to double its market share by 2020. This success could not have been possible without the leading role of the central bank in setting the direction of the industry and providing unusual support for its promotion and development. Promoting Islamic finance as a viable and competitive component of the financial system through an enabling legal, regulatory and supervisory environment has remained an important component of SBP’s strategic goals. Considering the evolutionary stage of the industry, we are continuously engaged in refining and improving the legal and regulatory framework to ensure: a) its responsiveness to the evolving industry dynamics and b) its effectiveness in identifying, measuring and mitigating the risks associated with Islamic finance. In the recently concluded fiscal year we issued detailed instructions for Profit & Loss Distribution and Pool Management to bring standardization, improve transparency and safeguard interests of Investment Account Holders (the savings depositors). The instructions developed through rigorous consultations with the industry have been well received both domestically and globally. BIS central bankers’ speeches Similarly to further improve the Shariah compliance environment in IBIs, our Islamic Banking Department has completed industry consultations on the draft Shariah Governance framework and will soon be issuing the same. The framework will be another key milestone achieved, which will institutionalize the Shariah compliance function and crystallize the Shariah compliance related roles and responsibilities of all key organs of IBIs including BODs, executive management and Shariah Boards Moreover, to encourage standardization and Shariah harmonization, SBP over time has issued permissible Islamic modes of finance model Islamic financing agreements besides adapting AAOIFI Shariah Standards for the Pakistani market in a gradual manner. The continuation of growth momentum achieved during last the 4–5 years is contingent on making an objective assessment of the successes, failures and future challenges and developing consensus strategies and action plans to build on the successes and address the challenges. We have accordingly developed the five year Strategic Plan for Islamic Banking industry again through a rigorous and meaningful consultation with all key stakeholders. The plan to be issued soon lays down the future road map of the industry, highlight areas of improvement in legal, regulatory and taxation environments, emphasize diversification of products and markets covering non-traditional but strategically important sectors of agriculture and SMEs and increasing the Islamic banking market share to over 15% of the country’s banking system during the next five years. SBP has also played a vital role in raising awareness and building capacity of the industry. To address the awareness and misconception issues, SBP launched an awareness campaign that consists of seminars, conferences, targeted programs and focused discussions for the business community, academia, bankers and policy makers. A recent significant milestone is the launch of a Mass Media Campaign where the whole Islamic banking Industry joined hands under the ambit of SBP to target the challenge of misconceptions related to the Islamic banking business model and practices. Similarly a number of initiatives have been taken to build the industry’s human resource capacity and enhance its skills mix. In this regard support from international organizations like the Islamic Research and Training Institute (IRTI) and Islamic Financial Services Board (IFSB) is also being leveraged. One key benefit of the promotion of Islamic finance is its potential to contribute significantly to financial inclusion by extending the outreach of the financial system to the masses who are out of the system due to faith reasons. Islamic Microfinance, a confluence of two industries; Islamic Finance and Microfinance, can not only be an efficient tool for financial inclusion by catering to both voluntary and involuntary financially excluded but also towards poverty reduction due to its inherent characteristic of being prudent and asset based. The Islamic finance industry has so far not done much to tap the potential of Islamic microfinance due to its perceived high risk and its preoccupation in serving the financing needs of the government and large corporates. I would thus urge the industry to make individual as well as collaborative efforts to develop this sector, which would improve their market perception besides enabling them to diversify their clientele. The IBIs may also develop partnerships with Islamic microfinance institutions to serve the low income population. Similarly, Agriculture and SMEs are areas that have so far been missed out by both conventional and Islamic banks due to the perception of high risk despite their paramount importance for the country’s economy. Financial inclusion is one of the key strategic objectives of SBP and as most are aware, very near to my heart; I would thus strongly emphasize the industry to come out of these perception myths and develop capacity to tap these strategically important sectors and create value for your shareholders, depositors and the country’s economy as a whole. SBP will provide every support and facilitation to the industry in s efforts to build and expand its portfolio in these sectors. BIS central bankers’ speeches Islamic capital markets, mutual funds and Takaful industry are also very important components of the Islamic financial system and need to be nurtured and developed along with Islamic banking. We are working closely with the Securities and Exchange Commission of Pakistan (SECP), regulator of capital markets to help develop these non-bank financial institutions. We appreciate and acknowledge the important steps taken by SECP, including review of Mudaraba guidelines, issuance of Sukuk guidelines, establishment of central Shariah advisory board etc, and believe that these are likely to help in development of the overall Islamic finance industry. Lastly, I would like to emphasize the critical importance of investment in research and development particularly for the evolving sectors of Islamic finance. Unfortunately we are not making adequate investment in this area, which is limiting our capacity to develop Shariah based solutions for various business and economic needs of the real economy. The research and development is also needed to develop solutions for bringing monetary and fiscal policies and practices in conformity with Shariah principles. The strategic plan for the next five years has envisages a number of such initiatives and I hope that the collaborative efforts by the regulator and practitioners would be instrumental in improving investment in R&D and developing better solutions for serving the financing needs of the real economy. In conclusion, I thank all the speakers and participants for coming here and hope that the deliberations and discussions during the Road show will help the industry in moving towards more inclusive growth and equitable distribution of gains in the economy. BIS central bankers’ speeches | state bank of pakistan | 2,013 | 9 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at National Defence University, Islamabad, 4 November 2013. | Yaseen Anwar: Fiscal and monetary policies Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at National Defence University, Islamabad, 4 November 2013. * * * Respected guests, esteemed servicemen, and students of this prestigious institution, Assalam-o-Alaikum! I am delighted to be invited to the National Defence University to talk about Fiscal and Monetary Policies in general and in the context of Pakistan. It is a fact, not many students like economics as a subject. But it is also true that not many subjects impact our lives as does economics. It is therefore not surprising that everyone likes to jump into discussion on economic issues even if their knowledge (on the subject) is rudimentary. One just has to flip thru channels on TV to see the variety of views on the subject, which are not always correct or informed. Over the years SBP through its various publications and seminars, has been trying to enhance the understanding of the general public on various economic issues. I would like to think that it is partly because of SBP’s efforts, that the general public today is much more aware of economic issues than they were, say ten years ago. I am sure you already have heard a great deal about monetary and fiscal policies, and there may be little I can add to enhance your knowledge on the subject. What I can do however, is to try to bridge the gap between theory and practice. In text books, monetary and fiscal policies appear simple enough and desired objectives can be achieved by manipulating policy instruments. The question arises: • Why do countries find it so difficult to get their policy mix right? • Why countries cannot strictly control the supply of money to keep inflation in check? • Why do countries struggle to smooth out economic fluctuations? • Why are countries’ fiscal accounts always imbalanced? The reason is that policy goals often conflict with each other, and economic variables cannot be determined in isolation. Therefore, while it is important to know about the policies individually it is equally if not more important to understand how these policies interact with each other. Broadly speaking, monetary policy involves central banks’ use of policy instruments to influence interest rates and money supply in order to keep overall prices and financial markets stable. The policy could be “expansionary”, to stimulate economic growth or “contractionary”, to check the rising price levels (inflation). Fiscal policy, on the other hand, is government’s management of its revenues and expenditures to achieve economic stability. The revenues mainly come through direct and indirect taxes besides non-tax collections through privatization and auction of license (like 3G licenses in telecom sector). Hence one can say that Fiscal Policy is managed by the Government whereas Monetary Policy is conducted by the Central Bank. Best practices require that both policies are coordinated in order to achieve the common objectives of financial and economic stabilization to promote sustainable growth. The global financial crisis and the subsequent recession, particularly in the developed world, have, however, elicited unconventional changes in the design and implementation of monetary as well as fiscal policies. The magnitude and the spread of the crisis have not only tested all the policy options available to policymakers across the board but have also BIS central bankers’ speeches renewed debate on the longstanding pillars of macroeconomics. Monetary authorities in the advanced economies responded by aggressively cutting policy rates and adopting several other “unconventional” measures aimed at providing stimulus to the economy directly. These measures represent important policy relevance for the existing institutional framework and policy instruments across world economies. Governments, these days, through their fiscal policy, do not limit themselves to accounting for revenues, expenditures and budget making. Nor do they restrict themselves to just mobilizing, allocating and redistributing national resources in the short and medium term. The ever changing economic landscape has forced countries to expand the ambit of their policies, both monetary and fiscal, to ensure financial stability as well. The global financial crisis of 2008 is one such example where the governments of the developed world (like USA and UK) had to step in and bail out their distressed financial institutions, at an unprecedented scale, using tax payer’s money. The ripple effects of the crisis, which primarily began in the developed countries, soon spread globally. Especially, those countries which had borrowed beyond their capacity to repay were the hardest hit. As cheap liquidity dried up and lenders started demanding higher interest rates or in some cases even refused to lend, highly indebted countries of Europe such as Greece and Italy, then had to agree to severe austerity measures proposed by the Troika (IMF, European Commissions and European Central Bank) as part of the bailout terms. The imprudent fiscal policies of the governments of those countries were to blame for their plight. * The use of monetary policy was also broadened from keeping prices in check through optimal determination of interest rates, to fighting recessions. During the crisis, apart from utilizing standard tools such as interest rates, central banks around the world used unconventional measures such as quantitative easing (QE) to provide cheap liquidity in the market to stem erosion of investor confidence. Thus, fiscal and monetary policies are no longer restricted to their traditional roles. In Pakistan, however, the situation under which the fiscal and monetary policies have to operate is fundamentally different and far more complicated. First, we have not had sustained periods of political and economic stability in recent history. We have been at the forefront of the war on terror for over a decade now. Besides damage to life and property, this participation has resulted in a huge strain on our country’s meager resources, which has not been fully compensated for. Second, the power sector crisis has crippled a significant part of economic activity. Inappropriate policies, which offered guaranteed equity returns and disregarded what is an appropriate fuel mix for the country,1 price distortions, expensive and poorly targeted subsidies, inefficiencies in the energy supply and distribution, and low recoveries have resulted in a crisis gripping the power sector. Persistent energy shortages have resulted in a decline in the productive capacity of our industrial sector which has lead to an increase in unemployment. Third, lack of diversification and innovation in the economy combined with scarcity of entrepreneurial talent has made us depend on a few sectors for economic growth and export earnings, such as textiles. Fourth, instead of exploring and developing abundant natural resources in the country, we import a number of essential goods like crude oil, that are, to a large extent, price inelastic (FYI every $5 reduction in price saver us $750 million in FX for the year). Fifth, from general public to higher echelons there is a general culture of tax evasion which limits the ability of the government to raise an appropriate amount of revenues. Sixth, a sizeable chunk of our Munir, Kamal A. and Khalid, Salman. 2012. “Pakistan’s Power Crisis: How Did We Get Here?” The Lahore Journal of Economics 17: 73–82. BIS central bankers’ speeches economy is in the informal sector which remains undocumented and therefore beyond the tax net. Seventh, public sector enterprises instead of being a source of revenue for the government eat up scarce resources every year. Finally, we have had the misfortune of sufferings due to natural disasters i.e. floods and earthquakes in the recent past. All these endogenous and exogenous factors have resulted in domestic and external sector deficits with the private sector unwilling to invest and limited participation of foreign investors. Given these circumstances and successive government’s failure to implement major reforms, fiscal policy in Pakistan in recent years has mostly been “fire-fighting”. We have been trying to bridge the gap between growing expenditures amid falling revenues mostly through borrowings (both internally and externally). Since the year FY06, we have not witnessed any substantial primary surplus in our budget. The current revenues have not been enough to account for current expenditures of the government. If we add to it the ballooning interest payments, our budget deficit has been hovering around 6.5 percent of GDP, on average, over the last five years (FY09–FY13). In FY13 alone our budget deficit was 8 percent of GDP, which is one of the highest for Pakistan. The primary reason for these large budget deficits has been low tax collections. Although there has been a consistent gap between Federal Board of Revenue’s (FBR) budget targets and actual outcomes in the last few years, the gap of Rs445 billion in FY13 was exceptionally high. In fact, this was more than the cumulative shortfall of Rs349 billion during the last five years. Not surprisingly, therefore, the estimated fiscal deficit of 8.0 percent of GDP in FY13 was considerably higher than the budgeted target of 4.7 percent of GDP. Development expenditures, needed to sustain economic growth in the wake of receding private investments, have remained in a narrow range of 2.8 percent to 3.6 percent of GDP, during the last five years. On the other hand, debt servicing to current expenditure has jumped up from 35 percent in FY08 to 42 percent in FY13. This has resulted in average real economic growth remaining around 2.9 percent during the last five years. In fact the stock of government’s domestic debt i.e. borrowings has almost tripled since FY08 to reach Rs9.5 trillion as of end FY13. That the private sector investment is being crowded out due to excessive government borrowing from the banking system does not bode well for the external front as well. Despite SBP’s incentive scheme for exporters, the exports have remained stagnant at around 10 percent of GDP while imports have increased to 17 percent of GDP over the last five years. The resulting trade deficit coupled with meager net capital and financial flows and the external debt servicing costs put tremendous pressure on the reserve position of the central bank. A ray of hope is our workers’ remittances, which were around USD14 billion in FY13 with a 9% increase in the first quarter of this financial year. However, unless we are able to bring our trade deficit to a manageable level and create an enabling environment to help increase net foreign capital and financial flows, workers’ remittances alone cannot provide sustained support to our reserves position. Under these circumstances, the Government had to approach the IMF again for a medium term loan (i.e. Extended Fund Facility or EFF) to ease pressure on our balance of payments. Being in the IMF program increases the chances of receiving a higher amount of financial inflows besides stabilizing markets and improving the credibility of the country. * As a consequence of dwindling foreign inflows and low tax collection, the government had to resort to high level of borrowings from the banking system. During FY13, it borrowed over Rs1.4 trillion from the banking system of which Rs506 billion was borrowed directly from the central bank and the rest from the scheduled banks. Considering that the proposed outlay of the entire budget was Rs3.2 trillion, this volume of borrowing constituted 43 percent of the BIS central bankers’ speeches budget. This trend is indeed problematic and does not augur well for the economic management and growth of the country. Given this fiscal dominance and its impact on the balance sheet of the central bank, the role of monetary policy has been severely restrained. Some might argue that the State Bank, as an independent organization, should have taken a tough stand against the government’s insatiable bank borrowings. But, it is imperative to understand that any disruption in payment systems can potentially result in as negative repercussions for the economy as its inflationary consequences. This is the reason that SBP, despite not being comfortable to the idea, allowed the government to borrow from the banking system. Nevertheless, this trend needs to be checked in future. Notwithstanding constraints, SBP took several measures to achieve price stability and economic growth. In addition, it also took steps to safeguard depositors’ interest in recent years. SBP followed an accommodative monetary policy by lowering interest rates by 500 basis points over the last two years in the wake of declining inflation. It also undertook interventions to contain volatility in the foreign exchange market. It calibrated its liquidity operations in a manner that balanced financial stability considerations and medium-term inflation risks. Moreover, to protect the depositors of the banking system from any undue decrease in interest rates by the banks, SBP imposed a minimum rate of 6 percent on savings deposits and has recently linked this minimum rate to its repo rate. The minimum rate on savings deposits now stands at 6.5 percent. As a result of these actions, the weighted average lending rate declined by 423 basis points by end-July 2013 while deposits of the banking system grew by 15.9 percent and the depreciation of the exchange rate was limited to 5.1 percent in FY13. Moreover, a declining interest rate environment did contribute in a marginal pick up in loans to some sectors of private businesses in FY13 and Q1-FY14. However, as has been the case for some years now, most of the credit disbursed during FY13 was utilized for working capital requirements only; loans availed for fixed investments show retirement. Thus, there has been no real broad-based recovery in credit utilization by the private sector. As a result, real private investment expenditures have declined for the fifth consecutive year, reaching 8.7 as percent of GDP in FY13. This shows that higher interest rates were not the major constraining reason for the private sector credit off-take. Two fundamental factors responsible for the lackluster increase in credit demand are: persistence of energy shortages and deterioration in law and order conditions. Unless we overcome these, chances of reviving the economy through monetary policy stimulus would remain thin. Despite being in the IMF program, going forward, however, the challenges remain. The pressure on the external front has not fully abated. The foreign exchange reserves of the central bank as of October end, 2013 stand at US$4.3 billion and rupee dollar parity at Rs106 per dollar. Moreover, there are certain performance criteria for the IMF loan that we have to meet. We also need to implement strict reforms on the fiscal side. It needs to be understood that these reforms are absolutely essential. The aim of these reforms is to balance the budget in the medium term and reduce public debt to create space for private sector investments. Further, we need to be highly cautious and selective in terms of public expenditures as our debt burden continues to grow. It should be kept in mind that excessive public indebtedness cannot be cured with more debt. No government can sustain itself for long by borrowing heavily from the banking system. The unsustainable level of public debt and its borrowing costs can severely impact the economy. Some countries in the European Union, like Greece and Cyprus are an example. BIS central bankers’ speeches Furthermore, a host of issues need to be tackled including but not limited to law and order situation and energy shortfalls. A sustainable level of public debt will create space for the development expenditure to build infrastructure for sustainable economic growth; the deterioration of law and order situation is a big barrier and erodes investors’ confidence, both local as well as overseas; and the energy shortages hamper industrial growth and hence the real growth of the economy. A long term and sustainable solution to these problems should top the economic agenda of the government. In the end, I would like to say that if we commit ourselves to making tough decisions and implement reforms in the fiscal and external sectors then the problems faced by us can be resolved. Thank you BIS central bankers’ speeches | state bank of pakistan | 2,014 | 1 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at Bahria University Convocation, Karachi, 22 December 2014. | Yaseen Anwar: Brief overview of Pakistan’s banking sector and innovative banking practices Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at Bahria University Convocation, Karachi, 22 December 2014. * * * Vice Chancellor, Bahria University, Prof….