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Management of Financial Institutions - MGT 604

Lecture # 19

ROLE OF COMMERCIAL BANKING

(xi)LegalReforms

Legaldifficulties and time delays in recovery of defaulted loanshave been removedthrough

a new ordinance i.e. TheFinancial Institutions (Recovery of Finances) Ordinance,2001.

Thenew recovery laws ensuresexpeditious recovery of stuck up loans by the right of

foreclosure and sale of mortgaged propertywith or without intervention of court and

automatictransfer of case to executionproceeding. A BankingLaws ReformsCommission

is reviewing, revising, and consolidatingthe banking laws and drafting new laws such as

bankruptcylaw.

(xii)Taxation

Thecorporate tax rates on banks were exorbitantly high in Pakistan thus adverselyaffecting

theirprofitability and attractiveness as an avenue for investment and new equity injection.

TheGovernment has already reduced the tax rate from 58 percent to 44 percent duringthe

lastthree years and it is envisaged that the rate will be reduced gradually and brought at par

withthe corporate tax rate of 35 percent in the next three years. This will in turn help in

reducingthe spread between the deposit rate and lending rate and benefitfinancial savers.

(xiii)AgricultureCredit

A complete revamping of AgricultureCredit Scheme has been done recently with thehelp

of commercial banks. The scope of the Scheme which was limited to production loansfor

inputshas been broadened to thewhole value chain of agriculture sector.

We have, with the grace of Allah, become a surpluscountry in foodgrains, livestocketc. and

thusthe needs of agriculture sector have also expanded. The SBPhas included financingfor

silos,godowns, refrigerated vans, agro processing and distribution under thecover of this

scheme.This broadening of the scope as well the

removal of other restrictions have enabled the commercial banks to increasetheir lending

foragriculture by a multiple of fourtimes compared to FY 1999-00 thusmainstreaming

agriculturelending as part of theircorporate business. Unlike theprevious years whenthey

wereprepared to pay penaltiesfor under performance theyhave set up higher targets for this

year.The private commercial banks have also agreed to step in and increase their lending to

agriculture.

(xiv)E-Banking

The banks are being encouraged to movetowards Electronic banking.There is a big surge

amongthe banks including NCBs to upgrade their technology and on-linebanking services.

Duringthe last three years there is a large expansion in the ATMs has been witnessed and at

present about 500 ATMs are nowworking throughout thecountry. The decisionmandating

the banks to join one of either two ATM switches available in thecountry will provide a

furtherboost. Progress in creatingautomated or on-line branches of banks has been quite

significant so far and it is expected that by 2004 a majority of the bank branches will be on-

line or automated. Utilitybills payment and remittances would be handledthrough ATMs,

Kiosks or Personal Computers reducing bothtime and cost. Investment in information

technology is being undertaken by the banks to enhance efficiency, reduce transactioncosts

and promote E-Commerce. It hasbeen estimated that a bankingtransaction through ATM

costs one fourth as much a transactionconducted over the counter in a traditional branch

Management of Financial Institutions - MGT 604

and the similar transaction overthe internet costs a mere fractionof the traditionalteller

costs.

(xv)HumanResources

The banks have recently embarked on merit-based recruitment to build up theirhuman

resource base an area which hasbeen neglected so far. Theprivate banks have taken lead

in this respect by holdingcompetitive examinations, interviews and selecting the most

qualified candidates. The era of appointment on the basis of sifarish and nepotism has come

to an end. This new generation of bankers will usher in a culture of professionalism and

rigour in the banking industry and produce bankers of stature who will provide the

leadership in the future.

(xvi)CreditRating

To facilitate the depositors to make informed judgments aboutplacing their savings withthe

banks, it has been made mandatoryfor all banks to get themselvesevaluated by creditrating

agencies. These ratings are then disclosed to the general public by theSBP and also

disseminated to the Chambers of Commerce and Trade bodies. Such public disclosure will

allowthe depositors to choose betweenvarious banks. For example, those who wish to get

higherreturn may opt for banks with B or C rating. But those who want to play safemay

decide to stick with only AAA or AA rated banks.

(xvii)Supervision and Regulatory Capacity

Thebanking supervision and regulatorycapacity of the Central Bankhas beenstrengthened.

Merit based recruitment, competency enhancing training, performance linked

promotion,technology driven process,induction of skilled humanresources and greater

emphasis on values such as integrity,trust, team work havebrought about a structural

transformation in the character of theinstitution. The responsibilityfor supervision of non-

bankfinance companies has beenseparated and transferred to SecuritiesExchange

Commission.The SBP itself hasbeen divided into two parts one looking aftercentral

banking and the other after retailbanking for thegovernment.

(xviii)PaymentSystems

Finally,the country's payment systeminfrastructure is being strengthened to provide

convenience in transfer of payments to thecustomers. The Real-Time Gross Settlement

(RTGS)system will process largevalue and critical transactions on real time while

electronicclearing systems will be established in allcities.

These reforms will go a long way in further strengthening theBanking sector but a vigilant

supervisoryregime by the State Bank will help steer the futuredirection.

CommercialBanking in a FreeSociety

Although we can say a great deal about theinstitutions of a free society, and why they are

desirable, speculating about thespecific ways in which people will choose to organize

themselveswithin such institutions is always a trickymatter

Afterall, the whole justificationfor the institutions of a free society is thatonly

throughits institutions can human beings discover progressively betterways of dealing with

scarcity(of both goods and knowledge)

and thus improve both ourmaterial and non-material welfare.Our ignorance of the

details of a free society is precisely why having a free society is so important.

Management of Financial Institutions - MGT 604

Thebanking industry is especiallysuited for just thiskind of analysis. If we want to know

whatcommercial banking mightlook like in a free society, we need only turn to

contemporaryregulation and the historicalrecord to begin to piecetogether a coherent

story.

PrivateDeposit Insurance

Banks in a free society mightchoose to purchase privately supplied deposit

insurance as a way to reassure customers.They might also enter intointerbank mutual aid

agreements, or be insured throughclearinghouses.

Historically, banks have used these and other methods to conveytrust to customers.

Before deposit insurance banks would advertisetheir balance sheets and listthe members of

theirboards of directors.

Providingthis kind of information was a way to establish theirtrustworthiness to

actual and potential depositors. With deposit insurance, banks need not do this.

It is reasonable to expect that banks in a free society will use theseways, and

discovernew and imaginative ones, of creating the trust on whichall banking systems rest.

Banks in a free society will be literallynothing special. What makesbanking so un-

freetoday is that banks are treated differently from otherbusiness enterprises.

Therule of law that wouldcharacterize a free societywould demand that banks be

treated no differently than otherfirms. If they arefraudulent or use force,then they need to

face the consequences. Otherwise,any sort of voluntaryarrangement banks make with

customers will be allowed.

Theresult will not only be a more free banking system,but a more efficient,safe,

and productive one.

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