Pakistan’s Banking System

Author: Pakistan Habib Bank Chief Representative in Beijing Cheng Wei

As a long-standing friendly neighbor of China and an important cooperative country along the “One Belt, One Road” initiative, Pakistan has provided a broad strategic opportunity for Chinese enterprises to “go global”. As the flagship project of the “One Belt, One Road” strategy, the “China-Pakistan Economic Corridor (CPEC)” has made significant progress in key projects such as energy and infrastructure construction included in the first phase of the project, and also promoted the second phase of the corridor smoothly. The construction has laid a good foundation and can provide reference for the construction of other countries in the “Belt and Road” project.

The author has been working for a long time in Pakistan’s leading representative office of banking institutions in China. He wrote this article on the basis of the China Economic Network. It aims to help more Chinese institutions understand Pakistan’s domestic situation through the elaboration of Pakistan’s domestic banking system. Relevant business considerations and decision-making provide assistance within reach.

Economic situation review and outlook

Pakistan was founded in 1947, and in the following 40 years it achieved economic growth above the world average and decelerated in the 1990s. The International Monetary Fund’s aid program and the huge debt relief in the United States have played a role in reducing Pakistan’s external debt. In the past few years, the overall situation of the Pakistani economy has been relatively stable and the economic growth rate has improved significantly. From 2013 to 2014, Pakistan’s real GDP growth rate exceeded 4%, and the GDP growth rate from 2016 to 2017 increased steadily to 5.28%. Thanks to the positive effects of a significant recovery in agriculture, service industry development and large-scale manufacturing output, Pakistan’s GDP growth in 2017-2018 reached 5.8%, the highest level of economic growth in a decade. Among them, the agricultural sector grew by 3.46%, the industrial sector’s comprehensive contribution was 5.02%, and the large-scale manufacturing (LSM) grew by 4.61%.

Pakistan has a population of about 200 million and is a developing country in a capitalist market economy. The national economy is dominated by agriculture and the industry is relatively backward. In recent years, the proportion of services in the Pakistani national economy has increased to 60%. The service industry as a whole has performed well, and its growth rate has remained above 6% for two consecutive years.

Pakistan’s infrastructure and industrial sectors are undergoing reforms, with the government making infrastructure and exports a top priority for development. The textile industry has contributed the most to exports, accounting for 21% of Pakistan’s large-scale manufacturing. Other major industries include food, petroleum, pharmaceuticals, chemicals, automobiles, fertilizers, steel and electronics.

With the construction of the China-Pakistan Economic Corridor and the gradual implementation of the established development projects in the public sector of the Pakistani government, investment in the public sector will greatly boost domestic demand and promote the development of related industries such as construction and retail. Foreign direct investment increased from $2.75 billion in 2017 to $3.09 billion in 2018. The driving force for economic growth is mainly the adaptive monetary policy and the subsequent expansion of private sector investment, especially fixed investment, steady growth in agriculture, steady increase in infrastructure construction, and infrastructure under the China-Pakistan Economic Corridor. The landing of projects and energy projects.

The import of machinery and raw materials has a positive effect on the improvement of economic production efficiency. However, the continuous increase of consumer goods imports is still a major concern. The import compound growth rate from 2015 to 2018 is 11%. The export performance was average, the import and export deficit continued to expand, and the slowdown in remittance growth caused the current account deficit to increase from 1% in 2015 to 5.8% in 2018. Therefore, Pakistan’s dependence on external financing to mediate import and export contradictions is also increasing, and the pressure on foreign exchange reserves is gradually increasing. Pakistan’s external debt continued to grow last year, from $65.1 billion to $83.4 billion.

The China-Pakistan Economic Corridor will be a key factor in Pakistan’s economic growth strategy. The China-Pakistan Economic Corridor is one of the six economic corridors of the “Belt and Road” and aims to promote regional interconnection and trade activities. According to data released by the National Bank of Pakistan, Pakistan attracted US$1.81 billion in investment in FY18, which is close to 60% of Pakistan’s foreign direct investment. The areas attracting investment are concentrated in the power industry, construction industry and retail industry. The construction of China-Pakistan economic corridor has become a new impetus for Pakistan’s economic development. The total bilateral trade between China and Pakistan in 2018 is about 13 billion U.S. dollars. After the Central Bank of Pakistan encourages the use of RMB in bilateral trade and investment activities, it is expected to promote the increase in bilateral trade. This initiative will increase trade activities and market remittances centered on the renminbi, while facilitating the diversification of Pakistan’s foreign exchange reserves.