….. Distinguished Faculty members, Dear students, Ladies and Gentleman, I would like to thank Bahria University for inviting me to this Convocation. First of all, let me congratulate all position holders and students who have earned their distinctions and university degrees through sheer willpower, hard work and dedication. Your education has provided you with the resources to lead and change. You should be determined to create your own individual voice upholding the values of creativity championed by this institution, while acknowledging your link with the community. The importance of education cannot be overemphasized. Education is fundamental to any society’s progress for it prepares generations to equip themselves with the knowledge and skills to meet the challenges of the ever changing world. When education blends with youthful energy, it organizes people economically, socially and politically, which helps the society to step-up on the ladder of civilization. Education is the catalyst of national development; it is what distinguishes nations form one another. Pakistan has immense human potential. More than half of our population is below the age of 25; sadly the education systems aren’t appropriately managed and sufficient enough to exploit this potential. This is where institutions such as Bahria University and the rest of private sector can play their role to ameliorate current educational level. To increase the pace of economic development, our policies must be focused towards advancement of education. For a stronger, respected and flourishing Pakistan, we must in our capacity address the issues related to education. Taking benefit of this opportunity, I would like to share my thoughts on the state of banking sector and the need for adopting innovative banking practices from around the world to deliver better customer value and financial inclusion in Pakistan. In recent years, growth and turnaround in Pakistan’s banking sector has been remarkable and unprecedented. Classified as Pakistan’s and region’s best performing sector, the banking industry’s assets have risen to over US $97 billion with profitability of Rs 187 billion (pre-tax) in FY12 which is exceptional and at an all-time high. Similarly, during FY 2012 deposits have grown at a fast clip of 17 percent which is the highest in the last five years. The Capital Adequacy Ratio (CAR) of the banking sector, which was already well above the regulatory requirements; increased further to 15.4 percent in FY12. The solvency of the banking sector has improved due to robust profitability, fresh equity injections and decreasing Risk Weighted Assets (RWA) owing to riskaverse behavior. However, the important question that we all must ask ourselves is that has the banking sector exhausted market opportunities and maximized return on equity? Here I would like to quote some statistics to flash the untapped opportunities for retail banking in Pakistan: • First, banks are yet to tap in the banking opportunities with the vast unbanked masses as the credit to private sector is only around 18 of the GDP which is too low. According to the Access to Finance Study (A2FS) only 12 percent of the population has access to formal financial services. Whereas of the remaining 88 percent, only 32 percent are informally served and 56 percent are completely excluded. BIS central bankers’ speeches • Second, the existing branch network of the banking system is insufficient to serve the millions of unbanked masses. The total number of bank branches in Pakistan is very low at around 10,600 which place Pakistan among the countries with the highest per bank population of around 15,000 persons per branch. • Third, private credit to GDP ratio is abysmally low at 18.4 percent compared with other countries at the same level of development. • Fourth, the sectoral distribution of credit is highly skewed and very low compared to the needs of the producing sectors of our economy. • Finally, the banking sector has nearly neglected the financing needs of the Mico Small and Medium Enterprises (MSME) as 80% of the credit is availed by only 25,000 borrowers. A recent World Bank study confirms a positive relationship between financial inclusion, faster economic growth and poverty alleviation. Given these challenges, SBP aims to address financial exclusion through variety of interventions, it aims to enhance delivery of financial services through technology based branchless banking, mobile wallets etc. Let me share my thoughts on financial inclusion, our efforts, and its current landscape. Financial inclusion is core component of financial sector development strategy. It envisages transforming the financial market into an equitable system with efficient market based financial services to the otherwise excluded poor and marginalized population including women and young people. Pakistan microfinance regulation had been ranked number 1 in the world by the economist intelligence unit of the economist magazine 2010 and 2011. Pakistan has become one of the fastest growing markets for branchless banking in the World. These developments include increased competition, technological innovation, new business models, transformation in customers’ needs and behaviors, and regulatory proportionality. International development agencies and media have now been highlighting Pakistan for its market and institutional environment for branchless banking. Moreover, according to a recent CGAP publication, “Pakistan serves as an example of how public and private institutions together can move a country towards a digital financially inclusive system.” In fact the branchless banking is going to dominate the retail banking landscape in the long-term. Branchless Banking has also proved to be an effective instrument in channelizing the Government to Persons (G2P) payments in trying times like serving Internally Displaced Persons (IDPs), flood affectees during the last two years, and beneficiaries of the Benazir Income Support Programme. In the coming days, this channel is expected to continue playing an important role towards the promotion of financial inclusion and the management of Government to Person (G2P) Programs like Salaries Disbursements, Pensions, BISP, Watan Cards, Pakistan Cards and tax collections services, etc. The existing Branchless Banking deployments can cater to the needs of over 10 million potential beneficiaries of G2P payments in Pakistan. SBP has partnered with DFID to launch a financial inclusion program. A number of initiatives have been taken to promote access to finance in the MSMEs, agriculture and housing which creates enabling environment by addressing regulatory barrier market failures and industry bottlenecks and ensuring consumer protection. Lack of financial literacy is a major constraint in advancing financial inclusion SBP launched the first ever nationwide financial literacy program last year, the pilot phase of the program has been concluded successfully by targeting about 50000 beneficiaries in various provinces regions and districts with emphasis on low income strata. BIS central bankers’ speeches SBP has deepened global partnership with World Bank, Asian development bank and other international and bilateral development agencies to make financial services accessible to the unbanked population. We will see the impacts of these initiatives in near future, which should create more opportunities for the marginalized segment of the society, so they can play their part in the development of this country. At this point in time, you’re curious minds will have a lot of questions, some of them will be answered by your mentors, some will be left unanswered, and for them you have to use your imagination and knowledge. Some of you have already chosen a path for yourself and some of you are yet to decide, questions like what field will be more appealing. In which organization you will learn more? Should you apply in fast growing private sector or should you join public sector? Should you apply for a job or pursue higher studies? Whatever you do, do it with utmost dedication I am sure optimism, creative thinking and challenging conventional wisdom will help you achieve your goals and lead you towards a more prosperous future. Let me once again congratulate the graduates who have received their degrees today. I wish you well in your future pursuits. BIS central bankers’ speeches | state bank of pakistan | 2,014 | 1 |
Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Round Table Conference on "Islamic banking potential of Pakistan", Karachi, 15 January 2014. | Yaseen Anwar: Islamic banking potential of Pakistan Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Round Table Conference on “Islamic banking potential of Pakistan”, Karachi, 15 January 2014. * * * Mr. President, Honourable Governor Sindh, Honorable Finance Minister, Distinguished guests, ladies and gentlemen, Assalamualaikum, I am indeed privileged to be here today for addressing this prestigious gathering comprising all major stakeholders of the Islamic Banking Industry in Pakistan. The presence of foreign experts have today brings global experience to this roundtable conference and thus will further enrich the knowledge sharing experience. My appreciation to the organizers for holding this event to explore the real potential of Islamic banking in Pakistan, which I believe will give further boost to our efforts and optimism for growth and development of the industry. Islamic finance during the last four decades has witnessed considerable progress at the global front. Besides the traditional Islamic finance markets of the Middle East, financial centers across various Western countries are also accepting and recognizing the viability and utility of this alternate financial system. In particular the relative resilience of Islamic financial institutions during the recent financial crisis due to its asset backed nature and being devoid of speculation and uncertainty, has significantly improved its credibility as a more prudent and stable system. The scope and range of Islamic finance products has also widened considerably over the years and Islamic financial institutions are presently catering to most of the financial services needs of various sectors of the economy. There are dedicated regulatory, legal and academic institutions at the international level working and providing support for maintaining the high pace growth of the Islamic finance industry. Pakistan, with more than 95 percent Muslim population, and a constitutional obligation of ensuring a riba free economic system, has had a favorable response to Islamic finance. Pakistan is amongst the pioneers of Islamic finance as we started planning for nurturing the Shariah compliant financial system way back in 1970s, and made a bold attempt in 1980s to bring the whole banking and financial system in conformity with Shariah principles. The pioneering work of 1980s particularly on the legal and regulatory front has been a source of guidance and inspiration for many countries that initiated Islamic finance in the 1980s and 90s. The attempt to transform the whole system however, met with limited success largely due to slippages at the implementation and execution stage. This lead us to re-launch Islamic banking in 2001 in parallel to conventional banking thus allowing both Islamic and conventional banks to co-exist and enabling the consumers to do banking with the system of their choice and preference. This approach has proved to be a huge success in promoting Islamic banking in the country and ensuring its demand driven development. The industry has been growing at an impressive annual growth rate of over 30 percent over the last five years with sustained growth momentum despite significantly increased base. Islamic Banking is currently spread across 80 districts of the country with a network of 1200 branches offering Shariah compliant products and services. Islamic banking assets presently constitute almost 10 percent of the overall banking system in the country while in terms of deposits the share is above 10 percent. The future outlook of the industry is also very positive with bright prospects of doubling its market share by 2020. The presence of his Excellency, the President of Pakistan, and the honorable finance minister in the conference speaks volumes about the strong commitment of the government for the promotion of Islamic banking and finance in the country. I would like to take this opportunity to highlight that State Bank of Pakistan has been playing a leading role in BIS central bankers’ speeches nurturing Islamic banking in the country on sound footings. Being the regulator of the banking sector, SBP over the years has introduced and implemented key regulatory reforms and prudential measures to ensure financial stability and to meet the evolving needs of the industry. We have also given a comprehensive and multi-tiered Shariah compliance framework to ensure Shariah conformity of Islamic banks’ operations. To further strengthen the Shariah compliance environment in Islamic banks we have also developed a Shariah Governance Framework, which explicitly defines the Shariah related roles and responsibilities of all key organs of IBIs including Board of Directors, the executive management and Shariah Boards. It also institutionalizes the Shariah compliance function in IBIs. Moreover, to develop an effective prudential and risk management framework for Islamic finance, an incremental approach was adopted wherein new regulations for only such areas and risks of Islamic banks were developed which were not being covered by conventional prudential regulations and risk management framework. Further, in order to align its regulatory framework with international regulatory standards and best practices, SBP regularly reviews and evaluates the standards issued by IFSB, AAOIFI, and IIFM for their possible implementation keeping in view our local legal, regulatory and economic environment. Last year we issued landmark Instructions for Profit & Loss Distribution and Pool Management for Islamic Banking Institutions (IBIs), which were well received both locally and internationally. The instructions are aimed at bringing standardization and improving transparency in profit & loss distribution practices of the industry and will be instrumental in improving the perception of Islamic banking amongst the masses. Considering the demand of Islamic microfinance, SBP has offered various options to offer the services of Islamic microfinance. These options include the establishment of full-fledged Islamic microfinance banks, Islamic microfinance services by full-fledged Islamic banks and Islamic microfinance Divisions in conventional microfinance banks. This, coupled with its inherent checks on end use of the funds provided by microfinance institutions, the outlook for growth and development of Islamic microfinance in Pakistan is positive. Similarly for an agro-based economy like ours, there is huge potential for development of Shariah Based Agriculture financing. SBP is working with the industry to develop Shariah compliant agriculture finance products particularly Dairy products which can generate more than $ 500 million in foreign exchange exports. Islamic finance is an evolving industry and so is its understanding by the masses, the business community and the policy makers. Despite significant improvement during the last decade, still a large segment of our population does not have adequate understanding of Islamic finance and is unable to comprehend its distinction over conventional finance. The State Bank therefore, besides developing a supportive regulatory and supervisory framework, is also actively engaged in undertaking awareness creation and capacity building initiatives through its awareness campaign whereby targeted seminars and conferences are being organized for the business community, academia, bankers and policy makers throughout the country. In this context, the most significant milestone that has been achieved in the recent past is the launch of an industry wide media campaign under the support and guidance of SBP. This campaign is targeted to address mass awareness issues by using print, electronic and digital media. Further, SBP has recently developed a five year Strategic Plan (2014–18) for the Islamic banking industry in Pakistan in consultation with all key stakeholders, which gives a consensus agenda and strategy to take the industry to its next level of growth and development. The plan has an extensive focus on improving public perception of Islamic banking as a distinct and viable system capable of catering to the varied financial services needs of various segments of the society. It envisages intensifying the awareness creation efforts, strengthening consultation mechanism with stakeholders, removing confusion and BIS central bankers’ speeches inconsistencies in legal, regulatory and taxation environment, deepening and broadening of product offerings by Islamic banks, doubling the outreach of Islamic banks during the next five years and increasing the market share to 15 percent of the banking system. Pakistan has been an active member of leading global International Islamic finance institutions like the Islamic Financial Services Board (IFSB), the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), and the International Islamic Financial Market (IIFM) that are all playing a key role in developing prudential and Shariah standards for the industry. Being part of the global efforts for the development of global standards for the industry has certainly helped us in improving our presence on the global Islamic finance map and adopting the prudential and Shariah standards in Pakistan. I would also like to mention here that SBP is also a key member of the recently constituted steering committee for the promotion of Islamic banking by the government which is mandated to devise a comprehensive policy framework for the Islamic financial system, suggest practical steps needed to be taken for implementing Shariah-based financial system, and propose solutions for the Islamic secondary market / money market for liquidity management. These initiatives on part of the government sends a clear signal that the present government views Islamic banking and finance as an integral part of the overall financial system. We at SBP share the same view and believe that steps like these can go a long way in further increasing the scope of the industry in the country. Innovation requires research, hence it is imperative that the industry players give utmost importance to research in their organizations. I am pleased to inform this esteemed audience that SBP has a dedicated team of researchers focusing on key areas relevant to the industry. We have recently conducted an extensive survey based study of 10,000 household across the country to assess the demand for Islamic banking and its attributes. The results of the survey will be shared with the industry soon and are highly encouraging as there is a huge untapped demand for Islamic banking in the country; and an even faster pace expansion of the industry would be needed to fill the demand and supply gap in the medium to long term. Lastly! I would like to reiterate the full support and ownership of SBP in developing and nurturing a sound and stable financial system that meets the Shariah principles in letter and spirit. We will work with the industry and other stakeholders to ensure further strengthening of risk management practices, and an effective macro prudential framework and transparency in financial transactions and exposures. The State Bank of Pakistan remains committed to finding appropriate solutions to these challenges. I have no doubt that the support and cooperation of all stakeholders exhibited here today will lead to further strengthening the foundations of this important industry. A pure Islamic financial system with its inherent focus on equity justice and social responsibility is ideal and this demands serious and coordinated efforts of all stakeholders on the continuous basis. I wish the best of luck to the industry and thanks once again to all the participants and organizers. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,014 | 1 |
Welcome address by Mr Ashraf Mahmood Wathra, Acting Governor of the State Bank of Pakistan, at the launching ceremony of the Financial Innovation Challenge Fund 2nd Challenge Round on "Promoting Innovative Rural and Agriculture Finance in Pakistan", Islamabad, 6 March 2014. | Ashraf Mahmood Wathra: Promoting innovative rural and agriculture finance in Pakistan Welcome address by Mr Ashraf Mahmood Wathra, Acting Governor of the State Bank of Pakistan, at the launching ceremony of the Financial Innovation Challenge Fund 2nd Challenge Round on “Promoting Innovative Rural and Agriculture Finance in Pakistan”, Islamabad, 6 March 2014. * * * Hon’ble Federal Minister for Finance, Revenue, Economic Affairs and Privatization, Senator Muhammad Ishaq Dar, His Excellency UK High Commissioner, Mr. Philip Barton, Head of DFID Pakistan, Mr. Richard Montgomery, Distinguished Guests, Speakers, Colleagues, Ladies and Gentlemen, Assalamu alaikum and very good morning! I would like to express my gratitude to all the distinguished guests: the Chief Guest, Honorable Finance Minister Senator Ishaq Dar, representatives from the diplomatic community, development partners and agencies, government officials, agriculture chambers, representative of all Banks, non-governmental organizations and agriculture sector stakeholders for joining us today. It is my great pleasure to extend a very warm welcome to all of you to this auspicious ceremony held to commence the launch of 2nd challenge round of Financial Innovation Challenge Fund, aiming to promote financial innovation for development of rural and agriculture sectors in Pakistan. Ladies and gentlemen! To quote Thomas Edison “There’s a way to do it better – find it” While defining innovation, this quotation clearly emphasizes on doing things in a unique and better way. Therefore, tackling poverty also demands fundamental rethinking and innovation. The alleviation of poverty is a universal goal, to ensure prosperity, we as a society need to focus on inclusive growth, which requires fundamental innovation in designing financial models aimed at the poor segment of the society. Distinguished guests! Improving financial access to alleviate poverty is a global challenge. More than 2 billion adults in the world do not have access to formal or semi-formal financial services. At the same time, one billion people with mobile phones do not have even a basic bank account. As the costs of information and communications technology have now shrunk, the time is ripe for using technology to address financial exclusion. Therefore, financial inclusion is one of the key pillars of the G- 20’s development agenda. The G20 leaders at their Korea Summit in 2010 included “innovation” as one of the key principles for promoting financial inclusion. While urging the developing countries to cultivate a broad based government commitment to financial inclusion to help alleviate poverty, the G20 Principles urge them to promote technological and institutional innovation as a means to expand financial system access and usage. Since financial exclusion is particularly pronounced in Pakistan, both the Government and the State Bank of Pakistan are addressing this challenge using innovative policy approaches and actions. There is a full commitment of the government to provide sustainable financial access to the under-served economic and geographic segments including youth, women, and SMEs. In this effort, the role of multilateral institutions and BIS central bankers’ speeches bilateral donors particularly the UK’s Department for International Development (DFID) has been critical. Ladies and gentlemen! In Pakistan rural population is above 60% and most people living in rural areas drive their income directly or indirectly from agriculture. It employs around 45 percent of our total labor force. If we were to develop any logical linkage between the economic development of Pakistan with any of the sectors, that sector would most probably be agriculture. Agriculture plays a strategic role in ensuring food security, generating economic growth, reducing poverty & inequality. To combat poverty in rural sector, financial innovation needs to be targeted towards the productivity of the agriculture sector specifically to the productivity of “small farmers”, improvement in farmer’s education, and better availability of fertilizers, and agriculture equipments. Financial services outreach in the rural sector can play the most indispensable role in this regard. Ladies and Gentlemen! Promoting financial inclusion by developing agri credit market, rural SMEs and microfinance sector is one of the top priorities at SBP. Over the past few weeks, State Bank has taken some ground-breaking initiatives to uplift financing to the farmers and small and medium entrepreneurs: State Bank has revamped Prudential Banks for Agricultural Financing whereby banks have been advised to formulate all-inclusive agri. finance policies and set up dedicated agri divisions within banks. Under the revised PRs, the scope of agri. financing has been widened to include value chain financing and Islamic mode of financing. We have just revised the per acre Credit Limits for crops, orchards and forestry which were previously set in 2008. This was done to meet the enhanced credit requirements of farmers and also increase the agri credit portfolio of banks manifold. Farming community and banks have been overwhelmed by this initiative. We all know the significance of livestock that accounts for 55 percent of agri. GDP. However, the share of credit to livestock is disproportionately small due to high risk perception. Therefore, to address this issue, SBP has introduced a Livestock Insurance Scheme for borrowers to mitigate risk of loss of livestock due to disease, natural calamities & accidents. To ensure diversity of agri. financing institutions, SBP has included Microfinance Banks and Islamic Banks into the agri. Indicative Target scheme of SBP. The Agricultural Credit Advisory Committee (ACAC), which is the apex consultative forum for agri financing with representation from all the relevant federal & provincial departments, farming community, banks and experts, has been re-activated. The ACAC met on 17th February 2014 which supported my six-point agenda to boost agri financing. This includes: – Launching of the 2nd Round of Financial Innovation Challenge Fund (FICF) under the UKAID-sponsored Financial Inclusion Program, to promote innovative techniques in agri and rural financing (for which we have gathered today). – Further, the ACAC approved my proposal of upward revision in the agri credit disbursement target from Rs. 360 billion to Rs.380 billion for the current year, which is 13 percent higher than the actual disbursement of Rs.336 billion in last year. BIS central bankers’ speeches – SBP is going to launch a country-wide Internship Program for 100 top graduates in agriculture to be funded under the ADB’s Improving Access to Financial Services Endowment Fund. – Banks have been assigned targets for outstanding agriculture portfolio and number of borrowers to have high impact of financing at grass roots level from the current year. – SBP has made agricultural finance a key indicator of performance of banks which will be reflected in their supervisory ratings. – And, finally a working group of ACAC has been formed to review the state of affairs of small farmers financing and make recommendations for improving financial access to small farmers. Recognizing the economic significance of rural SMEs, State Bank has revised the Prudential Regulations for SME financing to put focus on ‘S’ part of SMEs. Further, following incentives for SME exporters have been introduced in the Export Finance Scheme (EFS). – Banks will allocate at least 10% of their EFS limits for SMEs. – For SMEs availing Export Finance under the Performance-based System, the mark-up rebate has been increased by 0.5 percentage point. – Further, to incentivize banks to provide more financing to SMEs their spread has been increased from 1% to 2% for SME borrowers WITHOUT changing prevailing end user rate for exporters. SBP has also provided regulatory support in designing and launching of Prime Minister Youth Business Loans. SBP has issued instructions to the banks for participation in PM’s Youth Business Loans and report financing under the scheme in their Annual Reports under CSR initiatives. For successful implementation of the PM Scheme, SBP is closely monitoring the progress of participating banks. SBP has also conducted twelve (12) training workshops on the Program across Pakistan and AJK to sensitize banks for their active participation in the PM Scheme. Ladies and Gentlemen! Now, SBP under the flagship ‘Financial Inclusion Program’, funded by the UK Aid, is about to unveil the Financial Innovation Challenge Fund round on innovative rural and agricultural financial services. The successful implementation of this challenge round requires utmost commitment and support from everyone who is present here. Our Deputy Governor and my colleague Mr. Saeed Ahmad will share with you the objectives and modalities of this Fund and the SBP-managed FIP in more details. I thank and welcome you all once again and hope that the stakeholders will join hands in getting behind this latest initiative to further enhance rural financial inclusion in Pakistan. Thank you! BIS central bankers’ speeches | state bank of pakistan | 2,014 | 3 |
