BY FAISAL BARI
Provision of efficient banking and financial services can contribute significantly towards achieving development and growth objectives. But has the banking/financial sector done that in Pakistan? Is it contributing, what it could, to Pakistan’s development and growth effort? It is not a bad question to ask at a time when there is talk of revival of growth and a number of industries have started to experience some expansion.
Growth has been slow over the last few years. And the growth we have had has mostly been driven by growth in the services sector and not manufacturing. In particular, growth in large-scale manufacturing has been quite slow. Some experts suggest that other than expansion in the services sector it is the informal economy that has been growing.
A number of questions continue to puzzle. Why is financial inclusion so low in Pakistan? Why are the majority of people in Pakistan unbanked? Why have commercial banks not gone to rural areas in a bigger way and why do they not have more clients in the areas in which they work? Formal-sector financial inclusion in less than 15pc. As many clients seem to be part of the formal sector as there are in the informal financial sector. Even where clients are in the formal financial sector, meaning they have bank accounts, they only have access to saving instruments (bank accounts). Most of them do not have the opportunity to borrow from banks. If these clients have to borrow, they have to request friends and/or relatives, rely on instruments like committees (community based saving and credit instruments) and/ or rely on the very expensive commercial informal market.
Informal finance seems to provide flexibility, even though it costs more, that formal sector has been unable to mimic. Penetration of microfinance banks, though it has expanded over the last decade, at around 1-1.5 million clients total, remains very low.
After nationalisation in the early 1970s, banks were forced to open a large number of branches in rural and far-flung areas. Many of these branches continued to function into the 1990s. When privatisation of the larger banks occurred in the 1990s, they carried fairly large networks with them into the private sector. And though they might have done some rationalisation on the margins, by and large, they have continued with the large branch network they inherited. But there have not been major expansions either.
GDP growth rates have fluctuated a lot over the last decade. We had a couple of strong growth years over 2004-6 period, but since then growth has been slow. It is only now that we seem to be moving towards some revival for growth. When growth rates are high, it is easier to find places where lending can generate good returns for banks. But when growth rates are low, it is harder to find reasonable risk-decent return sectors. Banks tend to lend less in bad times.
One of the fastest growing sectors, in the country over the last couple of decade has been the private, for-profit schooling sector. Today it is estimated that about 35-40pc of enrolled children attend private schools in the country. The proportion of children attending private schools in the larger cities is more than 60-70pc.
Some estimates of the number of private schools across the country put them well above 125,000. But the entire expansion in private schooling has happened through retained earnings, borrowings from friends/family and/or borrowing from the informal sector. Formal financial sector, commercial banks, investment banks and even microfinance banks have had nothing to do with the expansion of the sector.
There is plenty of evidence that the expansion of the sector would have been faster if formal finance had been available to the larger and more successful education-entrepreneurs (edu-preneurs, as they are called) in the sector, but formal banks have chosen not to lend to the sector.
Motorcycles and mobile phones have seen major expansions too. Some 1.7 million motorcycles are sold a year now and there are more than 100 million mobile connections that have been sold in Pakistan. Localisation of motorcycle production as well as its sale has been almost completely funded by informal finance. Similarly, formal finance has not had any role at the retail or distributive stages of the expansion in the mobile market.
It is hard to come up with an example of a sector that has seen expansion because of the formal financial sector. Banks have not taken any risks whatsoever with new sectors in the last couple of decades. Banking has been, to say the least about it, pretty boring and uninteresting.
Why does the banking industry have big and small banks coexisting? If big banks are more efficient, low in risk and high in profit, which they are and have been, and given banking is not a competitive market and has been and is oligopolistic in all societies, why have they not been able to drive the smaller banks out of the market?
There has been some consolidation in the banking industry over the last decade and some is still continuing. But banking-sector profits have been large enough to have allowed even smaller banks to survive, despite higher costs of funds for them, due to niche strategies and by making slightly more risky investments.