Read More: Entering The Mysterious Country Of Pakistan And Launching An Unprecedented Trip

Banking history

Pakistan’s financial industry was still in its infancy in the early days of the founding of India and Pakistan. The State Bank of Pakistan (SBP) was established in 1948 and functions as a central bank. Pakistan’s largest commercial bank, Habib Bank, moved its headquarters in Mumbai, India to Karachi, Pakistan, after its partition in India and Pakistan, becoming the first commercial bank to open a business in Pakistan. This initiative laid the economic foundation for Pakistan’s national economic stability and trade development in the early days of the founding of the People’s Republic of China.

Since the promulgation of the National Bank of Pakistan Act in 1956 to the implementation of the nationalization policy in the 1970s, the commercial banking sector has made great progress during this period. 13 banks have been controlled by the government and integrated into six state-owned banks. In the following years, the Pakistani government promoted privatization of the industry by issuing new licenses and selling state-owned bank shares. In the 1990s, after the revision of the Banking Nationalization Act, the Muslim Commercial Bank (MCB) was privatized in 1991. Most of the ownership of the Union Bank (ABL) has also been transferred to its management. Union Bank (UBL) followed closely and in 2002 also achieved economic privatization. With the promulgation of the Banking Companies Ordinance in 1962, the strengthening of the bank’s internal control and the improvement of the company’s management system, the power of the National Bank of Pakistan (SBP) was restored and the bank transformation reform was also initiated. In 1991, the Banking Nationalization Act was further amended to authorize the federal government to approve the establishment of private banks.

The wave of mergers and acquisitions in Pakistan’s banking industry at the beginning of this century has improved the rigid distribution mechanism of bank assets, and more investment in the science and technology sector to ensure capital balance and adequate allocation. At the same time, the National Bank of Pakistan (SBP) has made bank privatization projects a powerful regulation that reduces the likelihood of economic problems such as non-performing loans, government-guaranteed loans and inefficient management.

Current status of the banking industry

Pakistan’s banking industry is relatively open. The banking supervision system consists of the National Bank of Pakistan and the domestic banking industry, including state-owned commercial banks and private banks, collectively referred to as “scheduled banks” (Scheduled Banks), as well as foreign banks.

With the privatization of the economy and the liberalization of financial markets, the Pakistani banking industry has entered a long-term growth phase. As of June 2018, Pakistan had a total of 34 listed banks* (Note: Listed banks refer to banking institutions registered under the Bank of Pakistan 1956 Act and included in the bank statements held by the Central Bank of Pakistan. Banks are large banks with strong strengths. They have certain rights and must bear certain obligations. According to the regulations of the central bank of Pakistan, banks have the following rights: fund liquidation, free remittance, application to the central bank for rediscount loans, Foreign exchange business, etc.; its obligations must include: paying the paid-up capital in accordance with the agreed amount, submitting the operation status and data to the regulatory authorities on a regular basis in accordance with regulatory requirements, and paying deposit reserve according to regulatory requirements, etc.), with 13,692 Branch. Among the 34 banks, there are four foreign banks, of which Bank of China is the largest foreign bank in Pakistan’s banking system.

The following are the various financial institutions under the supervision of the National Bank of Pakistan:

The good development of Pakistan’s banking industry is due to the effective measures taken by the National Bank of Pakistan (SBP) to implement strong regulatory measures and at the same time take into account the development demands of the banking industry. SBP has played an important role in many aspects of national economic development, ensuring that banks have strong capital adequacy levels, good regulatory systems and a sound risk management framework. The regulations of the Pakistan National Central Bank in the areas of capital adequacy, non-performing loans and provisioning have played an important role in the stable and healthy development of the country’s financial industry in the past few decades.

As of September 2018, Pakistan’s domestic banking industry had total assets of 18.11 trillion bales, of which five major banks accounted for 52% of total assets. From 2015 to 2018, the compound annual growth rate of China-Pakistan banking deposits exceeded 9%, from 10.38 trillion at the end of 2015 to 13.60 trillion in September 2018. During the same period, the total amount of loans achieved a compound annual growth of 16%. Most of the growth comes from banking, and a small part comes from consumer loans. Due to regional cultural differences, the lack of public financial awareness and the lack of public education, the penetration rate of domestic banking services in Pakistan is still at a low level. Therefore, inclusive finance has attracted the attention of the banking industry, with the heads of the Habib Bank. Under the guidance of supervision, banks are increasingly investing in SMEs and agriculture.