Welcome address by Mr Ashraf Mahmood Wathra, Acting Governor of the State Bank of Pakistan, at the SAARCFINANCE Regional Seminar on "Risk Management Framework in Banks", Islamabad, 17 March 2014. | Ashraf Mahmood Wathra: Risk management framework in banks Welcome address by Mr Ashraf Mahmood Wathra, Acting Governor of the State Bank of Pakistan, at the SAARCFINANCE Regional Seminar on “Risk Management Framework in Banks”, Islamabad, 17 March 2014. * * * Good morning, Ladies and Gentlemen. I am immensely delighted to welcome you all in Islamabad. It is my pleasure to inaugurate this SAARCFINANCE event on the ever important theme of “Risk Management Framework for Banks”. I believe the program will facilitate sharing of best practices, latest developments in risk management and generate a fruitful discussion on impending challenges in the field of risk management while analyzing its different facets. An efficient and healthy banking system is a prerequisite for sustainable economic growth of a country. In this context, effective risk management practices enable the banking industry to build public trust and confidence in the institutions which is necessary for mobilizing private savings for investment to facilitate economic growth. On the flip side, inadequate risk management practices in the banking industry would result in bank failures leading to erosion of public confidence in the industry having adverse implications for the economic growth. Therefore, an effective risk management framework is a prerequisite for banks to achieve their own business objectives and also play their role in the economic growth of the country. Ideally, banks’ risk management framework should strive to cover the full spectrum of risks by analyzing them from both business and enterprise level perspectives. Each banking institution should tailor its risk management program to its need and circumstances. I would like to elaborate on the main elements of a risk management framework that apply to banking institutions irrespective of their size and complexity of business: First and foremost, effective risk management framework demands active involvement of the Board of Directors (BoD) and senior management in the formulation and oversight of risk management processes. Accordingly, they should provide strategic direction and approve the overall business strategies and significant policies of their institutions, including those related to managing and taking risks, and should also ensure that senior management is fully capable of managing the activities that their institutions undertake. Second, adequate Policies, Procedures, and Limits need to be defined by an institution’s directors and senior management to tailor their risk management policies and procedures to the types of risks that arise from the activities the institution conducts. Third, adequate Risk Monitoring and Management Information Systems need to be developed for effective risk monitoring and to identify and measure all material risk exposures. Consequently, risk monitoring activities must be supported by information systems that provide senior managers and directors with timely reports on the financial condition, operating performance, and risk exposure of the institution. Fourth, establishing and maintaining an effective system of controls, including the enforcement of official lines of authority and the appropriate separation of duties such as trading, custodial, and back-office is one of management’s more important responsibilities. A properly structured system of internal controls promote effective operations and reliable financial and regulatory reporting, safeguards assets, and helps to ensure compliance with relevant laws, regulations, and institutional policies. Given the importance of appropriate internal controls, the results of audits or reviews should be adequately documented, as should management’s responses to them. BIS central bankers’ speeches Fifth, the Risk Management Function should be institutionalized to supervise overall risk management at the bank. Ideally, overall risk management function should be independent from those who take or accept risk on behalf of the institution. Ladies and Gentlemen! One would assume that these principles are fairly simple to understand and practice, however, banks failures of the past & the recent Global Financial Crisis highlight weaknesses/ vulnerabilities in the risk management systems/ practices of the financial industry. Following are some of the key lessons which should not be overlooked, to ensure effective risk management at banks: • Boards need to be more actively engaged and involved in risk policy setting and governance, and spend more focused, higher-quality time on risk issues. • The responsibilities and influence of Chief Risk Officers (CROs) need to be elevated and strengthened with CROs actively participating in business strategy and planning as opposed to having only veto power over decisions that adversely impact risk. The risk function is not in place to manage risk, but to make sure that risks are managed.” • Banks need to align pay to risk-adjusted performance • There is a need to institutionalize an appropriate risk culture throughout the organization, where risk is everyone’s business from the board to the front line. • Banks need to improve the transparency, quality, accuracy and timeliness of information to support risk management. • Institute enterprise wide risk management systems instead of managing the risks in silos. • Use both qualitative and quantitative techniques with varied assumptions instead of blindly following the models. Ladies and Gentlemen! I would now like to give a brief overview of some of the main steps taken by Pakistan to improve the soundness and stability of its banking system. Over the years, our banking sector has witnessed a transformation from an entirely public sector owned industry to the now majority privately owned sector. This shift was one of the main factors which led to improved performance of the overall banking sector. Keeping in view the importance of risk management for banks, SBP has put in place detailed guidelines for banks in the area of Risk Management (2003), Internal Controls (2004), Country Risk (2004), internal credit rating systems (2007), general policies framework which provides broad guidelines for the formulation of polices in the major risk areas, stress testing (2012) and Fraud Risk Management & Reporting (2014). In addition, we have constantly been refining our regulatory and supervisory oversight. For instance, we have issued separate set of prudential regulations for corporate/ commercial banking, Consumer financing, SME financing, Microfinance & Agriculture financing which are updating on an on-going basis. PRs for corporate/ commercial banking cover four areas of risk management, corporate governance, CDD & AML and banks’ operations. Likewise, stress testing guidelines have been revised extensively in line with BCBS reforms package which provide for a bigger role for stress testing in the determination of capital buffers under Pillar 2. Moreover, as per Pillar 2 of Basel capital accord, risk management framework is dealt under the “Internal Capital Adequacy Assessment Process (ICAAP)” of banks, therefore, in order to make the ICAAP exercise more effective we have issued a standardized reporting template for ICAAP in December 2012. BIS central bankers’ speeches Moreover, a major on-going development is the implementation of Basel III in Pakistan from December 2013. Our efforts to keep the banking sector well capitalized and have sufficient capital buffers to absorb minor to moderate shocks can be judged from the fact that our banking sector has healthy capital adequacy ratio of 16%. I am sure you will hear more about the implementation of Basel III in Pakistan during the presentation of country papers. As a regulator, SBP has established a comprehensive and well balanced regulatory and supervisory set up to ensure that sound risk management practices are being followed within the banking sector. Ladies and Gentlemen! In the end, I would like to say that expanding business arenas, globalization of financial activities, emergence of new financial products and increased level of competition have opened up opportunities but also increased the potential risks from such developments. I strongly believe that regional forums such as SAARCFINANCE are very helpful in facilitating knowledge exchange and ongoing collaboration for region specific issues which may pose potential risks for each of our banking sectors. I hope you will enjoy your stay at Islamabad and continue deliberations in the forthcoming sessions of the seminar. Thanks. BIS central bankers’ speeches | state bank of pakistan | 2,014 | 4 |
Speech by Mr Ashraf Mahmood Wathra, as Acting Governor of the State Bank of Pakistan, at the Bank Alfalah Mobile Commerce Conference 2014, Karachi, 13 March 2014. | Ashraf Mahmood Wathra: The importance of financial inclusion in Pakistan Speech by Mr Ashraf Mahmood Wathra, as Acting Governor of the State Bank of Pakistan, at the Bank Alfalah Mobile Commerce Conference 2014, Karachi, 13 March 2014. * * * Assalam-o-Aalaikum and Good Morning It is my great pleasure to join you at the international Conference & Exhibition on Mobile Commerce in Pakistan, and share with you some of my thoughts on this important subject. I must congratulate the organizers and sponsors for their efforts in bringing together the stakeholders of mobile banking eco-system at one platform. Being a regulator of banking sector, SBP believes that financial exclusion is hindering our fellow citizens in availing economic and business opportunities. Today, there are an estimated 2.5 billion adult people worldwide who do not have access to formal financial services. According to World Bank’s Global Findex Survey, almost 80 percent of those living within incomes of less than $2 per day are financially excluded. Pakistan is a country of over 180 million people living in geographically diverse areas. Our branch network of almost 12,700 is insufficient to serve the millions of unbanked masses. Banks operating in Pakistan are hosting only 35 million customer accounts including 3.5 million accounts opened by branchless banking providers. Despite phenomenal spread of banking business in Pakistan, we have a long way to go to achieve digital financial inclusion in the country. Given the complexities and challenges of limited financial access in the country, State Bank of Pakistan has adopted a multi-pronged and long-term strategy to address financial exclusion through structured policy & regulatory actions, and market-development interventions. Our program initiatives have been catalysing the market developments and fostering market ecosystem to especially promote innovative ways of doing banking business. As we all know that people around the world increasingly use technology and communication networks to live, work, socialize and remain informed and entertained through the use of online services via personal devices like PCs, smartphones and computer tablets. Therefore online and other-off-branch modes of doing banking transactions have reduced the hassle of visiting a conventional bank branch to a considerable extent. Ladies & Gentlemen, Pakistan is amongst the pioneers of mobile/branchless banking in the developing world. Our branchless banking framework and models have achieved worldwide recognition and remarkable success in a short span of four and a half years. This could not have been possible without an effective and enabling regulatory regime, dynamic, innovative and always eager banking and telecom industry in the country. I would like to share some numbers that show the level of take-up of branchless banking services in the country. For example: • Currently, eight branchless banking deployments are live in the market and four more are yet to go live this year. • Up to December 2013, providers’ combined network has reached to almost 125,000 agents spread across all over Pakistan. • Total number of branchless banking transactions has shown continuous growth in each successive quarter. 54 million transactions worth Rs. 234 billion were performed during the quarter ended December 2013. BIS central bankers’ speeches • Currently 3.5 million customers hold branchless banking accounts (also known as m-wallets) to avail host of services including fund transfer, utility bill payment, domestic remittance, mobile top ups, loan repayment, and saving account features. • Branchless banking has played a pivotal role in providing efficient Financially Inclusive Government to Person (G2P) payments to welfare beneficiaries of Benazir Income Support Program (BISP), Watan Card and Bayt-ul-mall. Ladies & Gentlemen, while we have achieved initial success through accumulating a critical mass of transactions and customers’ acquisition in branchless banking, we are by no means complacent. We are focusing our energies to identify gaps and bring solutions to address those gaps. SBP is strengthening its regulatory oversight through measures such as regular diagnostic and inspections, compliance forum, and agent monitoring System. SBP has also formed the National Branchless Banking Consultative Group which draws representation from branchless banking industry players including banks, mobile operators, and technology service providers. This group is actively working on different protocols including agent code of conduct, agent sharing models, interoperability schemes, consumer protection framework etc. Ladies & Gentlemen, it is a matter of great comfort and satisfaction for banking and telecom companies that their respective regulators i.e. SBP and PTA share the vision and are working in close collaboration to provide an enabling regulatory environment for development of mobile / branchless banking services. Keeping in view the importance of interoperability for promotion of branchless / mobile banking, SBP and PTA are working closely in developing a regulatory framework for Third Party Service Provider (TPSP). Eventually, mobile financial services would become interoperable once TPSP regulatory framework is issued. Going forward, much is still needed to be done. SBP is keen to work with different stakeholders of mobile/branchless banking industry eco-system to provide an enabling environment for the creation of mobile/branchless banking ecosystem in the country. I trust that the today’s deliberations will take stock of the opportunities and challenges offered Branchless Banking and its related products. I also hope that the forum would come up with recommendations on how to harness potential of branchless banking for financial inclusion in Pakistan. Thank you! BIS central bankers’ speeches | state bank of pakistan | 2,014 | 5 |
Keynote address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the International Conference on Innovative Agriculture Financing, Islamabad, 28 April 2015. | Ashraf Mahmood Wathra: Financing agriculture in Pakistan Keynote address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the International Conference on Innovative Agriculture Financing, Islamabad, 28 April 2015. * * * Hon’ble Senator Mohammad Ishaq Dar, Federal Finance Minister Hon’ble Mr. Sikandar Malik Bosan, Federal Minister for National Food Security and Research Mr. Patrick T. Evans, Country Representative, FAO of United Nations Mr. Chamnong Siriwongyotha, General-Secretary, Asia-Pacific Rural & Agriculture Credit Association (APRACA) Mr. Saeed Ahmad, Deputy Governor, State Bank of Pakistan (SBP) Our esteemed experts/guests from overseas Distinguished CEOs/Presidents/Executives of banks, MFBs, Representatives of Farmers & Business Associations, and Academia. Colleagues, ladies and gentlemen. Assalam-o-Alaikum and Good Morning! 1. I extend a very warm welcome to all the participants in today’s International Conference on Innovative Agriculture Financing and to Islmabad. I am particularly grateful to our international speakers who have taken out time to travel long distances to attend this conference; and share their knowledge and insights with us on a topic which is crucial to our national food security, growth and well-being. I would like to express my special gratitude to our Chief Guest Senator Mohammad Ishaq Dar and Guest of Honor Mr. Sikandar Malik Bosan whose presence here today is a reflection of the focus and importance that the country’s leadership places on the development of Agriculture sector. 2. Honorable Finance Minister: we are grateful for all the support that you have provided to the promotion of inclusive finance in the country. We all know that you have great passion and high commitment for expanding the contribution of agriculture in the economy. In line with your vision of a progressive and equitable economy, the Government has initiated unprecedented programs and schemes for the promotion of financing to agriculture, especially to small farmers. SBP and banks are striving to optimally leverage these initiatives to make far-reaching impact on financial inclusion and economic development. 3. Honorable Minister for Food Security, Mr. Sikandar Malik Bosan: The importance of your office and its contributions to the development of agriculture sector are widely acknowledged. The crucial role that your Ministry is playing for the growth and development of Agriculture with special focus on providing relief to small farmers by linking them to the market; introducing cutting edge farm technology and state of the art high yield seed varieties and numerous other innovations for the promotion of agri-based exports for the uplift of agriculture in the country. Ladies and Gentlemen, 4. Majority of the world’s poor, an astounding number of over two billion people share one common profession: farming. But where agriculture harbors so many of the world’s poor; it also offers the key to graduate economies out of the vicious cycle of poverty and food insecurity. Beyond direct links to rural livelihood, agricultural sector has strong links to rest of the economy, and this is one of the most powerful ways in which it generates overall growth and reduces poverty. Empirical evidence suggests that investment in agriculture is 2.5 to 3.0 times more effective in increasing the income of the poor than is non-agricultural BIS central bankers’ speeches investment. Based on this premise, State Bank of Pakistan (SBP) is making relentless efforts to promote agriculture finance. My dear fellows and colleagues, 5. In our efforts to promote financial services to the agriculture-based community, we are faced with the challenge of removing numerous stumbling blocks to meet the financial needs of the agri-sector. 6. However, with the Grace of Allah Almighty, the financial sector has not only stood strong against these challenges but has also registered remarkable growth. Over the years, we have moved away from the ‘mandatory-credit regime’ where force-feeding of targets to highly regulated commercial banks was the norm; towards a more open and ‘market led’ model where State bank has adapted itself into the role of a facilitator and developmental partner of financial institutions to accelerate the growth of agriculture finance in its natural eco-system. 7. Today, more than ever before, banks are successfully exploiting business opportunities in agriculture financing. We started off with a hand-full of banks as reluctant financiers of agrisector but now we have 33 institutions, including Islamic and Microfinance banks that are providing financing efficiently to their agri-clientle. 8. Agri credit has demonstrated a consistent rise with annualized average growth rate of 16.2 percent for last three years. As a result agri credit increased to Rs 391 Billion in 2013-14 with Agriculture Credit Advisory Committee (ACAC) pushing the limits to even more aggressive credit disbursement target of Rs 500 Billion to be achieved during FY 2014-15. It is encouraging to note that banks have already disbursed Rs 326 Billion during the first 9 months, which is 65% of the target of FY 14-15, and is 28 % higher than the same period last year. It is also heartening that the portfolio quality of banks agri portfolio has also improved over the recent period. I believe that the banks would be able to further improve the portfolio quality of agri-lending by using innovative lending models supported with their experience curve. 9. It has been through the collaborative efforts of all stakeholders that the banks have improved their actual agri disbursement to financing requirements ratio from 37% to 53% over the last 5 years and we are working to improve it even further so that more and more farmers can free themselves from the shackles of exploitative informal credit. In order to make it happen, SBP has taken initiatives to promote agri-financing to bring depth, inclusion, efficiency and stability into the system: • Innovations in agri-financing are being promoted by adoption of value chain and warehouse receipt financing through constant guidance and pilot projects. • Enhanced risk management through crop and livestock loan insurance schemes and credit guarantee schemes, to help banks venture into providing financing to farmers, particularly the smaller ones. • SBP has been extensively involved in capacity building of farmers through offering financial literacy programs and financial service providers, through engagement of local and international experts who are helping the financial service providers to tailor their approach for improved service delivery and increased profits. Distinguished guests! 10. Yes State Bank views positively at the recent increasing momentum, but we should not lose sight of the fact that our long journey in agri-credit market has just started. In this context, I feel we will be wrong if we say that Rs. 500 billion is a big target. Let us not forget that this is only 53% of our credit demand. BIS central bankers’ speeches 11. Going forward, the most critical challenges are inclusion of majority small and marginalized farmers, addressing geographical imbalances and financing to non-crop activities, which will lead to enhancing the share of agri credit in banks’ advances. SBP is committed to continue its efforts to deliver real benefits to the farming community and it is hoped that with the joint efforts of policy makers and the industry, agri-financing would soon emerge as a sound, scalable and sustainable business segment for banks in Pakistan. 12. In the end I would like to sincerely thank FAO for their remarkable support in collaborating with SBP for organizing this event. FAO has long played a strong role for the development of agriculture sector in Pakistan through introduction of innovation and technical assistance and this event is a mark of their continued commitment to the cause of developing an exceedingly vibrant agriculture sector in Pakistan. I am also grateful to UKAID for their continued and long-term support to advance financial inclusion in Pakistan. Let me also express our gratitude to Asia-Pacific Rural and Agricultural Credit Association (APRACA) for the importance and attention that you always give to Pakistan and SBP in the regional initiatives. Ladies & Gentlemen, 13. I wish you all a pleasant participation in the conference and hope that this experience will invigorate the spirit of transformation that challenges the conventional beliefs and fosters innovative thinking to find lasting solutions to the problems of agriculture-financing. Thank you our Chief Guest Senator Muhammad Ishaq Dar, Finance Minister, and the Guest of Honour Federal Minister Mr. Sikandar Malik Bosan, and all the participants and speakers! BIS central bankers’ speeches | state bank of pakistan | 2,015 | 6 |
Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, on Independence Day, Karachi, 14 August 2015. | Ashraf Mahmood Wathra: Strengthening Pakistan’s economy and financial services Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, on Independence Day, Karachi, 14 August 2015. * * * Ladies and Gentlemen, Assalam-o-alaikum, It is my pleasure and honour to speak to you on the 69th Independence Day of Pakistan. First of all, I congratulate you. The day is celebrated in the memory of those leaders who rendered innumerable sacrifices for the liberty of the nation from shackles of slavery. It was their untiring struggle and perseverance which delivered the fruit of independence for the Muslims of the subcontinent. The Muslims of the subcontinent followed the call of the Quaid-e-Azam Muhammad Ali Jinnah and the dream of a new homeland became a reality at a time when it seemed almost impossible to win it. Pakistan was created for lofty ideals. To win freedom was the first step in that direction. The real freedom means achieving the goal of becoming a self-reliant nation – one that is able to guard her interests and promote her values. Freedom will really be freedom only when we follow the principles taught by our founding fathers and remain united in confronting the challenges the country faces in its move towards growth shared by all Pakistanis. It is our collective responsibility to play our roles to transform Pakistan into a strong, prosperous and thriving country. This may require some sacrifices on our part but if we keep the principles taught by our great leaders in mind, we will have the vision to see that such sacrifices effect great advancement for the future of a nation. A strong economic system based on strong institutions is the key to progress. No nation can hope to grow without a robust financial system and powerful economy. Despite challenges Pakistan managed established a central bank and a viable economic system early on. Although our economy has had many rises and falls and has sometimes seen crises, I believe there is still enormous potential for growth and the economy is now headed in the right direction. On this auspicious occasion the State Bank is launching its five-year Strategic Plan. We have titled this Plan SBP Vision 2020. The Plan has devised by the management and officers of the SBP after months of ceaseless work. SBP Vision 2020 has been developed through a participative and consultative process. SBP took the Vision 2025 into account. Moreover, as a part of the process, surveys were conducted of external stakeholders. The results of these surveys were combined with a global scan of central banking issues and domestic and global economic and financial developments. Our aim is for SBP to be a role model for corporate best practices in Pakistan and to deliver effective and efficient outcomes at every level. We need to empower all staff members to help deliver SBP Vision 2020 and drive the organization’s change. In this respect, our core values of Integrity, Accountability, Teamwork, Courage, Excellence and Result orientation shall be the focus for further inculcation into the SBP culture. SBP Vision 2020 organizes activities around the six strategic imperatives which include: enhancing the effectiveness of monetary policy; strengthening the financial system stability regime; improving the efficiency, effectiveness, and fairness of the banking system; increasing financial inclusion; developing modern and robust payments systems; and strengthening SBP’s organizational efficiency and effectiveness. BIS central bankers’ speeches Around 50 percent of Pakistan’s adult population has no access to financial services such as formal savings, payments, deposits, credit or insurance. Despite efforts, the level of financial inclusion has remained very low, and the need for a new comprehensive national strategy has been recognized. Following extensive development and consultation, the National Financial Inclusion Strategy was launched in May 2015. SBP Vision 2020 with respect to increasing financial inclusion is closely linked to implementation of the NFIS. The NFIS creates the foundation for SBP, the Government and private sector to implement a comprehensive set of coherent and sequenced reforms needed to make a meaningful impact on financial inclusion in Pakistan. The NFIS will guide efforts to promote financial inclusion over the coming five years. Apart from its core functions, the SBP is playing an important in preserving the cultural heritage of the country. In this regard, State Bank Museum and Art Gallery has a prominent role. In a very short span of time the State Bank Museum has become the member of International Forums such as International Council of Museums and Commonwealth Association of Museums. As an ongoing drive State Bank has taken another pioneering initiative by inviting private collectors to be part of SBP Museum, by donating or selling their collections, which will be preserved professionally under an ideal environment, not only this but depending on the size and type of the collection, SBP Museum will reserve a corner, or show space in the name of the donor. I am very pleased to see the positive response of the citizens and collectors. I am pleased to welcome Pakistan’s renowned artist Mr. Adil Salahuddin who has donated a valuable collection to State Bank. It gives me immense pleasure to acknowledge the contribution of Mr. Adil Salahuddin, who is recipient of Sitara-e-Imtiaz and President’s Pride of Performance award. He played an important role in the design process of stamps and currency notes in Pakistan as well as abroad. SBP is launching the collection of Mr. Adil Salahuddin on this auspicious occasion of our Independence Day. At the end, I would like to say that the State Bank of Pakistan is one of the few institutions that are the pride of the country. In spite of hazards and challenges, it has made great strides towards the goal of taking the economy to new heights. Our vibrant banking industry is an example of the unremitting efforts that the past and present employees of the SBP have been making. We still have a long way to move forward. There are many, many milestones that remain for us to conquer. Let us make a firm resolve today that we will live up to the ideals of the Quaid-e-Azam and further our efforts to achieve the ends for which the State Bank of Pakistan was established. BIS central bankers’ speeches | state bank of pakistan | 2,015 | 9 |