But, even smaller banks have not been experimental enough and none of them have tried strategies for banking the poor and/ or going into sectors that have historically been served by informal finance. The cost of funds for the larger banks is quite low. There has been plenty of free float. They make quite a bit of money lending to smaller banks for short-term needs as well. Between lending to government at high rates, not giving much to clients in interest and having a very low cost of funds, it is not surprising that the larger banks continue to show significant profits without taking any risk or developing new sectors and/or markets.
Banks have been making too much money in the last few years by just lending to the government. Treasury bonds, going from a few months’ duration to that of a decade, have given yields up to 13-14pc. If the banks can get this sort of return in risk-free paper, why would they want to go for risky investments, and why would they want to develop new clients and/or new markets?
This is exactly what has been happening. Banks are heavily invested in government papers. They do not need to lend to service providers, small and medium enterprises (SMEs), agriculture or any other sector where there is risk or the credit markets have not developed fully. They can leave all that to either the smaller banks or the government.
Pakistan relies a lot on agriculture and we have done reasonably well in agricultural production historically. But, if it was not for State Bank of Pakistan (SBP) stipulations and/or encouragement for banks to lend to agriculture, banks would not be lending to farmers at all. No commercial bank has ever developed any interesting product for the agriculture sector. The market for agriculture loans is as primitive as it was decades ago.
Pakistan has a shortage of millions of houses (dwellings). Yet our housing loan and mortgage markets are almost non-existent. If it was not for the House Building Finance Corporation (HBFC), even the nascent market in housing would not have developed.
More than 95pc of registered enterprises in Pakistan are micro, small and/or medium enterprises. Report after report has established that SMEs have been and continue to be credit-constrained and non-availability of credit is one of the major constraints that has hampered and is hampering optimal growth paths of enterprises. Yet, the banking sector has never prioritised the development of credit products that could work for SMEs.
There is no point in talking about loans to professionals and/or service providers. The notions of collateral remain archaic in our banking industry. New products, in the area of collateralisation, have not been seen for ages.
Even though the government stepped in with Khushali Bank and Pakistan Poverty Alleviation Fund (PPAF) to develop and deepen the microfinance market, the total number of clients of microfinance, including all private providers, stands barely above a million or so clients.
If banks continue to make effective returns through buying risk-free government papers and have low cost of funds as they do, they will continue to be risk-averse and will not invest in developing sectors for lending that could contribute a lot to overall development and growth of the country: SMEs, housing sector, service sector, microfinance and even consumer finance.
Historically, new sectors and/or clients have only been developed, like banking sector expansion post-nationalisation, when the regulator either forced the banks to enter a sector or underwrote the risk for lending to a sector. Maybe the same strategy should be used by the government and the SBP again.
Should the government form some funds for underwriting part of the risk for developing mortgage products, products for SMEs, venture capital and so on? And, should the government try to create ‘incentives’ for banks to experiment more in these areas/markets and in ‘forcing’ them to expand services to rural areas? We could, potentially, develop links between mobile companies, banks and microfinance providers to keep risk of lending to the poor manageable but at the same time offer services to the poor, like income smoothing, that the poor really need.
The banking sector could contribute a lot more to the development effort. But its contributions so far have been limited. It could extend banking services to a majority of citizens of the country. This can have significant saving enhancement as well as income smoothing possibilities for people. The banking sector could help in developing a much better housing market in the country. And, by serving the services sector as well as SMEs, the banks could contribute a lot of the overall growth and development effort. But, so far, it has not.
Having access to cheap funds and the possibility of making more than reasonable returns through risk-free government paper, the banks have avoided taking risks and/or developing new products and markets. The government, through underwriting some part of the risk and through design of incentives and appropriate regulation, should encourage banks to enter some of the areas mentioned above. This can have significant impact on the overall growth rate of the country and on the pace of development.
From the Dawn Special Report on Banking, Published Friday May 13th, 2016