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).
The economic functions of banks include:
- 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.
- 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.
- Credit intermediation – banks borrow and lend back-to-back on their own account as middle men
- 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.
- 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 26th largest economy in the world and 47th 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.
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.
Increasing terrorism, instable political situation, lawyers’ strikes, protests and panic created by the media happen to be some of the killing factors for the economy. From MCB to NBP every bank has become very careful in offering loans and credits to its customers. A recent report of SBP has revealed that slowdown was also seen in auto finance which was the salient product of the last 5 years. Higher profit rates and dollar price were the other factors which were pushing car sales to lower direction. Mortgage finance and advertising were also seen as the slow trend.
Pakistan’s banking industry was able to maintain its resilience and showed improvement in key solvency indicators despite current economic situation in the country. However, due to deterioration in macroeconomic indicators, the credit risk remained high.
According to the State Bank’s performance report of the Banking System for quarter ended March 31, 2009, the aggregate Capital Adequacy Ratio (CAR, a ratio of a bank’s capital to its risk), improved to 12.9 percent for all banks (13.3 percent for commercial banks).
The CAR improved to 13.8 percent jointly for banks and Development Finance Institutions (DFIs). This improvement was due to the reduction in risk-weighted assets, improvement in capital markets leading to appreciation in the value of available-for-sale investments and satisfactory earnings.
Asset base of the banking system grew 1.6 percent over the quarter to reach Rs 5,744 billion. The asset mix, however, witnessed a significant shift from advances to investments in Government papers and government guaranteed debt securities that are relatively risk free and liquid. Resultantly, the liquidity profile further improved as compared to the second half of the year 2008 when the system faced a significant liquidity shortage, says SBP report.
According to the report, the heightened credit risk transpired in significant increase in Non-Performing Loans (NPLs, A non-performing loan is a loan that is in default or close to being in default). However, even in the face of constraining factors, the banking system earned before tax profit of Rs 26.2 billion for the March, 2009 quarter that was higher compared with Rs10.5 billion in Dec-08 quarter, though lower than corresponding quarter of 2008.
The report pointed out that Non-Performing Loans (NPLs) of the banking system increased to Rs 379 billion (Rs 313 billion in Dec-08) giving infection ratio of 11.5 percent and net infection ratio of 3.9 percent. NPLs are covered by the loan loss provisions to the extent of 69 percent, but due to increased loan provisions in absolute amounts, earnings of the banking system came under pressure and remained lower than corresponding quarters of last couple of years-after tax Return on Asset (ROA) of 1.1 percent for Q1-09 versus 1.2 percent for 2008 and 1.5 percent for 2007.
|Highlights of the quarter ended Mar-09||
|Capital Adequacy Ratio||13.00||12.22||12.92|
|Capital to Total Assets||10.40||10.36||10.35|
|NPLs to Total Loans||7.70||9.13||11.54|
|Net NPLs to Net Loans||1.30||2.48||3.86|
|Return on Assets (Before Tax)||2.20||1.73||1.84|
|ROE (Avg.Equity & Surplus) (Before Tax)||20.70||16.74||17.70|
|Liquid Assets/Total Deposits||41.70||36.92||41.51|
|Advances to Deposit Ratio||72.30||75.94||71.69|