Address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan and Chairman of SAARCFINANCE, at the 7th SAARC Finance Ministers' Meeting, Kathmandu, 20 August 2015. | Ashraf Mahmood Wathra: SAARCFINANCE – sharing experiences on macroeconomic policy issues among South Asian member countries Address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan and Chairman of SAARCFINANCE, at the 7th SAARC Finance Ministers’ Meeting, Kathmandu, 20 August 2015. * * * Honorable Chairman, Honorable Ministers, His Excellency, SAARC Secretary-General, Distinguished Guests, Ladies and Gentlemen: Good Afternoon/Namaste/Namskar/Aaiban and Assalamualaikum. 1. I feel honored and privileged to have been invited to this eminent gathering in the capacity of chairman of SAARCFINANCE network. I am thankful for providing me the opportunity to get your feedback on our activities and future direction. 2. It was during the 10th SAARC Summit, held on 29th July 1998, that the Heads of States of the region agreed in principle to establish a Network of Central Bank Governors and Finance Secretaries of the region. The core objective was to have a forum for dialogue on macroeconomic policies of the region and sharing mutual experiences and ideas. Accordingly, the SAARCFINANCE was established on 9th September 1998 as a regional network of the SAARC Central Bank Governors and Finance Secretaries, which, during the 11th SAARC Summit, held in Kathmandu, Nepal in January 2002, got formal recognition as permanent body of the SAARC. 3. More specifically, our terms of reference include: promoting cooperation among central banks and finance ministries in the member countries by regular exchanges of information and staff exchange programmes, working towards a more efficient payment mechanism within the region, striving for higher monetary and exchange cooperation, forging closer ties on macroeconomic policies, and sharing of experiences and ideas. 4. I am pleased to inform your Excellencies that over the years, a number of useful initiatives have been taken by the SAARCFINANCE to achieve the objectives envisaged in its terms of reference. The details of the activities, following various initiatives, have been continuously shared with you through the SAARC Secretariat in the form of progress reports. Honorable Chairman, 5. Let me first start by describing our work mechanism. Two meetings of SAARCFINANCE Network take place annually: one alongside the IMF/World Bank Annual Meetings, while the other one is held within the SAARC region. Since its inception, the SAARCFINANCE has held thirty meetings of the Network. For smooth functioning of this network, dedicated SAARCFINANCE Country Cell has been established in member central banks, where the work is supervised by a SAARCFINANCE Coordinator with support from an Alternate Coordinator. For effective coordination with Ministries of Finance of the region, one SAARCFINANCE focal point has also been appointed from each country. Further, the Network has a rotating Secretariat which shifts to the member central bank holding the Chair, rotating annually in an alphabetical order. During the 29th Group Meeting held on 9th October 2014, the SAARCFINANCE chair was shifted to State Bank of Pakistan. BIS central bankers’ speeches Honorable Chairman, 6. I will now proceed to a presentation of our activities. In doing so, I will take the liberty to present our progress of the past few years since it has been a while that the SAARC Chairman has been invited to this forum, to be precise since 2013. 7. As a part of its core objectives of information sharing and sharing of expertise, the Network holds regular staff exchange programmes. These programmes provide an excellent opportunity to the officials of the member central banks to learn from each other’s experience and expertise. Since 2013, the network has facilitated around 35 staff exchange and training programmes. To facilitate information sharing, a number of regular and non-regular publications and other documents, especially on policy issues, are exchanged among the member institutions. Similarly, the Network arranges seminars, workshops and symposiums on regular basis. For example since 2013 ten seminars and three Governors’ Symposiums have been organized. The subjects of these programs cover varied topics. To name a few: monetary policy framework, central banking operational procedures, banking supervision, currency management, internal audit, and human resource management. Similarly, the Network has initiated a scholarship scheme for capacity building of the officials of SAARCFINANCE members. This is a relatively newer initiative and so far 5 officials have been awarded scholarships for PhD and Masters programmes. 8. To further facilitate information sharing, every member central bank has created a web folder on their official websites. The Network has its own official website, which provides an informed platform to all members for disseminating important information contents. Furthermore, a SAARCFINANCE Portal has also been created which serves as a powerful tool to retain institutional memory of our Network. The portal enables SAARCFINANCE central banks to share experiences and hold online discussions on issues of mutual interest. As you know this Portal was launched in Islamabad during our Group Meeting in June 2013. 9. The SAARCFINANCE e-Newsletter is another important source of information sharing which embodies useful information about each member economy, its latest monetary policy stance, key macroeconomic indicators and summary of the activities taken place under the aegis of SAARCFINANCE. Recently, we have published 17th edition of the e-Newsletter. The frequent staff exchanges and increased level of information sharing have been greatly beneficial in fostering close relationships and building expertise and human capital on the practical side of the central banking field. Honourable Chairman, 10. The SARCFINANCE network has also marked another important mile stone by highlighting the importance of economic research in the form of collaborative research study arrangement. This arrangement, as a fresh initiative, is expected to focus on areas having some regional significance and common economic interests. Thus far two topics have been selected under collaborative research study arrangements, which are: (a) Managing Capital and Remittance Flows in SAARC Region for Safeguarding Financial Stability, and (b) Promoting Financial Inclusion in the SAARC Region. The modalities for collaborative research studies have also been recently accorded approval. To facilitate the collaborative researchers, State Bank of Pakistan hosted the 1st meeting of researchers for collaborative study on Monday 17th of this month in Islamabad. We hope that the collaborative research work would not only help strengthen our understanding on the impact and intensity of economic and financial shocks to our economies but would also open up new areas of cooperation in responding collectively and cohesively to these shocks to minimize their adverse implications. 11. To facilitate region-specific research activities, the SAARCFINANCE has initiated the development of a regional statistical database. In this context, the core dataset has already been identified based on the availability of data with SAARC central banks. The BIS central bankers’ speeches database will be created on Oracle platform, with easy search and accessibility. It will also be made available free of cost to the general public. We have also planned to house the database on SAARCFINANCE website with links to websites of all member central banks. This is likely to provide a boost to research in the field of economics and finance in the SAARC region. 12. Let me now turn to our efforts on strengthening financial and economic cooperation in the region. As you know, the Network has developed a framework for currency SWAP facility. The main objective of this facility is to meet any balance of payments difficulty and short-term liquidity needs. RBI has offered the facility which is available to all member countries in specific conditions. Under the facility, the requesting member countries can make withdrawals in US dollar, Euro or Indian Rupee in multiple tranches. So far, Bhutan and Sri Lanka have availed the aforesaid facility. This kind of agreement also helped promoting economic cooperation between member countries, besides providing them a back-stop arrangement to meet their balance of payments difficulties and short-term liquidity needs arising from market turbulence. 13. Now, turning to our objective on forging closer ties in macroeconomic policies, the progress has been slower. In my humble opinion, this I think is one area in which much more can be done given the nature of our common shocks, configuration of our economies and our cultural ties. This however, will require inter and intra agency collaborations, which is why this is so challenging. Nevertheless, let me highlight three ways in which we think we have made progress to meet this objective. 14. First, the Governors’ symposium, which happens on the sidelines of the regional group meeting, has been playing an important role in terms of discussing and comparing solutions to common economic issues chosen by the Governors. For example, the latest symposium showed the stark differences on our approaches to microfinance and the regulations of this sector. Second, it is becoming a tradition to complement the regional group meetings with a lecture by an eminent personality. The first of these lectures was organized in Islamabad’s group meeting in June 2013 and delivered by Prof. Ha-Joon Chang, while the second one was recently organized in Dhaka and delivered by the Governor RBI, Raguram Rajan. This is an encourageable development since it helps policymakers at the highest level to debate grand issues and policy designs. Third, the SAARCFINANCE network initiated a meeting of senior economists to discuss economic conjecture of member countries. The idea is to share and compare notes on economic policy experiences, albeit informally and at an executive level. The first of these meetings were held in Islamabad in June 2013, which could also be followed by member central banks. 15. Although, these three steps represent ways in which important economic issues of common interest are debated, they fall short of economic policy coordination within the member countries. We hope that the new collaborative research programme will mature and also help policy makers to start discussing and evaluating the possibilities of coordinating policies on the basis of evidence-based outcomes. Concurrently, we can start broaching the idea of SAARCFINANCE as an economic alliance to meet the challenges of the future. 16. Let me now turn my attention to the long term. To set a future direction and priorities for SAARCFINANCE, currently we are in the process of developing a roadmap for the Network. In this context, we have identified five areas of regional cooperation and integration, which include: (i) reducing the transaction cost of cross-border remittances in the SAARC region; (ii) facilitating the cross-border trade in the region; (iii) capacity building programmes for our staff; (iv) the creation of SAARCFINANCE statistical database; and (v) undertaking of collaborative research studies. Out of the five areas, the first two are ambitious programs, the next one is about the capacity building of the officials of members, and the work on other two projects is already going on. With your support, we believe that these five areas of cooperation will initially form the roadmap for SAARCFINANCE and would help set a clear direction and priorities for our future cooperation. BIS central bankers’ speeches 17. All the above identified areas are important. However, I would like to highlight the role of central banks in facilitating the cross-border trade. I believe that the regional central banks have the ability to form cohesive policies towards gearing up cooperation in banking and finance with a view to facilitate cross border trade and investments. Similarly, we further intend to integrate and improve our payments and settlement system. Among others, the cooperation on this specific area would help promote bilateral and regional trade besides strengthening financial infrastructure in the region. 18. Before I make my concluding remarks, I would like to record one proposal. “The SAARC Secretary General or his representative is invited for participation in regional Group Meting only. It will be appropriate to invite SAARC Secretary General or his representative into SAARCFINANCE meetings to ensure effective liaison with all SAARC bodies”. Second is a request to Honourable Finance Minister of Maldives. For the last one a half years Maldives Monetary Authority has not been representing our meetings or events. In this context, I would request Honourable Finance Minister of Maldives to look into this issue and facilitate us with MMAs participation in our various meetings/events in future. Honourable Chairman, 19. Let me conclude by saying that the SAARCFINANCE Network has made considerable progress in achieving the objectives as envisaged in its terms of reference. However, this is merely the beginning of a long journey which requires us to accelerate our efforts to make this network more effective. We may also need to take more initiatives and identify areas where we can further deepen our cooperation. Also, the future role of the SAARCFINANCE will become more challenging in the wake of ever-growing competition and growing economic and financial integration in the SAARC region. In this context, the regional central banks would need to join hands with other SAARC bodies and enhance coordination with them, especially with SAARC Chamber of Commerce and Industry, as it is engaged in promoting cross border trade and investment flows. We would also need to play an active role at IGEG on financial issues. I am confident that our collective commitments, level of cooperation & information sharing, and efforts towards better shaping the future course of the SAARCFINANCE would be instrumental in meeting the challenges confronting us in the fields of economy and finance. With this update, I thank you for giving me this opportunity and your continued support to the SAARCFINANCE Network. BIS central bankers’ speeches | state bank of pakistan | 2,015 | 9 |
Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the National Institute of Banking & Finance (NIBAF), Islamabad, 16 May 2016. | Ashraf Mahmood Wathra: Payment systems and correspondent banking in the SAARC region Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the National Institute of Banking & Finance (NIBAF), Islamabad, 16 May 2016. * * * Ladies and Gentlemen: Assalam-o-Alaikum and Good Morning. I am privileged to welcome all the distinguished participants and speakers on behalf of SBP, my colleagues and SAARC friends at the seminar who have gathered here today to exchange views on payment systems and correspondent banking. At the outset, let me share with you that since the 10th SAARC summit in 1998, the SAARCFINANCE Group has been a key gateway that has allowed regulators to gather at the forum and share their experiences about the efficacy of the existing policy framework, identify the emerging challenges, and brainstorm ideas to tackle these challenges. Over the years, the SAARCFINANCE Group has taken a number of constructive initiatives to achieve the objective of regional economic cooperation and trade facilitation. Since the year 2002, State Bank of Pakistan has been organizing seminars under the umbrella of SAARCFINANCE; these events have covered topics as diverse as monetary policy, SME financing, BASEL-II, consumer protection, risk management and internal audit. One of the major objectives of the SAARCFINANCE Group is to strengthen payment mechanisms to boost intra-regional trade. To achieve this, I feel it is imperative that regulators, especially those from our region, interact and coordinate with each other to address the policy gaps and bottlenecks impeding intra-regional trade, commerce and remittance flows. During the last few years, State Bank of Pakistan has taken a number of steps to improve the efficiency of our domestic payment system. We have a comprehensive Payment Systems Act, a well functioning RTGS, and a Branchless Banking system that provides payment related services to ordinary customers through an expanding network of around 300,000 agents. We also have the Pakistan Remittance Initiative (PRI) that is playing a significant role in facilitating overseas Pakistanis in sending home remittances through legal channels, in partnership with commercial banks. Pakistan has also implemented the International Bank Account Number (IBAN), which plays an important role in integrating various domestic and cross border payment systems. Recently, we have also issued regulations governing the security of internet banking services offered by commercial banks to ensure that international security standards are being implemented in the banking system. Ladies and Gentlemen! The world is now more inter-connected; this offers not only benefits but also poses risks for our banking and payment systems. Due to rapid technological innovations, consumers are now especially demanding instant funds transfer facilities, both at domestic and cross border levels. We need to understand these changing consumer preferences and find ways to address them. This is vital, not only for the growth of domestic and regional trade and commerce, but for facilitating home remittance transfers by overseas nationals as well. At the same time, we cannot afford to ignore the risks related to anti money laundering and counter financing of terrorism (AML/CFT) that are increasingly being faced by financial institutions in today’s world. You are all aware that correspondent banking is the contractual relationship between banks that provide payment services for each other. However, as identified by international stakeholders like BIS and the World Bank, correspondent banking relationships are weakening due to various factors, such as higher costs and increased KYC requirements, especially for firms operating in risky jurisdictions. As a result, smaller banks in weak jurisdictions have suffered the most. BIS central bankers’ speeches To address these weaknesses, Central Banks of the SAARC region must work together and support banks in their respective countries in addressing these challenges. This can be done through policy development that supports mutual coordination and communication with regards to sharing of customer due diligence information and effective compliance with AML/ CFT regulations, as recommended by international bodies. The regulators can, therefore, focus on the following broader areas: First, A risk-based approach needs to be adopted to identify, assess and understand money laundering and terrorist financing risks in the area of correspondent banking, and the corresponding AML/CFT measures that are largely implemented but still needs more reinforcement. Banks also need to be more proactive in their customer due diligence by gathering and sharing sufficient information among themselves, in a timely manner. Second, as highlighted by the Financial Stability Board (FSB), the reduction of correspondent banking relationships or what is now commonly called DERISKING has implications for financial inclusion in general and for the remittance transfer business in particular. This is important because financial inclusion has lately emerged as a priority policy objective for many central banks in developing countries across the world. Therefore, regulators need to take steps to address this issue. And finally, the importance of modern and robust domestic payment systems in strengthening and complimenting correspondent banking in a particular jurisdiction cannot be overemphasized. Some recent events related to security breaches in banking sector underscore the importance of enhanced safety and security measures, especially in the domain of international payments. Ladies and Gentlemen, Now, there is no denying that a direct implication of these measures will be an increase in the cost of correspondent banking services and consequently cost of transactions to tackle this, innovative solutions need to be explored. For example, in the SAARC region, we can create a correspondent banking model that will facilitate smaller banks and provide services at lower cost, while also adequately managing risks. One way of doing this can be to designate one bank in each of our countries that will provide correspondent services to all the respondents in their respective jurisdictions. These designated correspondent banks can then interact with each other to facilitate payments and settlements within the SAARC region sounds primitive but can be good starting point. This, I am sure, will reduce transaction costs, while at the same time mitigate risks, especially those related to anti money laundering and counter financing of terrorism. Finally, I will request all of you to take full advantage of this seminar to discuss the challenges facing the correspondent banking business and then suggest regulatory measures that can be adopted to strengthen the regional correspondent banking framework. A modern, intra-regional payment and trade facilitation system is paramount for our collective economic growth and prosperity. I wish you a pleasant stay in the beautiful city of Islamabad and hope you find time to explore the surroundings. Thank you. BIS central bankers’ speeches | state bank of pakistan | 2,016 | 7 |
Keynote address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the World Islamic Finance Forum (WIFF), Karachi, 5 September 2016. | Key Note Address by Ashraf Mahmood Wathra Governor, State Bank of Pakistan World Islamic Finance Forum (WIFF) September 05, 2016 Respectable Senator Muhammad Ishaq Dar, Federal Minister for Finance, Revenue, Economic Affairs, Statistics, & Privatization, Justice (R.) Muhammad Taqi Usmani, Dr. Ishrat Hussain, Chairman, Dr. Azmi Omar, Director General, Islamic Research & Training Institute, Professor Dr. Abbas Mirakhor, Dr. Farrukh Iqbal, Dean and Director, Center of Excellence in Islamic Finance Education-IBA, Distinguished Guests, Ladies & Gentlemen Assalam-o-alaikum It gives me immense pleasure to see global strategic players like International Centre for Education in Islamic Finance, The Islamic Research and Training Institute, International Shari’ah Research Academy for Islamic Finance (ISRA) joining hands with the Centre of Excellence in Islamic Finance Education, IBA for organizing World Islamic Finance Forum in the largest city of Pakistan. This is a clear reflection of Pakistan being a significant contributor towards the growth and development of Islamic finance industry. I want to appreciate the Page 1 of 6 organizers for providing this forum bringing together global thinkers and practitioners who can synthesize the work so far done and build on the core competencies of Islamic finance for its sustainable growth. I wish all the best for the success of this global event and a very pleasant stay to the distinguished foreign delegates. Ladies & Gentlemen The ability of Islamic finance to introduce greater discipline into the financial system owing to its inherent strengths indicates this system is relatively more stable and resilient. Islamic banking is a growing reality which is expanding outside the traditional borders of Muslim countries into western economies; at present global Islamic financial assets have reached US $1.8 trillion in 2015 from US $150 billion in the 1990s and are expected to exceed US $6.5 trillion by 2020. Asia is expected to be the key driver in advancing the growth of the Islamic finance industry; according to Islamic Financial Services Board’s (IFSB) Report, 2015, Pakistan is among potential leaders of Islamic finance. Despite its impressive growth, Islamic finance Industry cannot be complacent as there still prevails huge untapped market. There are some challenges that the industry is facing in order to sustain its growth Page 2 of 6 momentum. I would like to touch upon some of these challenges with respect to the theme of this event. Enabling supervisory, regulatory and legal environment, a suitable accounting and auditing framework and supportive financial market infrastructure are all pre-requisites for successful development of the industry. It is agreed that prudential supervision on banks is just as necessary in an Islamic system as in conventional systems, however, the supervisory framework needs to recognize special characteristics of Islamic banks in order to be more effective. State Bank of Pakistan (SBP) being the regulator of banking sector is aware of the significance of prudent and effective supervisory framework and remains committed to this end. Improving market development and regulatory regimes are continuous processes in the context of changing industry needs and overall macroeconomic environment; therefore, we regularly review and update our regulatory framework. In this regard one significant example of recent past is the issuance of Shariah Governance Framework for Islamic banking institutions which has enhanced the earlier issued Shariah compliance regulations for the industry. Moreover, we are working on improving regulatory and legal infrastructure by providing a balanced tax regime, enhanced disclosure requirements, strengthening of insolvency framework and standardizing Page 3 of 6 practices. By taking the advantage of having global audience here, I would suggest for a dialogue at global level for harmonization and standardization of practices all across Islamic finance industry. Ladies & Gentlemen Many researches including the Knowledge, Attitude and Practices of Islamic banking in Pakistan (KAP) Study issued by the State Bank of Pakistan indicated the concentration of demand for Islamic financial industry in the category of clients who are not only faith sensitive but are also responsive to efficient operations and high quality services. This signifies that the strategy of Islamic banking industry should be customer centric in its proposition, delivery and service. This demands for widening product range, improvement in operational efficiency and service quality. I would take this opportunity to urge industry to take full advantage of these Centres of Excellence with particular respect to product innovation and for conducting research on contemporary issues. As a system, Islamic Finance facilitates in stimulating economic activity and entrepreneurship towards promoting comprehensive human development and addressing poverty and inequality. Under this system, not only the prevalence of re-distributive instruments such as zakat, waqf (endowment) and sadqaat (charity) can play vital role towards broad based development and poverty alleviation but characteristics like Page 4 of 6 equity financing can also lead to the same objective. Equity financing enables Islamic finance to cater to needs of unconventional but strategic sectors like small and medium enterprises (SMEs), agriculture and low income housing. However, like many other jurisdictions, the penetration of banking industry and especially of Islamic banks to these sectors is very low in the country. Lack of skilled professionals and relatively young age of the industry is quoted as one among major reasons in this regard. Centers for Excellence for Islamic Finance Education have been established with the main objective of providing human resource for the industry with desired skills and knowledge. Closer interaction between industry and these centres is critical in making Islamic Finance & Banking successful in Pakistan. I would also like to encourage industry to make use of technology especially to cater to these sectors to minimize cost. By expanding the range and reach of financial products, Islamic finance can help in improving financial access and foster the inclusion of those deprived of financial services whether voluntary or involuntary. Ladies & Gentlemen While growth is likely to continue at reasonably fast pace, issues and challenges confronting the industry need attention and ownership on part of all stakeholders. The huge untapped potential market of Islamic Finance can be harnessed by capitalizing on its distinct characteristics. I Page 5 of 6 would encourage all Islamic financial institutions to actively engage themselves and be recognized as value embedded, efficient financial players committed towards contributing to the real economic growth. I am optimistic about the future outlook of the industry and events like today’s are helpful in mapping out a strategy for sustainable growth of the industry. I assure the full support and cooperation from the central bank. I wish you successful deliberations during the conference and the best of luck for all future endeavors. Thank You. ______________________________________________________ ____ Page 6 of 6 | state bank of pakistan | 2,016 | 10 |