Banking deposits grew in tandem with the growth of broad money and remittances. In 2015-2018, the compound annual growth rate of remittances (overseas) was 2%, from $18.7 billion in FY2015 to $19.6 billion in FY18. The operation mode of the banking industry is mainly based on the interest rate of deposits and loans. Most of the deposits of the five major banks come from interest-free accounts and current account deposits. Therefore, banks can maintain a low deposit cost on the one hand, and the loan interest rate is linked to the Karachi Interbank Offered Rate (KIBOR). Small-scale banks tend to provide savers with higher deposit rates, thereby increasing their market share. The key factors for banks to compete with their peers are the scale of operations and branch networks, as they are keen to provide services to large corporate customers, while large corporate customers can bring objective intermediate business income to the Treasury and the Investment Banking Department. Derivative branch networks in key business areas can help banks develop customers, cross-sell other products and reduce deposit costs.

Interest rate cycles and inflationary pressures affect savings habits, and savings habits determine consumption patterns. During the period of high interest rates, bank assets were revalued, and the bank did not pass the increase in the return on profitable assets to the savers, thus enjoying higher profits. Since the FY2015, interest rates have been declining, and the National Bank of Pakistan has decided to link the deposit savings rate (the lowest deposit rate) to the policy rate. In recent years, the net interest margin has been continuously compressed. In 2018, due to the weak state of the local currency, the price of public utilities increased, and import tariffs increased, leading to increased inflationary pressures. Therefore, the central bank of Pakistan raised interest rates by 425 basis points to 10% in 2018.

Habib Bank of Pakistan

The top five banks in China

The five largest banks in Pakistan include Habib Bank, National Bank, United Bank, Muslim Commercial Bank and Union Bank. The five major banks accounted for 52.1% and 52% of the total banking assets and deposits, respectively, while the capital adequacy ratios of the five major banks were higher than the industry average, reaching 16.28%.

As of September 2018, the rankings of the top five commercial banks in Pakistan by total assets are as follows:

Remarks:

The data is taken from the unaudited semi-annual financial report for the fourth quarter of 2018. The US dollar to rupee conversion rate is 1 US dollar: 124.25 rupees

Habib Bank ranks first in terms of total assets, deposits, total loans, etc.

Figure 4: Five major banks’ return on investment sources: financial statements

Among the top five banks, Habib Bank ranked first in Pakistan, and it is the largest bank in Pakistan in terms of total assets, total deposits and branches. In addition, the largest amount of public loans in domestic banks, in 2012 Habib Bank became the first bank with a total deposit of more than 1 trillion bales. Compared with other domestic banks in Pakistan, Habib Bank has the most international distribution, with branches in more than 15 countries and financial centers around the world. The bank is currently the only Pakistani bank that has a branch in China and has obtained full currency and RMB full currency licenses.

With the central bank of Israel and Palestine as the supervisory guidance, the Pakistani financial system led by the five major banks has continuously improved the economic structure and passed the test of the “Belt and Road” China-Pakistan Economic Corridor. It has shown obvious strategic advantages and effectively dragged economic development, mainly reflected in the following several aspects.

1. Credit growth

Thanks to a stable financial environment with low interest rates, capital-intensive industries have attracted many investments in recent years, with energy, cement, steel and automotive industries taking advantage of low interest rate opportunities and large-scale investments. At present, enterprises are still the main force of borrowing, and the proportion of total loans has increased from 67% at the beginning of 2015 to 70% in September 2018. In the past three years, the amount of loans in the energy sector has increased rapidly. The loan amount in the energy sector accounted for about 17% of the total loans. It surpassed the textile industry, the former main force in the Pakistani market, and ranked first.

In the case of rising interest rates, banks re-priced loans and portfolios, resulting in an increase in net interest margin yields. At the same time, due to slow GDP growth and rising interest rates, the growth of bank assets has slowed down, which may lead to an increase in non-performing loans in the near future.

2. High level of capitalization

As of September 2018, the Bank of Pakistan had sufficient capital, healthy income growth, accumulation of reserves, and risk-weighted asset portfolios driven by risk-free investment to promote asset growth. Based on the above three conditions, the capital adequacy ratio reached 16.1%.

Although the government has adopted fiscal consolidation measures, it is expected that the banking industry will maintain a deficit fiscal, and banks may remain active in the national debt market. But I believe that the banking industry can adapt to the current challenging macroeconomic and business environment.

3. Non-financial income and interest income structure is stable

The ratio of non-financial income to total income has stabilized at around 28% in the past three years. Non-financial income is mainly composed of commissions, commissions, brokerage fees, and foreign exchange earnings and capital gains obtained from capital transactions, including subsidiary equity. Dividend income from investments.

At the same time, banks are also trying to diversify – investing in asset management companies, most of which come from within the banking system. Compared with the general interest income of 35%, the bank’s income from open-end funds and closed-end funds can be applied to lower tax rates. Due to the restrictions of the National Bank of Pakistan, banks can only invest 30% of their share capital in the capital market, and stipulate that the investment amount of any one project should not exceed 5% of the actual capital.

