Pakistan Banking Sector Overview

A bank is a financial institution licensed by a government. Its primary activities include borrowing and lending money. Banks are important players in financial markets and offer financial services such as investment funds. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries such as the United States banks are prohibited from owning non-financial companies. In Japan, banks are usually the nexus of a cross-share holding entity known as the zaibatsu. In France, banc assurance is prevalent, as most banks offer insurance services (and now real estate services) to their clients.

The level of government regulation of the banking industry varies widely, with countries such as Iceland, the United Kingdom and the United States having relatively light regulation of the banking sector, and countries such as China having relatively heavier regulation (including stricter regulations regarding the level of reserves).

Economic functions

The economic functions of banks include:

1. Issue of money, in the form      of banknotes and current accounts subject to cheque or payment at the      customer’s order. These claims on banks can act as money because they are      negotiable and/or repayable on demand, and hence valued at par. They are      effectively transferable by mere delivery, in the case of banknotes, or by      drawing a cheque that the payee may bank or cash.
2. Netting and settlement of      payments – banks act as both collection and paying agents for customers,      participating in interbank clearing and settlement systems to collect,      present, be presented with, and pay payment instruments. This enables      banks to economise on reserves held for settlement of payments, since      inward and outward payments offset each other. It also enables the      offsetting of payment flows between geographical areas, reducing the cost      of settlement between them.
3. Credit intermediation –      banks borrow and lend back-to-back on their own account as middle men
4. Credit quality improvement –      banks lend money to ordinary commercial and personal borrowers (ordinary      credit quality), but are high quality borrowers. The improvement comes      from diversification of the bank’s assets and capital which provides a      buffer to absorb losses without defaulting on its obligations. However,      banknotes and deposits are generally unsecured; if the bank gets into      difficulty and pledges assets as security, to raise the funding it needs      to continue to operate, this puts the note holders and depositors in an      economically subordinated position.
5. Maturity transformation –      banks borrow more on demand debt and short term debt, but provide more      long term loans. In other words, they borrow short and lend long. With a      stronger credit quality than most other borrowers, banks can do this by      aggregating issues (e.g. accepting deposits and issuing banknotes) and      redemptions (e.g. withdrawals and redemptions of banknotes), maintaining      reserves of cash, investing in marketable securities that can be readily      converted to cash if needed, and raising replacement funding as needed      from various sources (e.g. wholesale cash markets and securities markets).

Banking Sector in Recession

For economists, the word “recession” means the reduction of a country’s Gross Domestic Product (GDP) for at least two quarters. In 2008, The International Monetary Fund (IMF) issued a report during the time when the global growth was less than 3%. According to that report, the world economy was predicted to an all time low. This report was a source of panic for the economies of the world.

The recession did not affectPakistan, as the country’s banking sector was already low.

Pakistan, which is the 26^th largest economy in the world and 47^th in terms of the dollar, is not totally untouched from the global recession but it has had little impact from the recession as compared to western countries.

Last year in 2008, the profits of the banks declined because of the overall market perception of the customers and the role played by IMF in increasing the interest rates which slowed down the business activities and affected the banking sector as well.

The banking system ofPakistanhas escaped the major ravaging effects of recent financial market turmoil emerging from US and engulfing the developed European economies. This was stated by the Governor, State Bank ofPakistan, Dr Shamshad Akhtar Ex-Governor of State Bank ofPakistan.

However, she also said, ‘In my assessment,Pakistan’s economy to date has been affected mainly by the indirect impact of global events which led to the rise in the global commodity prices.’

Citing an example to explain this situation, she explained that almost 80% of the external current account deficit in FY08 is equivalent to the import oil bill which shot up to over $11 billion in FY08 as compared to below $3 billion a few years back. Similarly, a large increase in FY08 fiscal deficit is on account of delay in pass through of the international price hike at retail level.

Present Situation

It is a well known fact that we had a splendor time in Pakistan’s banking industry during recent years. We all witnessed that the banking sector was the most expanding and growing sector of Pakistan (along with Telecom). First time in the history of Pakistan, consumer products were launched and banks were offering easy and small loans to every employee of the Government and private sector.

However, the global economic downfall has impacted our local banks as well, even with the 7.5 billion US $ International Monetary Fund injection could not do much. The banking sector has yet to reach the moment of relief.