Opening address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at a seminar with Her Excellency Ms Christine Lagarde, Managing Director of the International Monetary Fund, Karachi, 24 October 2016. | STATE BANK OF PAKISTAN Opening Address by the Governor SBP Seminar with Her Excellency Ms. Christine Lagarde, Managing Director IMF Emerging Markets in the World Economy” 24th October 2016 • Her Excellency Madame Christine Lagarde, Managing Director IMF, • Hon’ble Senator Mohammad Ishaq Dar, Federal Minister for Finance, Revenue, Economic Affairs, Statistics, and Privatisation, • Esteemed Diplomats • Learned scholars from academia, • Heads and representatives of national and international financial institutions, • Government officials, • Friends of Media, • Distinguished Guests, Ladies and Gentlemen, I warmly welcome you all to this seminar! First, let us all greet Her Excellency Ms. Lagarde on her visit to Pakistan and thank her for gracing today’s seminar as the Keynote speaker. Armed with her remarkable credentials, Ms. Lagarde has not only led the IMF judiciously during a time of global economic and financial stress, but in fact it has been under her leadership that the IMF has forged successful collaborations with many emerging countries for their economic betterment. Most of these countries have now overcome their short-term external imbalances and adopted better standards of governance – and you can be sure they know exactly who to thank! Befittingly, we will request Ms. Lagarde to enlighten us today on the role of emerging markets in the world economy, drawing on her invaluable insights and extensive firsthand experiences. STATE BANK OF PAKISTAN Ladies and Gentlemen, The relevance of the topic for Pakistan is high, as it is an emerging economy with a large population. When we observe the evolving global economy, it is evident that emerging markets face a unique set of challenges, but if managed well, the results have far reaching implications for growth. However, economic developments do not occur in a vacuum; in fact, they often precipitate a host of new considerations, such as income inequality, social security, environmental concerns, and so on. Moreover, for any progress to be truly sustainable, the need for macroeconomic stability in general – and financial stability in particular – is a matter of paramount significance. Ladies and Gentlemen, It was within this context that Pakistan – faced with a balance of payments crisis – embarked upon the IMF’s External Fund Facility Program in September 2013. At that time, the economy was mired in persistent energy deficiencies, declining development expenditures, rising inflation, and meager foreign exchange reserves. As a result, the country’s economic potential was on the decline and investor confidence was badly shaken. There was a need to reform policies and systems which could be instrumental in reversing the meltdown and add to the well being of Pakistanis. I believe that the Government took the right step to enter the IMF program at that crucial juncture. Furthermore, its sincere efforts and commitment have been instrumental in driving the program to a successful completion. Indeed, the Government and State Bank of Pakistan have worked hard together to achieve this goal, and restored the much needed stability and stakeholder confidence in doing so. Before I go on to highlight the achievements of this Program, let me make two things clear: One, no IMF Program is an easy program. This explains why Pakistan has never in the past completed an IMF program. The fact that we have completed one also shows the STATE BANK OF PAKISTAN seriousness towards reform. Two, having completed the IMF program, one should not be complacent about what remains to be done. Specifically, on the continuous consolidation of the macroeconomic stability gains we have made and the reforms that remain to be done. Let us briefly look at some evident achievements made during the program. Under the program, establishment of an independent Monetary Policy Committee and publication of minutes of the Monetary Policy Committee meetings, besides enhanced SBP autonomy, is expected to bring further transparency in monetary policy decision making. In plain words, these reforms provide us with a superior and structured decision–making technology. Similarly, strengthening of the internal operations of SBP, improvement in capital adequacy of banks, enactment of Credit Bureau Act, amendments to Anti Money Laundering Act, promulgation of Deposit Protection Corporation Act, and amendment to Financial Institutions Recovery Ordinance, are the major reforms that would increase financial sector resilience against any domestic and external shock. Indeed, these reforms directly address bank runs and related financial crisis. Further, amendments in Fiscal Responsibility and Debt Limitation Act to enhance fiscal prudence, removal of Federal Board of Revenue’s powers to grant exemptions through issuance of Statutory Regulatory Orders and removal of tax exemptions are critical reforms that will go a long way to support a sustained increase in tax revenues. These reforms and range of other actions taken by the government have produced concrete results. These have not only helped the country to build the foreign exchange reserves and provide stability to foreign exchange market – a direct consequence of the program, but also supported a sustained increase in tax revenues, lower fiscal deficit, and a significant reduction in direct fiscal borrowings from State Bank of Pakistan. STATE BANK OF PAKISTAN Overall, the improvement in economic environment has supported the revival in real private investment and gradual recovery in economic activity with well anchored inflation expectations. In light of this consolidation, and factoring in an improved security situation, the future for Pakistan is very encouraging. Backed by concrete reforms, I am confident that real GDP growth – which has shown improvement in the last three years already – is poised to continue on an upward trajectory. Ladies and Gentlemen, Before we move on, I would like to take this opportunity to acknowledge and congratulate the Prime Minister, Mian Muhammad Nawaz Sharif, who mandated, took tough political decision, and spent his political capital for the success of the IMF program. I would also like to acknowledge Finance Minister, Senator Mohammad Ishaq Dar, who led and coordinated the program with relentless energy and deep acumen, while providing space and support to the Central Bank to strengthen institutional credibility. Here, I also wish to recognize the commitment, professional standards and technical expertise of the IMF team, under the able guidance of Mission Chiefs, Mr. Harald Finger and Mr. Jeff Frank. Indeed, they deserve special accolades. I have fond memories of long hours of tough discussions and negotiations. There are other members of Pakistani team who actively supported and worked hard, but, due to paucity of time, cannot be named here. I, however, cannot resist naming a few whose contribution to the success of this program remains remarkable. These are Finance Secretary, Dr. Waqar Masood Khan; current and former Chairmen of FBR, Mr. STATE BANK OF PAKISTAN Nisar Muhammad Khan and Mr. Tariq Bajwa; and Chairman Privatization Commission, Mr. Muhammad Zubair. Last but not the least my own staff and the able members of our Independent Monetary Policy Committee. Two final points before I conclude. First, for reforms to take place, the timing and the sequencing matter. In this program, perhaps in more than any other programs in the past, these two factors were taken into consideration and probably these strategically contributed much to reaching the finish line as much as to actually implementing the innovative changes themselves. Much remains to be done. Second, there is a specific reason why I thanked many personalities moments ago. It is that the power of a shared-goal, which we achieved on this occasion, and the productive synergies that this common-path creates is my own greatest lesson from the exercise we have concluded: Together is better. Thank you! | state bank of pakistan | 2,016 | 10 |
Address by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, for the Bloomberg Economic Forum, Karachi, 23 November 2016. | State Bank of Pakistan “Improvements in Pakistan’s Economy and Opportunities for Investment” Governor’s Address for Bloomberg Economic Forum November 23, 2016; Karachi Distinguished guests, Ladies and gentlemen, Assalam-o-alaikum! I would like to begin by thanking Bloomberg for organising this discussion, and for inviting me to speak on the improvements in Pakistan’s economy and the opportunities for investment these improvements have opened up. As Pakistan enters the next phase of its growth story, I feel that it is important to take a dispassionate look at the past three years, and see how far along we have come, as a country. A review of some key macroeconomic indicators is in order here. From FY09 to FY13, real GDP growth averaged just 2.8 percent; this increased to above 4 percent over the next three years. In fact, real GDP growth touched an eight-year high in FY16. Meanwhile, the government’s ongoing fiscal consolidation efforts limited the average budget deficit to 4.6 percent in FY16, against 8.2 percent in FY13. Moreover, the country’s foreign exchange reserves continue on their rising trajectory: the country’s FX reserves are now hovering around US$ 24 billion, which are enough to finance over seven months of the country’s import bill. To put this in context, just three years back, our reserves couldn’t even finance three months of imports! At this point, you might be tempted to ask, what has driven this improvement? The answer is prudent economic policies – on the monetary, fiscal and industrial fronts. SBP’s decision to keep interest rates at record lows encouraged the private sector to opt for bank loans and finance key projects. On the external front, the support lent by the sizable reduction in global oil prices figured prominently, and helped offset export sluggishness. Remittance growth during the period also remained strong and financed the trade deficit to a great extent. And Pakistan’s continued engagement with the IMF and other IFIs, and its re-entry into the international capital market, ensured that the country was not only able to easily make its FX payments, but also accumulate foreign exchange. At the same time, the government’s sharp focus on addressing the energy constraints has stimulated industrial activities. Besides, as you are all well aware, the security situation in the country, including Karachi, has improved considerably. These improvements on the economic and security fronts have bolstered investors’ views about Pakistan. Just last month, Standard and Poor’s upgraded Pakistan’s sovereign rating, and the country was able to issue a US$ 1 billion Sukuk in the international market at extremely competitive rates. Speaking of challenges, the first and foremost is the export decline, which entered into 10th straight quarter in Q1-FY17. The comfort provided by remittances, in terms of covering the trade deficit, has also weakened lately. On the fiscal side, the government is committed to meeting the Economic Policy Review Department State Bank of Pakistan budget deficit target for this year, without compromising on essential development spending. This will be crucial from public policy standpoint. And most importantly, as SBP economists recently highlighted in our Annual Report, we have to focus on social sector of the country in order to improve living conditions of the population. Although we have made a lot of progress in the field of financial inclusion and social safety nets, like BISP, the key sectors including health, education and other civic facilities still need more resources. So, all in all, I would say that it is crucial how carefully the country is able to leverage the hardearned macro stability to drive economic growth and social sector development going forward. In this backdrop, the role of private sector cannot be overemphasized. The private sector is the engine of growth in all leading economies of the world, with governments largely providing an enabling policy environment and playing a regulatory role. In Pakistan, due to a variety of reasons, the private sector has not been able to play as active a role in development as one would have hoped. Ladies and gentlemen! On our part, we truly believe that the private sector needs to be supported as long as it is willing to invest not only in physical capital, but also in capacity-building and skill-enhancement of human resources. To promote domestic investment, State Bank has not only brought down borrowing costs for all businesses by its easy monetary policy stance, but it has also put in place refinance facilities for exporters to cater their working capital requirements and technological up gradation needs. SBP has also facilitated the federal government in establishing the EXIM Bank to enhance export credit and provide export credit guarantees and insurance facilities. Furthermore, we have simplified documentary procedures for businesses to expedite processes; for instance, exporters can now electronically file Form-E without visiting bank branches. Similarly, SBP is making all out efforts to boost economic activities at small and medium level: our initiatives in this arena include: introduction of SME financing targets for banks/DFIs; credit guarantee scheme for small and rural enterprises; efforts for putting in place a secured transaction registry in the country; and separation of prudential regulations for small and medium enterprises. While concluding, I would like to draw your attention to the recent interest shown by foreign investors in the country’s economy. Corporate deals have been either concluded or are under discussion in sectors as varied as power generation and distribution, food processing, and automobiles. These examples offer just a glimpse of the huge investment potential that is available in the country. So, by utilising the financing facilities that are available, as well as record-low interest rates and low inflation, the private sector can take the lead role in the country’s economic development. With the strong domestic demand and improving business climate, the private sector has more reasons than ever before to take the driving seat. I thank you for your time! Economic Policy Review Department | state bank of pakistan | 2,017 | 3 |
Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the signing of the Share Purchase Agreement with the Consortium of Chinese Exchanges and local financial institutions, Karachi, 20 January 2017. | State Bank of Pakistan Governor’s Speech Share Purchase Agreement with the Consortium of Chinese Exchanges January 20th, 2017 Bismillah Hon’ble Senator Muhammad Ishaq Dar, Finance Minister of Pakistan Mr. Zafar Hijazi, Chairman SECP Mr. Munir Kamal, Chairman, Pakistan Stock Exchange Ambassador Peoples Republic of China Distinguished Guests, Ladies and Gentlemen, Assalam-o-Alaikum and Good Morning! I am very thankful to Pakistan Stock Exchange to invite me today at this historic occasion in our economic history. Can a single word be used to describe the prosperity of developed countries in the past few decades? If I were to answer this question, I would say collaboration. In this global world, it is not possible for economies to grow in isolation. Hence, it should not come as a surprise to anyone that the most successful countries are the one that work in tandem with their neighbors and/or trading partners. Pakistan and China are taking that exact path beyond which a great future awaits! Before I move any forward, please allow me to take you to a short visit down the memory lane when Pakistan economy was challenged with multiple headwinds. Be it war on terror that led to lower than desired security situation in the country, energy shortfalls, insufficient foreign exchange reserves, or lack of foreign investment; we have rebounded strongly than what was anticipated of us. With adequate economic policies and the assistance of international agencies, we have firmed up our feet on the ground. However, we did not stop there; we continued with our efforts to take our economic growth and public well-being to a higher level. To achieve those goals, Pakistan required the necessary impetus in the form of capital investment and opportunities. This is where the role of our closest friend and ally China has been instrumental! State Bank of Pakistan It is an applaudable step of a country like China to get integrated with the rest of the world. For this purpose, the country has rightly focused on the strategic location of Pakistan. The investment of China in Pakistan as just one route of its corridor has now begun a string of partnerships that would further strengthen the bond between the two countries. Ladies and gentlemen, one of the outcomes of those efforts is the reason that we have gathered here. The signing ceremony of share purchase agreement by the consortium of Chinese exchanges and local financial institutions is a surely a landmark event for the Asian capital market. The investment of the consortium will not only enhance the credibility of Pakistan Stock Exchange – which let me remind you has been the best performer of Asia in 2017, but will also make it accessible and desirable to a host of investors across the world. To further add, the technological improvement would be a further boost for trading within and outside the country. I am sure that the partnership of Pakistan Stock exchange with China will bear fruits by developing competitive and profitable securities and derivative products. The local financial institutions in this consortium have an important role to play as well. With the thorough understanding of the domestic markets and wellpoised to assist their foreign counterparts, the consortium would be instrumental in raising productive capital from both within and outside Pakistan. This capital would play a critical role for the corporate sector at a time when the ChinaPakistan Economic Corridor is in full swing. This is just the tip of the iceberg, ladies and gentlemen. With proper planning and execution, such future collaborations could be game turners for all the stakeholders. Not only would this help raising the economic growth of the country, but will also unlock the business-to-business and person-to-person barriers, and may be a good avenue to learn from each other in various fields such as banking, engineering, transportation, telecommunication, energy, and many more. To sum up, the possibilities are limitless. The key, ladies and gentlemen, would be to have an open mind and learn from the experiences of such co-ordinations in other parts of the world like the Trans-African Highway network, Pan-American and Pan-European corridors. Our year on year LSM growth in Nov 2016 is 8.1% compared with 4.5% in Nov 2015. Private sector credit expanded by Rs. 376 billion and is broad based in State Bank of Pakistan July-Dec FY 17 compared with Rs 283 billion in corresponding period 2016. Such good news will contribute to PSX and the investors sentiments. In the end, I would like to thank you all for your time, and congratulate you for making this step a success. God Bless! | state bank of pakistan | 2,017 | 3 |
Speech by Mr Ashraf Mahmood Wathra, Governor of the State Bank of Pakistan, at the Pakistan Banking Awards 2017 Launching Ceremony, Karachi, 27 March 2017. | PAKISTAN BANKING AWARDS 2017 LAUNCHING CEREMONY Ladies and Gentlemen – Assalm o Alaykum. After the tremendous success of the 1st Banking Awards in 2016, I am delighted to address this distinguished gathering of executives and academicians from the banking and finance sector at the Launching Ceremony of the 2nd Pakistan Banking Awards 2017. As you are well aware, the financial sector plays a pivotal role in determining the overall economic growth and development of a country. The contribution and achievements of the institutions contributing to this sector should be recognized and acknowledged. The initiative of launching the first ever Banking Awards by The Institute of Bankers Pakistan with Dawn Media Group in collaboration with A.F. Ferguson & Co in 2016, is indeed a landmark in the history of banking in Pakistan. I am delighted that these prestigious awards are now an annual affair and encourage new entrants to make their mark while motivating the established institutions to strive for excellence. These awards honor and promote the efforts of banks for developing new and innovative products and services, while giving them the incentive to enhance their performance for the coming year. They encourage the active participation of banks by setting the benchmark and allowing them to gauge their standing within the industry. Most importantly, they inculcate a spirit of healthy competition as the awards are a great source of pride for the winning institutions. The distinguished members of the jury selected are indeed institutions in themselves and are worthy to do the needful. I am confident that like in the past, this year again complete transparency and secrecy will be maintained and all nominations would be made exclusively on merit. This is the essence of building credibility of these awards. It is a matter of satisfaction from the view point of regulator as well that the performance and contribution of banks are being recognized by an independent body in a transparent manner. On behalf of the State Bank of Pakistan and the organizers, I urge you all to participate and make this magnanimous event a success. I wish you all the very best. | state bank of pakistan | 2,017 | 5 |