Similarly, the proportion of net interest income of the top five banks to total revenue has remained stable in recent years. Among the five major banks, the non-financial income of the National Bank contributed the most to total revenue, consistent with the growth trend of state-owned banks in recent years.

The improvement of the Pakistani banking financial system is a test of practice. In the face of the impact of unfavorable factors on economic development, it is imperative for Pakistan to improve and upgrade its financial system, strengthen internal supervision, popularize basic public finance education, and strengthen the inclusive economic system. To this end, the Pakistani banking industry has actively introduced new countermeasures.

4. The latest developments in the banking industry

Domestic systemically important bank governance framework

In keeping with the latest industry best practices, especially the index-based approach issued by the Basel Committee on Banking Supervision, the Bank of Pakistan has sent corresponding positions and institutional arrangements to implement the Domestic Systemically Important Bank Governance Framework (below) Referred to as D-SIB). The requirements under this framework are designed to enhance the resilience and risk management capabilities of large banks in response to shocks.

The D-SIB governance framework clarifies the D-SIB identification and designation methodology, improves the regulatory and supervisory systems, and lays the groundwork for the implementation of the guidelines. According to the framework, the Pakistani central bank will identify D-SIB samples and announce relevant arrangements in June each year. The designated D-SIB should complete higher loss absorption requirements as required and increase regulatory requirements. Other banks in the D-SIB sample are only required to meet enhanced regulatory requirements.

In June 2018, the Central Bank of Pakistan announced the first batch of D-SIB designated banks, and the designated D-SIB banks should meet the requirements for strengthening supervision and supervision by March 2019. According to the specified standards, the Pakistani central bank has designated Habib Bank, National Bank and United Bank as D-SIB banks. These three banks must achieve higher loss absorption capacity through additional primary common stock (CET1). Habib Bank will maintain 2% of the first-class common stock, and National Bank and United Bank will maintain 1.5% of the first-class common stock. In addition to these three banks, other major banks operating under the global banking system in Pakistan (G-SIB) will maintain additional Tier 1 common stocks based on their risk-weighted assets in Pakistan, with specific ratios referring to the corresponding G-SIB requirements.

surtax

The 2015 Financial Act of 2015 imposes a one-time additional tax on recognized taxpayers (including institutional taxpayers), with a reference to the regular tax system or the final tax system. Financial institutions such as banks have a tax rate of 4% and the tax period is extended to 2017.

According to the 2018 Financial Act, the additional tax collection period for banking financial institutions is extended to 2021, but the tax points for subsequent years are correspondingly lowered, as shown in the following table:

Economic Development and Prospects for Financial Cooperation between China and Pakistan

Pakistan is also a developing country dominated by agricultural development. Relying on the export of textiles to obtain trade income still accounts for half of the export volume of Pakistan. Under the joint action of the “Belt and Road” China-Pakistan Economic Corridor, Pakistan has increased its industrial exports. . However, due to factors such as increased consumer demand, increased infrastructure investment and sluggish exports, Pakistan still faces a double deficit in fiscal and trade, and foreign exchange reserves are under considerable pressure.

The China-Pakistan Economic Corridor will continue to be a key driver for future economic growth, gradually breaking down bottlenecks such as poor infrastructure, setting up economic zones and enhancing global connectivity. Financial institutions such as the Bank of Pakistan will continue to stand at the forefront of national economic growth. The profit margin of the banking industry is expected to rise in the short term as the net interest margin yield increases.

With the assistance of the World Bank, the National Bank of Pakistan has successively introduced a series of measures aimed at improving the country’s financial inclusion, including the National Inclusive Financial Strategy (NFIS). The strategy will set up a special Pratt & Whitney platform to promote the implementation of new initiatives for inclusive financial reform. Pakistan’s credit penetration rate is low, and there is still a long way to go to increase financial inclusive rates and integrate funds from informal channels into the formal channels of the banking industry. In this regard, local banks represented by Habib Bank will Play a major role.

The financial cooperation between the two countries, especially the banking industry, has experienced a new phase of cooperation from a single international settlement agency to the current inter-institution, joint project financing and capital market cooperation in the past few years. It is believed that the banking institutions of the two countries can work together to develop more extensive cooperation in the development of third-party markets along the Belt and Road, green financial practices, financial technology and inclusive finance, RMB in direct listing and liquidation in Barubi, and capital market business. . (Author: Pakistan Habib Bank Chief Representative in Beijing Cheng Wei Source: China Economic Net).