Speech by Mr Tariq Bajwa, Governor of the State Bank of Pakistan, at the opening ceremony at Mega Event Islamic Banking & Finance Awareness Drive - 2017, Karachi, 3 August 2017. | Governor : Mr. Tariq Bajwa Title : Islamic Banking & Finance Awareness Drive - 2017 Date : August 03, 2017 Event : Opening Ceremony at Mega Event Islamic Banking & Finance Awareness Drive - 2017 Venue : Movenpick Hotel, Karachi Dr. Ishrat Hussain, Chairman IBA Centre of Excellence in Islamic Finance Education, Dr. Imran Usmani, Shariah Scholar, Mr. Irfan Siddiqui, Chairman Steering Committee on Islamic Finance Media Campaign, members of the Dunya Media Group, Presidents/CEOs of Banks and Financial Institutions, Distinguished Guests, Ladies & Gentlemen; Assalam-o-alaikum I am pleased to be here today at the opening ceremony of the mega event of Islamic Banking & Finance Awareness Drive-2017 by Dunya Media Group which was aimed at creating awareness and removing misconceptions about Islamic banking and finance in the country. Dunya Media Group deserves appreciation on successful completion of this awareness raising venture. I am hopeful that results of this campaign will be long lasting due to effective collaboration among various stakeholders and arranging multiple programs for public and targeted groups like students and business communities all across the country. Ladies & Gentlemen; Growth of Islamic banking industry particularly over the last decade is reflective of increasing acceptability of its merits; the total global size of the Islamic financial assets by end 2016 has reached to US $ 2.29 trillion and is expected to go beyond US $3 trillion by 20201. However, practitioners of Islamic finance cannot be complacent with this growth especially in the backdrop of changing global infrastructure for the financial sector. Today there is more than ever a compelling environment for Islamic finance industry to capitalise on its inherent strengths like asset backed nature of financial Global Islamic Finance Report 2017 Page 1 of 4 transactions, being devoid of interest and prohibition against gambling, uncertainty and speculation to move away from the traditional business models and explore new opportunities. Talking about domestic industry, the fast growth of Islamic banking in Pakistan would not have been possible without sound regulatory, supervisory and Shariah foundations laid down by the State Bank of Pakistan under my illustrious predecessors. Promoting Islamic finance has remained an important component of strategic goals of the central bank. Overwhelming demand coupled with the support of the regulator and other stakeholders has contributed towards significant progress of the industry; Islamic banking industry by now constitutes 11.6 percent share in assets while 13.7 percent in deposits of the total banking industry with 21 banking institutions and more than 2,300 branches across the country. It would also be befitting to acknowledge the commitment and determination of the Government of Pakistan towards developing conducive infrastructure for growth of Islamic finance industry in the country. Formation of a high level Steering Committee for Promotion of Islamic Banking in Pakistan followed by formation of Implementation Committee for implementing recommendations of the Steering Committee, issuance of international sukuk after a gap of nine years and allowing tax neutrality for Islamic financial institutions and their customers through Finance Act 2017 are few examples in this regard. I would also like to take this opportunity to applaud other stakeholders of the Islamic finance industry for their strenuous efforts in achieving stellar growth. Ladies & Gentlemen; Islamic financial institutions have the potential to be major contributors towards growth and broad based development of a country owing to their closer link with real economic activities. However, in line with global trends the domestic industry is also concentrated in corporate clients and few big sectors ignoring others that are either unserved or underserved by conventional industry. I believe that given their risk sharing model and ability of financing ventures on the basis of their feasibility, Islamic financial institutions can penetrate into underserved sectors like agriculture, small & medium enterprises (SMEs) and housing, particularly low cost housing, which are sectors of paramount importance in terms of their contribution to inclusive and sustainable GDP, employment generation and overall development of the country. This will also contribute towards improving financial inclusion in the country. Recognizing the importance of these sectors, State Bank of Pakistan is persuading the industry to increase their financing to SMEs and agriculture sectors. We are assigning annual indicative targets to banking industry including Islamic banking institutions for SME and agriculture sectors. We at State Bank of Pakistan do not compromise on stability of the sector and hence fully acknowledge issues like adverse selection and moral hazard linked with participatory based modes of financing particularly to these sectors. However, this challenge demands the industry to diverge from traditional business approaches and develop adequate risk management framework through coordinated efforts. This can enable Page 2 of 4 industry to tap these strategically important sectors and create value for their shareholders, depositors and country’s economy as a whole. While talking about these unserved sectors I would also like to draw your attention to the fact that like any Muslim dominant country financial exclusion in Pakistan is voluntary and involuntary. Islamic banks can play a key role in minimizing both segments of this incidence. Along with significant faith-sensitive voluntary exclusion in the country the prevalence of huge unbanked population in rural and semi urban areas signifies an attractive opportunity for Islamic banks. You must be knowing that our survey based research study on Islamic banking “Knowledge Attitude and Practices of Islamic Banking in Pakistan” identified the potential greenfield growth for Islamic banking in the country. This implies that the true potential of Islamic banking industry of the country lies in underserved areas/sectors, particularly Balochistan, interior Sindh, south Punjab. However, Islamic banking branches are still concentrated in very few regions; 80 percent of Islamic banking branches are concentrated in eighteen big cities only. Moreover, at present the share of Islamic microfinance is insignificant, though, the inclination of Islamic banking institution towards this sector is encouraging. Ladies & Gentlemen; There are three challenges to rapid growth for Islamic banking: the first is developing new instruments to cover all aspects of banking. We as stakeholders of Islamic banking industry should recognize that we cannot move the industry to the next level of growth trajectory unless innovative Shariah based solutions for all financial services needs of the clients generally and business community particularly are developed. This highlights the need of research and development to be the core ingredient of the strategy of Islamic banking industry. The industry needs to establish knowledge sharing and research platforms to evolve strategies on how best to meet the surging demand for Shariah compliant products and services in Pakistan. To this end industry can capitalise on strengths and expertise of Centres of Excellence in Islamic Finance Education that have been established as research incubator and for the capacity building of the industry. Moreover, collaboration between academia, Shariah scholars and industry professionals can be established through these research centers which will allow synergies along with identifying priority research area. Ladies & Gentlemen; The second challenge is capacity building and awareness. The State Bank of Pakistan, as a regulator performs the role of facilitator for Islamic banking industry in the country. In this role, our major focus is on capacity building and awareness raising about Islamic banking and finance in the country. To this end we are not only using our training arm, National Institute of Banking and Finance (NIBAF) for undertaking multiple capacity building programs but have also been Page 3 of 4 supportive for such initiatives of industry and academia. While talking about human resource of Islamic finance industry, the discussion about role of Ulema in promoting Islamic banking and finance cannot be ignored. Fortunately we are among those countries which are regularly producing good number of Shariah scholars with many of those being of international repute. However, with the high growth of the industry, there still prevails demand supply gap. State Bank of Pakistan is using multi-pronged strategy to ensure adequate supply of Shariah scholars in the country; Not only NIBAF is conducting targeted customised programs for Shariah scholars but Centres of Excellence in Islamic Finance Education have also been specifically mandated to develop customised programs for Shariah scholars. From the platform of State Bank of Pakistan, efforts are also being made to encourage madaris to play their role in growth of Islamic finance industry. The third challenge, especially in the context of Pakistan, is that Islamic banking is to find Shariah compliant instruments for investment. As Islamic banks have excess liquidity, we are already witnessing this. Unless we are able to develop asset-based Sukuk, growth may become stunted in future. The State Bank in its Vision 2020 has set target of 20% of deposit with the Islamic banking by 2020 and this is very much a focus of our efforts as a regulator. We will be interacting with all the stakeholders to ensure that the challenges highlighted above to sustained and high growth in Islamic banking and finance to overcome. Electronic and social media platforms have become most effective mean of opinion formation and information dissemination. One of the major benefits of advancement in information technology and communication is empowerment of masses through access to information. State Bank of Pakistan is supporting the industry's mass media campaign which is aiming at creating awareness among public at large in addition to conducting seminars, conferences, targeted programmes and focused discussions for business community, academia, bankers and policy makers. We feel that such initiatives taken by Dunya Media Group & its peers would contribute in creating the much needed awareness regarding Islamic finance and improving perception of public at large. Ladies & Gentlemen; At the end, I would encourage and persuade all stakeholders to collaborate more effectively to address challenges faced by the industry. I assure you full support and cooperation from the central bank side to develop a vibrant industry on sound foundations I wish again the success to all future endeavours of the Dunya Media Group. Page 4 of 4 | state bank of pakistan | 2,017 | 10 |
Speech by Mr Jameel Ahmad, Deputy Governor for Financial Markets, Islamic Banking & Special Initiatives Cluster at the State Bank of Pakistan, at the CFA Society Pakistan: 14th Annual Excellence Awards 2017, Karachi, 30 August 2017. | Deputy Governor Title Date Event Venue : Jameel Ahmad : CFA Society Pakistan: 14th Annual Excellence Awards 2017 : August 30, 2017 : 14th Annual Excellence Awards 2017 : CFA Society Pakistan Speech of DG SBP as Chief Guest CFA Society Pakistan: 14th Annual Excellence Awards 2017 30 August 2017 Ladies and Gentlemen, Assalam-o-Alaikum and Good evening, I am grateful to the CFA Society, Pakistan for inviting me to the 14 th Annual Excellence Awards ceremony. It is indeed a matter of great honor for me to address this auspicious gathering of financial analysts and industry professionals. I hope that today’s session, apart from being a celebration of achievements, will provide the participants an opportunity to exchange views and share ideas on issues of professional interest. CFA Society Pakistan deserves appreciation for organizing such events to reward the high achievers and bring together the stakeholders. The role that CFA Society Pakistan has played, in terms of providing a platform for industry professionals to connect with each other and Page 1 of 5 exchange views, is laudable. With initiatives like “Putting Investors First” the CFA Society has put in commendable efforts, in collaboration with SECP, to inculcate awareness about investor rights and to establish the standards of professional excellence. This is in line with CFA’s focus on promoting high ethical standards and fair market practices. I am delighted to know that the society’s contribution to our financial markets and industry has been continuously growing. The role of CFA in capacity building of organizations is globally acknowledged. Despite, primarily, focusing on investment decisions, CFA is highly useful for other market participants including the regulators (such as SBP) for deep financial analysis, proactive monitoring and effective policy formulation. These wide-spread benefits are due to CFA’s broad coverage encompassing important dimensions such as ethical standards and business conduct, portfolio management strategies, fixed income world, risk management tools (e.g. hedging strategies) and analysis of economic environment, etc. SBP in its role of regulator and supervisor of banks, financial institutions and financial markets, values qualified human resource. International certifications, such as CFA, provide opportunity to harness necessary skills. SBP, therefore, encourages the promotion of CFA culture and it has developed strong relations with the CFA institute. SBP has signed MoU with the CFA institute, through which, a specific number of SBP employees can enroll in CFA program at a discount. As a result of these incentives, SBP now holds a decent number of CFA charter holders and expects the numbers to grow as more and more SBP officers pursue CFA certification. Ladies and Gentlemen, let me now shed some light on why it is necessary for all of us to equip ourselves with advance knowledge and tools proactively. The Global Financial Crises (GFC) has aptly demonstrated the havoc that can be caused when profit taking motive combines with lack of transparency and disclosure standards, inadequate awareness of sophisticated financial products, optimistic expectations about asset pricing and lax regulatory standards. The Global Financial Crisis forced the regulatory attention towards containing systemic risk and ensuring financial stability through strong capital and liquidity standards (such as Basel III), more stringent regulations, and introduction of macro prudential policy toolkit. Financial stability demands timely identification of systemic vulnerabilities along with mitigating measures to limit Page 2 of 5 the spillovers and keep the public confidence intact. Appreciably, CFA institute has updated its curriculum to address the key lessons learnt from the global crisis. Ladies and Gentlemen; Not surprisingly, ensuring financial stability has now become the number one priority of many of the central banks around the world. SBP is also playing a pivotal role in ensuring stability of the financial sector in Pakistan. In line with its Vision 2020’s focus on strengthening the financial stability regime in Pakistan, SBP has established a separate Financial Stability Department (FSD). An executive level Financial Stability Executive Committee (FSEC) has also been constituted within SBP which is entrusted with the responsibility of discussing and monitoring financial stability issues. Further, SBP and SECP have formed a Council of Regulators, which will act as a forum for deliberating issues related to systemic risk, particularly those having cross market stability implications. Work is also underway to form a National Level Financial Stability Council (NFSC) involving other stake holders such as Ministry of Finance. It is no secret that developed financial institutions act as a catalyst for enhancing financial intermediation, reduce information asymmetries and allow central banks to implement and achieve policy objectives. Monetary policy is, generally, implemented through money and foreign exchange markets where financial institutions, particularly the banks, play a pivotal role. If financial institutions are fairly mature, markets are efficient and there is low uncertainty, the effectiveness of monetary policy increases as the monetary signals are smoothly transmitted to the entire spectrum of the yield curve. SBP, through its various policies and initiatives, has been endeavoring to create an enabling environment for the financial institutions as well as the markets. Besides well functioning and stable financial system, SBP is striving to broaden the base of financial landscape through enhanced financial outreach. SBP has been driving “Financial Inclusion” as a strategic goal through a dynamic regulatory framework, development of market information and infrastructure, and capacity building of service providers and clients. The SBP Page 3 of 5 strategy is particularly focusing on promoting Agriculture, Micro and SME Financing, and Islamic Banking. I am quite confident that these measures will lead to product diversification, while enhancing efficiency through competition. Though our regulatory framework is well structured and able to contain the systemic risk so far, the financial sector of Pakistan requires further improvement in few areas. For example, (a) debt market activities are still limited, (b) financial penetration is quite low and corporate sector is not adequately tapping the capital market, (c) equity market, perhaps, needs more diversification and depth, (d) investor awareness needs to be further enhanced. Moreover, savings to GDP ratio – which act as a catalyst to spur investment growth - is considerably low in Pakistan if compared to its peer countries. To address all these issues, joint efforts are required from regulators, industry and government. SBP is well aware of these challenges. Within its supervisory and regulatory domain, it has taken several initiatives to remove market frictions, enlarge financial landscape and bring more transparency and efficiency in the financial system of Pakistan. The list may be quite exhaustive but in the interest of time I would like to mention few key developments related to financial markets such as (a) introduction of interest rate corridor and SBP target rate, (b) strengthening of FX reserves and deepening of FX markets, (d) broadening the scope of money market to include Islamic Financial Institutions, (e) diversifying the investor base for government securities and (f) strengthening of primary dealers. Further, SBP is always trying to align itself with international guidelines and best practices. Within the supervisory landscape, regulators around the globe are gradually shifting their focus from compliance based supervision to forward looking risk based supervision (RBS). RBS focuses on continuous identification and mitigation of key risks associated with financial institutions, while helping the regulators to allocate their supervisory resources optimally and effectively. SBP has also initiated work on migrating to RBS in order to advance its current supervisory regime and improve its supervisory efficiency. RBS would help SBP in prioritizing supervisory resources and articulating responses to financial stress besides more structured profiling of Page 4 of 5 financial institutions. It will also help SBP to identify the problem and institute corrective action on proactive basis. I would like to stress here that achieving high level goals such as strengthening and deepening of financial markets, ensuring financial stability, and bringing more efficiency and transparency in the financial sector will be possible only through our collaborative efforts and supportive role of the industry. We at the SBP are making continuous efforts to adopt international standards and best practices, which are well suited to our domestic financial structure and needs. SBP is also closely coordinating with the banking industry and other market players for seeking their input on new regulatory initiatives and aligning the existing regulatory framework with international standards. Obviously, effective implementation of global standards and best practices would not be possible without qualified people, both, within regulatory bodies and the industry. I am quite hopeful that professional capacity building through globally recognized certifications, such as CFA, will enable us to achieve these goals. At the end, I would like to offer my heartiest congratulations to the winners of the Excellence Awards today. I wish them all the best for their future accomplishments. I am, once again, grateful to you for providing me the opportunity to share my thoughts with you. Thank you for your attention. *** Page 5 of 5 | state bank of pakistan | 2,017 | 10 |
Speech by Mr Tariq Bajwa, Governor of the State Bank of Pakistan, at the Official Opening Ceremony of Bank of China Limited Pakistan Operations, Islamabad, 7 November 2017. | Governor Title Date Event Venue : Mr. Tariq Bajwa : Opening of BOC Pakistan Operations : November 7, 2017 : Official Opening Ceremony of Bank of China Limited Pakistan Operations : President House, Islamabad H.E. President Mamnoon Hussain, Honorable President of Pakistan, Mr. Chen Siqing, Chairman Bank of China, Distinguished Dignitaries and Guests, Ladies and Gentlemen, Assalam-o-Alaikum and Good Morning, It is a great pleasure to be here at the inauguration ceremony of Bank of China’s operations in Pakistan. I welcome Bank of China in Pakistan. This is indeed a very auspicious occasion as the two brotherly countries, Pakistan and China, further cement their ties in the fields of Banking and Finance. Banks are to an economy what lubricants are for a machine. Page 1 of 4 Going forward, I hope that Bank of China will play its due role not only in the economic development of Pakistan but also be a catalyst in further strengthening our bilateral trade and banking relationships. Ladies and Gentlemen! In contrast to the protectionist sentiments that are gaining momentum in some parts of the world, Pakistan and China present a distinct example of regional cooperation and harmony. The financial linkages between Pakistan and China are growing manifold. We are already host to Industrial and Commercial Bank of China Limited (ICBC). Recently, consortium of Chinese investors acquired forty percent shares in Pakistan Stock Exchange. Chinese investors have evinced interest in acquiring KE. I am also aware that other Chinese institutions are exploring the possibility of making investments in the financial and other sectors of our economy. Our banks have also been venturing into China and some of them have established branches and representative offices in China, such as Habib Bank Limited, National Bank of Pakistan, United Bank limited and Bank Al-Habib. With start of Bank of China operations, ties between Pakistan and China will strengthen further. Bank of China is not an ordinary bank. It is one of the big-four banks in China and is a Global Systematically Important Bank. It is ranked amongst the top global banks in terms of assets and has a significant footprint in over 50 countries. It brings with it a rich heritage of over 100 years of banking experience, practices, and knowledge. As Bank of China is a key partner in China’s “One-Belt One-Road” initiative, we expect that it will be able to effectively cater to the financing needs of CPEC projects by leveraging its specialized services and expertise. Presence of Bank of China in Pakistan is also expected to benefit the banking sector through technology transfers and associated innovation in products and processes, human capital development and improved competition and efficiency in the financial services. Further, increased diversity of foreign banks and access to external financial resources will facilitate in enhancing the resilience of our financial Page 2 of 4 sector. The financial sector assets in Pakistan as a percentage GDP are still low at 74.3 percent. The presence of world top banks like BoC will facilitate in exploiting this potential through enhancing the size of bank assets and the much needed access to credit. These growing banking relationships between Pakistan and China are critical considering that the trade linkages have increased manifold. In FY17 alone, China-Pakistan merchandise trade volume has increased to USD 12.2 billion from a level of USD 7.4 billion in FY13. With the China Pakistan Economic Corridor (CPEC) now taking shape in the form of completion of various projects, the trade and financial linkages between the two countries are set to increase exponentially in the near future. In this perspective, as the CPEC continues to mature and more infrastructure projects are initiated, Specialized Economic Zones are established, and trade starts to flow faster; more and more economic and business opportunities will be created for the banking sector that can be capitalized with careful business strategies. The demand for fixed investment and infrastructure loans particularly relating to the CPEC projects is expected to rise. Banks with relevant expertise in long-term project financing and resources such as the Bank of China would be the key player to meet this additional demand. I am confident that with growing cooperation the two countries would continue to grow with a sense of solidarity and mutual benefit. I understand that Bank of China also provides services and products designed to meet the banking needs of Small and Medium Enterprises (SMEs), across the various jurisdictions in which it operates. We, at State Bank of Pakistan, believe that the growth of SMEs is vital for country’s economic growth and provision of quality banking services and products in this area remains paramount. I hope that, we can learn from Bank of China’s diverse experience in serving this particular segment. State Bank of Pakistan is already facilitating banks in this regard and is willing to support them further. Page 3 of 4 Ladies and Gentlemen! The future prospects of China and Pakistan’s economic cooperation are very bright; more so in the wake of sustained improvement in Pakistan’s GDP growth resulting in growing investor confidence. This is reflected by rise in private sector credit especially the increasing share of fixed investment loans across wide segments of the economy. Monetary easing, stable prices, better availability of energy, and improved law & order conditions have created an enabling macroeconomic environment. As a result, the GDP growth in Pakistan increased to 5.3 percent in FY17 highest since FY07. Moreover, stable economic outlook of Pakistan coupled with high dividends expected from CPEC suggest a promising future. However, of course we will have to manage the challenge of the Current Account Deficit. In the end, I am confident that the emergence of Bank of China on the financial horizon of Pakistan will be beneficial for our banking industry and the growing linkages between our two brotherly nations would create a better future for all of us. Thank you very much. Page 4 of 4 | state bank of pakistan | 2,018 | 1 |
Keynote address by Mr Jameel Ahmad, Deputy Governor for Financial Markets, Islamic Banking & Special Initiatives Cluster at the State Bank of Pakistan, at the 29th Annual Convention of the Association of Professional Bankers, Colombo, Sri Lanka, 21 November 2017. | Keynote Address: Mr. Jameel Ahmad, Deputy Governor, State Bank of Pakistan 29th Annual Convention of the Association of Professional Bankers Colombo, 21 – 22 November 2017 H.E. Dr. Indrajit Coomaraswamy, Governor Central Bank of Sri Lanka; Mr. Senarath Bandara, President of the Association of Professional Bankers (APB) – Sri Lanka; Distinguished Members of the APB’s Executive Council; Esteemed Speakers, Dignitaries and Guests; Ladies and Gentlemen, Good Evening and Ayubowan! It is indeed a great pleasure for me to be here today to address the 29th Annual Convention of the Association of Professional Bankers (APB) of Sri Lanka. I have always enjoyed visiting this beautiful country and am a great admirer of the friendly relationship that both our countries enjoy. Pakistan and Sri Lanka are time tested friends and share cordial bilateral relations which date back to as early as 1948. We have stood together and have shared strong cooperation with each other during difficult times. Pakistanis are also grateful to the people and government of Sri Lanka for the visit of their cricket team to Pakistan last month which is a major step towards the revival of international cricket in our country. Pakistan and Sri Lanka also share excellent economic cooperation. Pakistan is the second Page 1 of 15 largest trading partner of Sri Lanka in South Asia while Sri Lanka was the first country to sign a Free Trade Agreement with Pakistan, which became operational in 2005. I have no doubt in my mind that the bilateral trade between the two countries which is approximately USD 330 million today, has the potential to increase to more than USD 1 billion. I would also like to commend the role of Central Bank of Sri Lanka in fostering financial stability in the country and achieving decent economic growth. Central Banks of both our countries also regularly collaborate on SAARCFINANCE which provides an excellent platform for exchanging ideas and lessons learned among central banks of SAARC member countries. I hope that the experiences especially in today’s rapidly evolving banking and financial sector can further be shared as these are interesting times for Central Banks around the world. Before sharing my thoughts on the main topic, I would like to felicitate the Association of Professional Bankers of Sri Lanka for regularly organizing annual conventions on topics that are in sync with today’s changing realities and contribute to the debate on pertinent financial sector risks and challenges. The theme for this year’s Convention i.e. “Changing Dynamics: Bank of the Future” is of particular interest to banking professionals and policy makers given the fundamental shifts taking place in the financial sector and the wider economy. I am confident that the discussions held during the event will result in generation of innovative ideas for banks and provide important insights on the challenges being faced by the banking sector today and in days ahead. Page 2 of 15 Ladies and Gentlemen; in my speech, I would therefore reflect on the prevailing course of banking and the emerging challenges that are reshaping the banks’ business models along with developments in the supervisory approach of regulators. But more importantly, I would like to talk about the challenges that banks and their regulators face due to technological advancements. I will also briefly discuss the measures taken by State Bank of Pakistan (SBP) to keep up with the changing dynamics and in the end will make a few suggestions that can help prepare the banking industry to adjust to the new paradigms. I will discuss the future of banks and banking by focusing on two themes: The first one relates to the Global Financial Crisis of 2007-8 which was perhaps the most significant event in recent financial history that presented challenges relating to financial stability to regulatory authorities around the globe. The second theme that I would like to discuss today is the impact of technology on banks and their customers. As you all will appreciate, the bank customer of today, equipped with sophisticated gadgets and devices is demanding state of the art financial services from the comfort of their homes. Neither do they want to visit a branch, nor do they want to fill up long forms in order to open an account. Is this a threat for the banks or an opportunity to transform? I believe the latter is true which I will explain afterwards in my speech. But let me begin by talking about the Global Financial Crisis and its impact. The decade preceding this crisis saw remarkable expansion in international banking. As a result, heightened cross border lending coupled with sizeable presence of international banks across the globe, and particularly in developing countries, manifested an increasingly integrated world of Page 3 of 15 banking and finance. The financial crisis actually forced regulatory attention towards ensuring financial stability by beefing up capital and liquidity buffers, more stringent regulations, and introduction of macro prudential policy toolkit. There is no doubt, that the coordinated efforts made by the multilateral bodies and regulators have facilitated to better internalize systemic risk and strengthen the overall international financial system. Ladies and Gentlemen; while the post crisis regulatory response has resulted in a more robust financial system, it has also increased the complexity of regulatory framework. To give you an idea of the complexity of regulations, I will briefly describe some significant financial regulatory reforms which have been designated as priority areas for implementation: • Number one: creation of a quick and effective resolution regime with no tolerance for using tax payers’ money to bailout failing banks; • Two: application of stringent AML/CFT regulations to prevent the use of banking channels for illicit transactions. • Three, Implementation and adoption of policy framework on Global Systemically Important Financial Institutions and Domestic Systemically Important Banks as the prevailing regulatory regime and policies may not be sufficient to address the "negative externalities" that large financial firms create. • And finally, full and timely implementation of Basel III to ensure a sound and properly functioning banking system that is able to support economic recovery and growth on a sustainable basis. Page 4 of 15 Therefore, an important challenge and one of the top priorities of banking sector, is to adapt to the complex regulatory landscape while maintaining profitability. And let me tell you, this is a big challenge as not only the number of regulatory changes that banks need to comply with has more than tripled since the last decade but the scope and complexity of these regulations have expanded from multiple perspectives. I will now briefly discuss some of the consequences of the financial crisis and measures I just described. - First, while the focus of these measures was to repair banks’ balance sheets and improve financial stability, they also led to contraction of the cross border lending activities. - Second, you may all agree that since the Financial Crisis, a partial reversal in international banking continues as multinational banks from the developed world have scaled back their offshore operations. - Third, we have seen that the post crisis profitability of banks has declined as a result of deleveraging in international banks, a sharp slowdown in revenues due to lower demand for credit, high cost of compliance, and various other policy measures adopted by central banks like the sustained lowering of interest rates. Ladies and Gentlemen; before we discuss how banks can address these challenges let me switch to a second theme which is about the technological and digital revolution that may be threatening the very existence of banks today. Traditionally, the banking industry has been an early adopter of technology; they have embraced technology to automate and consolidate their core banking operations and offer services like the Page 5 of 15 credit cards. 1970’s saw the emergence of SWIFT, enabling rapid and secure cross-border financial messaging thus speeding up trade and remittance transfers across countries. During the decade of 1980’s and 90’s services like the ATMs and Point of Sale terminals started becoming ubiquitous and central banks implemented large value payment systems like the Real Time Gross Settlement Systems. But, I think that the banks of our time have mostly been unable to keep up with the rapid technological evolution of the post dotcom bubble with regard to innovative product offerings and enhanced customer experience. Let me briefly describe some of the technological trends that our banks are facing today: First is the rise of internet, Social Media and mobile devices. On one hand social media allows banks to reach their customers directly in ways that were not imagined before to offer them a variety of services like faster payments and instant credits while on the other, negative perceptions about banks and their services can also spread like wildfire. I therefore will not be surprised if Social Media becomes one of the most important sources of systemic risk going forward. But banks can also use these technologies to strengthen their core functions like collateral monitoring and investment and lending decisions to manage their risks better. At the same time, banks can collect and analyze data about the spending behaviours and other related transactions of their customers to proactively respond to their growing needs. Second, there have been tremendous enhancements in tele-density and mobile broadband coverage while simultaneously the cost of not only these Page 6 of 15 services but of end user mobile devices has also rapidly decreased. Customers can therefore afford smart cell phones, watches and other alltime connected gadgets and by using those can access their bank accounts, avail financial services and advice, and make payments anytime from anywhere. Most importantly, they can decide to switch their service providers as easily as their mobile phone SIMs. Third, Fintech companies who are small start-ups are using technology to challenge banks in providing innovative financial services like digital nano credit, crowd funding, peer to peer lending, online payments and financial advisory services with enhanced customer experience and in a more cost effective manner. On the other hand, large tech companies like Apple and Facebook are using their network power to make inroads in the domain of financial services thus threatening the very existence of banks themselves. Regulatory technology companies known as Regtech are offering low cost solutions to regulatory authorities for compliance purposes. In all likelihood, we would like to see the formation of partnerships of banks and these nonbank entities for lowered costs and superior customer experience in the financial industry. Fourth is the rise of what is called cloud computing or cloud hosting. These cloud based arrangements can offer extremely cost effective fully managed solutions including hardware and software as a service. Businesses now don’t have to worry about high cost of managing their IT or managing the associated risks rather they can simply outsource them to these cloud based digital platforms. These platforms are now offering the concept of “Banking as a Service” or “Digital Banking” which usually runs on infrastructure provided by a licensed entity and offers services using an Page 7 of 15 ecosystem of Fintech start-ups. These platforms have the potential to drive down cost of providing banking services, especially for smaller banks, and open new opportunities of product innovation and service delivery. Fifth, advancements in artificial intelligence, machine learning and big data analytics are set to transform the financial industry in many ways especially in areas of intelligent customer relationship management systems, fraud detection and prevention, e-commerce and detection of AML/CFT issues. Sixth, many of the financial services customers around the world do not want to go to a brick and mortar branch to open a bank account or even conduct financial transactions; they would like to be identified, authorized and served digitally. So regulators and government authorities are now focusing on instituting Digital on-boarding programs using National Identity Databases. Finally, I would like to talk about the emergence of Block Chain technology that enables customers and financial institutions to be directly connected to each other without the need of trusted third parties to perform intermediation functions like settlement and reconciliation. This would mean that, for example, a security trade may settle bilaterally in almost real time without the need of a depository function; or smart contracts would eliminate the need of escrow arrangements in cross border transactions. While virtual crypto currencies like Bitcoin that run on Block Chain technology are being frequently mentioned for their, mostly, upward price fluctuations it is unlikely that they will gain systemic importance as a means of payment. However, Central Banks can experiment with the Block Chain technology and consider issuing digital currency of their own. Block Chain Page 8 of 15 also has the potential to change the landscape of cross border remittances, trade finance, payments and settlements and identity management, etc. I am therefore not surprised to see the interest of many large international banks that are experimenting with Block Chain technology these days and would like to see banks of our region do the same. While combination of all these aspects will likely drive down costs for the banks and help them improve their service delivery and product innovation capabilities and offer enhanced experience to the customer, we must be aware that technology has its unintended consequences. These unintended consequences will primarily be related to consumer protection, data privacy and money laundering which are easier to camouflage using sophisticated technology. I must also mention that banks are facing aggravated challenges relating to cyber security. During the last decade or so, hackers and cyber terrorist have gained much superior capabilities of espionage and afflicting damage and are now targeting the financial industry. The theft of electronic identity through hacking could wipe off bank accounts of customers causing not only financial but reputational losses especially to larger banks and their regulators. The proactive detection and response to these cyber threats requires not only specialized security infrastructure within the organization but also enhanced mutual cooperation and information sharing among the banks. Ladies and Gentlemen; Since I have discussed various challenges that the banking industry is facing and certain worrying developments that are threatening its performance, let me briefly share with you what we at the Page 9 of 15 State Bank of Pakistan (SBP) have done so far and plan to do in the future to transform our banking sector. In Pakistan, the banking sector constitutes around 74 percent of the country’s financial sector with an asset base equivalent to almost 55 percent of the country’s GDP. As such, the stability and buoyancy of the banking system is of critical importance. Over the years, continuous improvements in prudential regulations in line with international best practices and capital strengthening measures have significantly improved the resilience of the banking system of Pakistan. The Capital Adequacy of the banking system at 15.6 percent is well above the local and international benchmarks. Like elsewhere in the world, SBP has set strengthening the financial stability regime as one of its key priorities under its Vision 2020. SBP is also working on adopting Risk Based Supervision (RBS) in order to advance its current supervisory regime and improve its supervisory efficiency. We are also looking towards a sustainable financially inclusive system which can spur socio-economic development in the country. Recognizing the gaps leading to financial exclusion, we have already developed National Financial Inclusion Strategy (NFIS) 2020 which lays down sound foundations for promoting financial inclusion and identifies the gaps leading to persistent financial exclusion. Our strategic approach to tackle financial exclusion is focused at creating a proportionate policy and regulatory framework that addresses sector-specific risks and strategies regarding infrastructure development and policy interventions - both on the supply and demand side for development finance sector like Microfinance, SMEs, Consumer Finance, Agriculture, Islamic Banking. Page 10 of 15 I am also happy to share with you that Pakistan has one of the most sophisticated National Identity Systems which is run by a government entity called National Database & Registration Authority or NADRA. NADRA has gained international recognition for its success in providing biometricenabled identity solutions to all the citizens of Pakistan. The government of Pakistan undertook a massive initiative to biometrically verify all SIMs issued in Pakistan and around 130 million SIMs were re-verified using NADRA’s database. State Bank of Pakistan also capitalized this opportunity by requiring banks to use the NADRA database for digital onboarding of customers, especially the unbanked population, and mitigating the risks relating to Money Laundering and Terrorist Financing. This is a great example of how technology can be used for not only customer facilitation but for compliance purposes also. Due to rapid technological progress, the global financial and payment landscape is transforming very rapidly. SBP has long recognized the importance of technology and has been facilitating banks and financial industry to reap the benefits of digitization. To keep pace with technological transformation and mitigate the associated risks, SBP has issued various guidelines encompassing frameworks for Enterprise Technology Governance and Risk Management, Payment Systems’ Designation, Security of Internet Banking, prevention against cyber-attack, Risk Management in Outsourcing Arrangements by Financial Institutions, etc. I am pleased to share that last year SBP facilitated the issuance of our domestic payment scheme called the PayPak. The encouraging aspect of PayPak is that it has been issued by a private entity that is owned by 11 Page 11 of 15 private banks thus ensuring full blessing and participation of the private sector in this payment scheme. Moreover, SBP is developing a National Payment System Strategy to modernize the clearing and settlement infrastructure for reducing cost, improving efficiency, enhancing security, and strengthening its regulatory and supervisory oversight. SBP is also playing a very important role of facilitator and catalyst and our doors are open to innovation and innovative ideas. SBP is also facilitating the entrance of non-banks particularly in payments arena and has issued Rules for Payment System Operators and Service Providers. We have seen encouraging response to these regulations and now a variety of nonbank, digitally enabled businesses have entered or are preparing to enter the Pakistani market with innovative and customer centric products. SBP also engages with the Fintechs in the country on regular basis to understand their business models and facilitate them if required. Ladies and Gentlemen; keeping in view the discussed challenges and opportunities, banks need to devise certain strategies that can help them grow and stay on course. I must say that banks are essentially required to acknowledge that times have changed and in order to stay competitive they must embrace technology and forge new partnerships to re-invent their business models. I will go to the extent of saying that the upcoming age may become the age of less or even non-intermediation where role of intermediary institutions like banks and their regulators could become limited if they don’t embrace these changes pragmatically. Page 12 of 15 Now I will present few suggestions which can help to proactively address the challenges of the future: • First, with regards to the global financial regulatory reforms, we need to be proactive and consider adopting them at an early stage. However, any implementation needs to be proportional to the complexity of the financial institutions and the system. While implementing the standards and regulations relating to AML and CFT we must be pragmatic in our approach so that growth of banking industry or their customers is not hampered. • Second, authorities are now increasingly focusing on improving the situation of financial inclusion in their respective jurisdictions. Banks and other players of the financial industry need to come forward and help in this regard. Without compromising on the basic regulatory requirements, technology-enabled, risk based approach for assessing client risk and customer on-boarding may be adopted. • Third, Central Banks and other regulatory authorities must work towards creating a strong, robust and ubiquitous payments system with focus on developing an enabling legal and regulatory environment that is commensurate with the new technological environment. Some of the areas to be covered may include, but should not remain limited to cloud computing, data privacy and protection, cybercrime and formalizing the role of non-banks including critical service providers in the area of technology services. • Fourth, it is important that we place special focus on formalizing the role of non-banks which include fintechs, Payment Service Providers and especially Critical Service Providers like technology and telecom Page 13 of 15 providers because the dependence of financial entities on these players is becoming critical and their failure may threaten the overall financial stability. Regulators must especially be wary of issues relating to consumer protection, data privacy and money laundering arising due to new and complex partnerships and data sharing arrangements between banks, fintechs and IT service providers. • Fifth, banks and the financial industry are facing threats from cyber terrorists which now have far superior capabilities, and probably a good knowledge of the internal vulnerabilities. In order to mitigate this risk, banks will have to pool-up their resources and share their experiences with each other on regular basis and devise strategies and programs to counter the threats they face as an industry. • Sixth, if the industry concludes that block chain enabled services and their providers will gain more prominence going forward then it is important to take proactive measures to contain their influence. For example, smart contracts and their legal enforceability in a court of law, role of crypto currencies, cross border trade and payments and customer identity management are some of the areas that I think will be important to be looked into. • Last but not the least, continuous capacity building of bankers and their regulators is the key for growing and thriving in a digital future. Empowering finance professionals with requisite skills will be necessary in wake of increasing complexity of global standards and transformation taking place in financial industry. Financial industry has to adopt collaborative approach for enhancing professional capacity of their human capital through local and international solutions to keep pace with the changing financial land scape. Central Banks must acquire and Page 14 of 15 enhance the capacity and skill set of their staff especially in areas of algorithmic based system audits, system integrity & security audit and data analytics based regulatory compliance skills. While the challenges are huge, I have full confidence in the skills and abilities of banking community in our two countries. I am sure that you will adapt to the changing realities of times ahead, take these challenges as opportunities and deliver the best of best to citizens of your great country. Ladies and Gentlemen; In the end, I would like to once again thank the Central Bank of Sri Lanka and the Association of Professional Bankers – Sri Lanka for inviting me to deliver the Keynote Address for this year’s Annual Convention. Thank you for your attention! Page 15 of 15 | state bank of pakistan | 2,018 | 1 |
Welcome note by Mr Tariq Bajwa, Governor of the State Bank of Pakistan, at State Bank of Pakistan's 70-year Celebration Event, Karachi, 1 July 2018. | Governor Title Date Event Venue : Mr. Tariq Bajwa : SBP’s 70th Anniversary: Welcome Note by Governor SBP : July 01, 2018 : State Bank of Pakistan’s 70-year Celebration Event : SBP Head Office Karachi. State Bank of Pakistan’s 70th Anniversary Welcome Note by Governor SBP Governor Sindh Mr. Zubair, Honorable Finance Minister, Dr Shamshad Akhtar, Respectable Former Governors, State Bank of Pakistan, Dr. Ishrat Husain, Mr. Yasin Anwar, Mr. Ashraf Wathra Distinguished guests, Ladies and Gentlemen, Assalam-o-aliakum and a very good morning! It is my pleasant duty and distinct privilege to welcome you all to the 70th anniversary of the establishment of State Bank of Pakistan. On the auspicious occasion of the opening of the SBP on July 1st, 1948, the Quaid said: “The opening of State Bank of Pakistan symbolizes the sovereignty of our state in the financial sphere. I need to hardly dilate on the important role the State Bank will have to play in regulating the economic life of our country. The monetary policy of the bank will have a direct bearing on our trade and commerce, both inside Pakistan as well as with the outside world and it is only to be desired that our policy should encourage maximum production and free flow of trade.” Page 1 of 4 The SBP as an institution has tried to live up to the expectations of the Quaid. From a modest beginning in borrowed premises, ladies and gentlemen, SBP rose to have earned the reputation of being a professional, progressive and forward-looking institution. The journey has been challenging, arduous, but rewarding. This has been achieved by the grit and determination of those who have served in this organization during these decades. The example was set by our first Governor Mr. Zahid Husain who guided the Bank through its infancy and laid the basis of a sound financial system in face of an almost nonexistent banking system. Over the years, the passion, commitment and integrity that the rank and file of this institution has exhibited is unmatched by any other organization in Pakistan. SBP is one of the few public institutions in the country that have adhered to excellence in all fields especially human resource. With a competent and motivated human resource, the SBP has always strived to deliver the best and remained ahead of time compared to its regional peers. It is no wonder therefore, that SBP stands out in various fields: • It was the first central bank in South Asia to have introduced a legal framework for microfinance in 2001; • It was the first central bank in South Asia to develop a regulatory framework for branchless banking in 2008; • It was the first central bank in South Asia, again, to have established an independent Monetary Policy committee in 2015. Today, the SBP is a respected organization not only regionally, but also globally. SBP’s professional excellence has been recognized at various international forums. Some of these, I will recall here to refresh our memories: • Pakistan ranked No.1 in the world in microfinance regulatory framework by the Economist Intelligence Unit in 2010 and 2011, and number 5 in overall financial inclusion environment in 2015. Page 2 of 4 • State Bank of Pakistan was voted as the Best Central Bank in Promoting Islamic Finance by a poll conducted by Islamic Finance News (IFN) in 2015 and 2017; • SBP Governors have received accolades from different international organizations, which not only reflects professional excellence of the leadership, but also the institutional quality of SBP. My predecessor, Ashraf Wathra, was declared best Central Bank Governor recently. Earlier, Dr. Shamshad Akhtar and Dr. Ishrat Hussain were also conferred with such prestigious awards. Similarly, SBP’s global partnerships with international organizations reached a new height during the tenure of Yaseen Anwar. Not just that, but the appointment of our former Governors at executive positions in leading international financial institutions, speak volume of their professional excellence. • Moreover, SBP’s senior staff have chaired and co-chaired various Groups and Committees at international forums, such as Alliance for Financial Inclusion and Islamic Financial Services Board. • Not just that, but our staff has also been providing expertise to regional central banks and organizations such as Saudi Arabian Monetary Authority, Bank of Oman, the Central Bank of Oman, Qatar and Bahrain and Gulf Monetary Council. Today, ladies and gentlemen, we are here to take stock of this institutional progress and celebrate our achievements. We will shortly play a documentary for you in which you will be able to experience this transformative journey that revolves around resilience, progress and modernization. We will also take this opportunity, ladies and gentlemen, to strategize our future based on the opportunities and challenges that lie ahead of us. To deliberate on these, we are privileged to have with us former Governors – the towering personalities of our country in the fields of economics and finance. We will seek their views and insight in understanding the granularities of evolving norms in the complex areas of political economy, institutional Page 3 of 4 management and inclusive and sustained growth. We will also seek their guidance in developing a long term vision for SBP. Once again, I thank all our distinguished guests for joining us today in our celebrations, despite being a Sunday. Thank you! Page 4 of 4 | state bank of pakistan | 2,018 | 8 |
Address by Mr Tariq Bajwa, Governor of the State Bank of Pakistan, at the Launching Ceremony of AAOIFI Shariah Standards - Urdu Version, Karachi, 12 December 2018. | Governor Title Date Event Venue - : Mr. Tariq Bajwa : Governor SBP’s Address to the Launching Ceremony of AAOIFI Shariah Standards – Urdu Version : December 12, 2018 : Launching Ceremony of AAOIFI Shariah Standards – Urdu Version : Marriott Hotel Karachi. Shaikh Ebrahim Bin Khalifa Al Khalifa, Chairman, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) - Mufti Taqi Usmani, Chairman Shariah Board, AAOIFI - Distinguished speakers, ladies and gentlemen Assalam-o-Alaikum and Good Morning! I feel honored to be here on this important occasion of launch of Urdu version of AAOIFI’s Shariah Standards. We are all aware that national language is an important ingredient of any culture and most effective mode of communication in a country. With this in perspective, translation of global standards into our national language is an important milestone, as it would remove language barriers to understand Shariah Standards. I believe this Urdu version of the Shariah Standards will be instrumental in improving awareness about Islamic finance especially amongst the Shariah scholars, academia and practitioners of Islamic finance. The scholars and all other experts involved in this project deserve great appreciation for their commendable role. As we are all aware, Islamic Finance Industry is relatively new to the Global Financial Landscape. Events like these are important not only for dissemination and awareness but also reinforce the emerging significance of fast growing Islamic Finance. Page 1 of 6 Ladies & Gentlemen! Islamic banking started initially as a niche market for the faith sensitive clientele and is now increasingly becoming an integral component of global financial system. Islamic finance industry has grown at a fast pace. The development of Islamic banking industry especially beyond Muslim jurisdictions is a recognition of its viability as a competitive alternate to the conventional banking. According to Financial Stability Report 2018 issued by Islamic Financial Services Board (IFSB), its asset base has grown by 8.3 percent to surpass US$ 2 trillion mark. With expanding scope and size of Islamic finance, and emerging global challenges, it is gaining importance from financial stability perspective. Inherent strengths of being asset backed and prohibition on speculative activities in Islamic finance lead to better resilience of Islamic banking institutions against excessive risks. However, these strengths alone may not be sufficient to immunize the Islamic finance from risks associated with deficiencies in due diligence, inadequate buffers, lack of transparency and weak risk management practices. The well thought out international standards issued by the global standard setting bodies like AAOIFI and IFSB facilitate in managing the challenges facing the Islamic finance and harmonizing the industry practices. Against the backdrop of growth of Islamic banking globally, our domestic industry is also demonstrating quite impressive headway. The industry has posted a healthy annual growth of over 20 percent during the last five years. The market share of Islamic banking industry stands at 13.6 percent in terms of banking assets and 14.7 percent in total deposits. Islamic banking industry has expanded its network to over 2700 branches in 111 districts across the country. Given the potential of Islamic finance to support broad based economic growth and our constitutional obligation to make available Islamic financial services in the country, Islamic banking has remained a priority area for State Bank of Pakistan (SBP). I feel pride in sharing that the sound foundations of legal and regulatory environment laid down by the State Bank of Pakistan has played a key role in sustained high growth of Islamic banking in the country. Our Shariah compliance environment is considered amongst Page 2 of 6 the best in the world. It encompasses a comprehensive Shariah Governance framework consisting of establishment of Shariah Board, Shariah compliance department and Shariah internal audit in Islamic banking institutions supported with Shariah external audits and SBP regular inspections. Let me also apprise you that SBP regularly reviews the regulatory framework to make sure that it is aligned with international standards and best practices and at the same time caters to the evolving needs of the industry. State Bank of Pakistan also believes that growth and development of other elements of Islamic finance ecosystem i.e. capital markets, mutual funds and takaful, is essential not only for Islamic banking industry but also for the overall growth and development of the country. In this regard, SBP regularly collaborates with Securities and Exchange Commission of Pakistan (SECP), the capital market’s regulator, to promote Islamic finance. We appreciate and acknowledge key steps taken by SECP in last few years including establishment of Islamic Finance Department, introduction of all share Islamic Index, issuance of Takaful rules and Sukuk guidelines. We believe that these measures shall facilitate the diversity and outreach of the Islamic finance. Ladies & Gentlemen! At this stage, let me highlight few potential risks and challenges that Islamic banking industry need to address for its sustainability and stability. Effective liquidity management has been the key challenge of Islamic banking industry. This issue has gained more prominence owing to factors like dearth of Shariah compliant investment opportunities, limited availability of Shariah compliant money market instruments and absence of Shariah compliant SBP standing facility. In Pakistan, sovereign sukuk being issued since 2008 provide the key liquidity management avenue to the domestic industry, however, demand for such instruments far surpasses their supply. Being cognizant of this challenge, SBP, in consultation with industry is working to develop alternate solutions for liquidity management for Islamic banking industry. The inherent advantage of Islamic financial industry to fund projects on equity participation and profit sharing basis enables it to cater to the huge, unmet demands of underserved sectors such as agriculture and SMEs. However, like conventional industry, Islamic banks are also not effectively serving these sectors. KAP (Knowledge, Attitude and Practices of Page 3 of 6 Islamic Banking in Pakistan) survey based study of SBP, also indicates these areas as potential growth avenues for Islamic banking industry. SBP is persuading the industry to capitalize on its innate strengths to cater to the needs of these underserved sectors. Housing finance is another attractive avenue for Islamic banks. Increased focus of incumbent government on this sector provides Islamic Banks an opportunity to diversify their asset portfolio. I am confident that present conducive environment provides opportunity to Islamic banking industry to tap potential in low income housing through Diminishing Musharaka instruments. This would also pave the way towards the ultimate objective of Islamic finance. i.e. Maqasid-e- Shariah. Another major issue restraining Islamic banking from realizing its true potential is lack of qualified and trained Islamic bankers. To tackle this issue, SBP is not only offering training courses on its own and through its training subsidiary-National Institute of Banking and Finance (NIBAF), but is also supporting industry in such initiatives. We have also collaborated and sponsored three Centers of Excellence in Islamic Finance Education (CEIFEs) at well renowned educational institutions- IBA Karachi, LUMS Lahore, and IM Sciences Peshawar. These institutions are fully operational and they are providing regular supply of trained human resource as well as conducting training programs for enhancing capacity of the existing human resource of the industry. Another important challenge for the Islamic finance industry, as identified in the KAP study, is lack of awareness among masses on demand side. As such a robust awareness campaign about Islamic banking is necessary for promoting Islamic banking. SBP is focusing on addressing this challenge through multipronged strategy; it is conducting various mass awareness programs and focused group discussions all over the country and supporting the industry and other related stakeholders for such initiatives. However, this is one area in which Islamic banks have also to play a far more proactive role. Ladies & Gentlemen! As I mentioned earlier, standardization in Islamic finance is essential for addressing various issues facing the Islamic finance in addition to promote disclosure, transparency and integration into global financial system. I think the rapid growth of Islamic banking and Page 4 of 6 finance requires further strengthening of its financial infrastructure. This will augment the ongoing efforts to bring the infrastructure of Islamic financial industry up to the international standards. The alignment of Islamic finance industry with the global best practices would not only help supervisors in their tasks but will also foster the integration of Islamic financial institutions into the international financial community. I would like to highlight here the commendable role AAOIFI has played in development and promotion of Shariah, accounting and governance standards to facilitate the growth of Islamic financial services industry. AAOIFI has also been instrumental in enhancing awareness of Islamic banking and finance globally through knowledge sharing and organizing capacity building programs, workshops, conferences, and seminars. Considering the constant changing dynamics in financial sphere, AAOIFI also reviews and updates its standards to keep them relevant. AAOIFI’s enhanced coordination with relevant stakeholders and increased collaborative efforts help Islamic financial services industry to grow on sound footings. The AAOIFI role in capacity building through offering Shariah based certifications in the area of Auditing, Accounting and advisory services is laudable. Such certifications provide the much needed qualified resources for effective implementation of the Shariah standards. SBP has long standing association with AAOIFI. As a member of the AAOIFI’s Board of Trustee, State Bank contributes in the overall oversight and supervision of its operations. Our officials participate as both speakers and participants in different knowledge sharing and capacity building initiatives. So far SBP has adopted 6 of the AAOIFI’s standards while another 8 to 10 standards are in the final stages of implementation. Besides, SBP has advised the banks to refer the AAOIFI’s standards for guidance in different areas of Islamic finance. Given the commitment and concerted efforts of all stakeholders, I am optimistic that Islamic banking and finance is likely to maintain its positive growth trajectory. The growth of Islamic finance on its distinct strengths would bring more stability to the financial system, improve equitable distribution of economic gains, and support overall economic development. I believe events and steps like these are vital steps towards achieving this goal; hence, we should not stop here and but continue to work towards establishing an ethical financial system. Page 5 of 6 At the end, I would like to reiterate that State Bank of Pakistan will continue to extend its full cooperation and play due role for achieving our shared vision of a vibrant and sustainable Islamic banking sector in Pakistan. Thank you! ******************************************************************************************** Page 6 of 6 | state bank of pakistan | 2,018 | 12 |
Keynote address by Mr Tariq Bajwa, Governor of the State Bank of Pakistan, at the launching ceremony of international remittance through block chain technology, Islamabad, 8 January 2019. | Governor Title Date Event Venue : Mr. Tariq Bajwa : Keynote address by Mr. Tariq Bajwa at launching ceremony of international remittance through block chain technology : January 8, 2019 : Launching Ceremony of International Remittance through Block Chain Technology : Serena Hotel Islamabad Mr. Yao Jing, Honorable Ambassador to the People’s Republic of China , Mr. Eric Jing, Chairman & CEO, ANT Financials, Mr. Roar Bjaerum, SVP, Head of Financial Services, Telenor Group & Chairman Valyou and Mr. Shahid Mustafa, President & CEO, Telenor Microfinance Bank, Ladies and Gentlemen! Assalam o Alaikum and Good Evening! 1. It is indeed very exciting for me to launch this initiative by Telenor Pakistan that would enable the transfer of cross border remittances using BlockChain technology in near real time. This would bring convenience and efficiency for both remitters and their beneficiaries. For this, I would like to congratulate ANT Financial, Telenor Microfinance Bank and other key stakeholders such as Standard Chartered Bank for being the pioneers in the adoption of new technologies for providing a payment solution, which many other market Page 1 of 10 players have only been thinking of. This puts Pakistan on the map of few countries in the world that have launched International Remittance using Block Chain Technology. 2. Though this initiative, Valyou in Malaysia and Easypaisa in Pakistan will facilitate cross-border remittance service through e-wallet platforms, which is based on block chain technology developed by Alipay, a subsidiary of ANT Financial. This block chain based wallet-to-wallet remittance service provides instant and secure way for Pakistani emigrants to transfer money from Malaysia to Pakistan and will significantly improve the current amount of USD 1 billion received from Malaysia in home remittances. 3. Ladies and Gentlemen! As you all know that remittances are considered a vital component in our economy since they play an important role in reducing the current account deficit and improve the level of our foreign exchange reserves. Pakistan received US$ 19.6 billion remittances during fiscal year 2017-18, which is equal to over 6% of our GDP, equivalent to over 50% of our trade deficit, 85% of exports and over one-third of imports. Home remittances from abroad therefore play an extremely important role in our economic and fiscal management. Pakistan is ranked among the top ten countries in the world in terms of receiving remittances. I have therefore no doubt in my mind that overseas Pakistanis are the silent heroes of our nation as their hard earned income is a major contributor to our economy. However, there is still considerable movement of remittances through illegal/informal channels. The thrust of the GOP and SBP policies is to divert this stream to the formal channel. Page 2 of 10 4. In the last few years, Government of Pakistan and State Bank of Pakistan have taken a number of initiatives to promote the transfer of home remittances using formal financial channels and it is showing positive results. Since the launch of Pakistan Remittance Initiative (PRI), there has been an upward trend of receiving remittances using formal financial channels that were previously sent through informal means of hawala and hundi. The Government of Pakistan have also announced another scheme to promote remittances using m-wallets where if the beneficiary choose to receive remittances in their mwallet, they will receive airtime worth of Rs. 2 for every one USD equivalent remittance. Further, GoP and SBP have also introduced a performance based scheme for financial institutions in order to encourage them to make extraordinary efforts to achieve the higher targets of remittances. I am confident that such initiatives and products would increase remittances through formal channels and accelerate financial inclusion in the country. Ladies and Gentlemen! 5. Despite all these efforts it remains a fact that we are still competing against very efficient and effective mode of remittance transfers such as hundi and hawala which because of their convenience and ease have remained a preferred choice of people especially who are less literate or live in far flung areas of the country. I think, one of the main reasons for this is that formal channels are based on centralized transaction processing, messaging and reconciliation systems, which inherently makes them slow. On top of it, if these transfer systems are paper based, they become even slower. This is where new technologies like the Distributed Ledger Technology (DLT) comes to our aid. Probably the biggest use case for these technologies is cross border Page 3 of 10 remittance transactions, including not just remittances, but import, exports and other services as well. It is noteworthy that a number of banks and nonbank entities around the world have started experimenting with the block chain technology for such cross border transactions and transfers. 6. While this block chain based wallet-to-wallet remittance service will likely provide an instantaneous and secure way for Pakistani migrants to transfer money from Malaysia to Pakistan, the success of this product will depend on the implementation of an effective and aggressive marketing and awareness creation strategy for customers both in Malaysia and Pakistan. Further, I would urge ANT Financials to launch this product from other countries to Pakistan also. I have been told that ANT Financials is already offering similar service for Hong Kong – Philippines corridor; and I would recommend starting this block chain based remittance services for Hong Kong - Pakistan as well. I am also confident that this Blockchain based arrangement will work well with our PRI system of tie-ups too. Ladies and Gentlemen! 7. Now, I would like to take this opportunity to share few of my thoughts on emerging technologies and how these could reshape the financial sector and the way financial services are delivered to ordinary citizen. Since the first decade of this millennium, emergence of new technologies especially in the domain of banking and payments are not only transforming the overall business landscape and bringing efficiency in the business models but providing convenience to the consumers as well. Technology is disrupting conventional models and methods of doing business; it is changing the way we Page 4 of 10 used to look at our customers and the manner in which we used to build businesses and deliver services. The ubiquitous proliferation of mobile devices and enhancements in tele-density is now enabling customers to demand services not just on their doorsteps but from the comfort of their living rooms. Millennials who are teenagers have different attitudes; they are more at ease in interacting with their devices rather than with formally dressed officials sitting in their bank branches. Unfortunately, I feel that traditional banks in Pakistan are not taking this challenge with the urgency that it deserves and have yet to come up with innovative solutions to satisfy their customer needs. And this is where I feel that innovative companies like AliPay can bring radical change to our industry. Ladies and Gentlemen! 8. Let me also share my thoughts on few disruptive technological trends that I believe are radically disrupting and transforming the financial industry worldwide; i. First is the rise of open platforms that are enabling buyers and sellers of a core service to come together without the help of any intermediary institutions. E-commerce, ride hailing and food services companies are a few examples of these platforms. On one hand these platforms enable businesses to quickly onboard using application programing interfaces commonly known as APIs and on the other, they enable customers to quickly search and avail their desired services. ii. Second, cloud based hosting services are enabling quick and low cost deployment of complex systems using tools that are open source and Page 5 of 10 easily available to anyone. These cloud-based arrangements can offer extremely cost effective fully managed solutions including hardware and software as a service. It is now very easy for any entity including Fintechs to offer innovative products to their customers thus putting them in direct competition with banks. iii. Third, advancements in artificial intelligence (AI) and machine learning are set to transform the financial industry in many ways especially in areas of intelligent customer relationship management, fraud detection and prevention, e-commerce and detection of AML/CFT issues. Developments in big data analytics combined with AI and Machine Learning are providing deeper insights about customer behavior, needs and wants and radically changing the way in which services are designed, delivered and consumed. iv. However, the Distributed Ledger Technology is truly likely to disrupt the financial sector. Block chain, which is one implementation of Distributed Ledger Technology, will introduce a new era of disintermediation leading to openness, decentralization and global inclusion that will give us unprecedented capabilities of efficiently creating and trading value in society. The block chain technology will play a major role in the transformation of financial industry across all value chain in the economy especially where asset holding and transfers are concerned. Ladies and Gentlemen! 9. As you all are aware that financial inclusion is one of the two cross cutting themes of policy initiatives of State Bank of Pakistan. Financial inclusion Page 6 of 10 would lead to empowerment of these segments of society. We believe that technology could be a great enabler of financial inclusion and as a progressive regulator; SBP has always been a great supporter of innovation and technology. I am sure that digitization of banking and payments using the technologies mentioned earlier presents a huge potential for us to provide service delivery to those who are at the bottom of the pyramid. For me, financial inclusion is not just about account opening; rather it is about enabling people to conduct their day-to-day transactions through digital means instead of relying on cash. You will appreciate that digitizing economic transactions carries the benefit of enhanced efficiency in the overall economy and has the potential to increase our GDP. It is therefore imperative that we take all efforts to enable our people to use formal financial services using digital means so that their productivity is enhanced and wastages for the economy are reduced. 10.On the other hand, if adopted without giving due thought, technology is likely to follow the law of unintended consequences and has the potential of becoming a cause of spreading systemic and financial instability. We have seen how social media can spread false rumors and negative news like wildfire thus creating panic and instability in financial markets. Further, technology also presents some very unconventional challenges that pertains to electronic identification, data privacy and cyber security, etc. The more financial systems depends on electronic platforms and digital records, the more susceptible they are to cyber-attacks, which can disrupt the flow of funds across the economy, cease economic activity and threaten the overall financial stability. With this in mind, SBP has issued various regulations and Page 7 of 10 guidelines including the frameworks for Enterprise Technology Governance and Risk Management, Security of Internet Banking and Payment Cards, Prevention against Cyber-Attack, and Risk Management in Outsourcing Arrangements by Financial Institutions. 11.To promote the adoption of technology, SBP has continuously been taking initiatives on the infrastructure side, to promote the adoption of technology for facilitation of masses. SBP has worked with FBR and customs and other provincial tax authorities like Sindh Revenue Board for collection of taxes and custom duties using alternate delivery channels. SBP is in the process of launching a knowledge management system that will facilitate the interaction of general public with SBP. We are also working with Bill & Melinda Gates Foundation and Karandaaz Pakistan to build a micro payment gateway that will introduce fully interoperable faster payments for consumers and businesses alike. This initiative will not only help to modernize the clearing and settlement infrastructure for reducing cost, improving efficiency, enhancing security, but will also help in digital on-boarding of customer using open API based platforms and directory services. Ladies and Gentlemen! 12.To adopt innovative technologies and promote the digitization of economy, SBP has always encouraged the role of banks and non-banks in the financial sector of Pakistan. We believe that non-banks like Fintechs and Bigtechs can play a big role in transforming the economic landscape of Pakistan. China is a great example for us where entities like Alibaba, Tencent and JD.com have innovatively used technology to provide efficient services to the masses. SBP Page 8 of 10 is also facilitating the entrance of non-banks particularly in payments and banking and in the past have issued enabling regulations on Branchless Banking and Payment System Operators and Service Providers. Right now, we are in the final stage of issuing regulations for e-money institutions. SBP is cognizant of the fact that Fintechs may find certain regulations as inhibiting for their offering so we are in the process of establishing a regulatory sandbox to identify such issues and find ways of supporting and facilitating innovative ideas. Ladies and Gentlemen! 13.I am confident that the challenges that I have mentioned earlier will provide great opportunity and space to banks like Telenor and companies like ANT Financials, who have great experience of transforming payments and banking landscape in China thus promoting digitization and financial inclusion. I am hopeful that based on its experience, ANT Financial will provide out of the box solutions for challenges being faced by the industry and consumers in Pakistan. Especially I expect that ANT Financials will bring innovative ideas to Pakistan especially to assist SBP in areas like financial inclusion, digitization of payments, e-commerce, SME Finance, increasing access points, partnerships with non-bank FinTechs and using innovative technologies further to bring efficiency in banking and payments. 14.For my colleagues from banking industry in Pakistan, I would like to say that we have to adapt to the changing realities of times. We shall take the challenge and use the opportunities provided by technology to deliver the best of best to our citizens. I expect that the financial sector will take advantage of Page 9 of 10 current favorable market environment by investing in innovative technologies and product offerings to expand services and broaden access to financial services in the country. 15.I would once again like to congratulate Telenor Microfinance Bank and ANT Financial for launching this initiative to facilitate cross border remittances. I am confident that ANT Financials will play its role in the economic development of Pakistan and would further strengthen Sino Pak ties in the fields of Banking, Finance and payments. I shall ensure that State Bank of Pakistan would continue to extend possible support to facilitate them. Thank you for your attention! Pakistan Zindabad. ***** Page 10 of 10 | state bank of pakistan | 2,019 | 1 |
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