Pakistan: Foreign banks lose some luster.

ISLAMABAD, 8 April — Once the star of Pakistani financial scene, foreign banks are loosing some of their luster, while the domestic ones have gained.

The data for the first half — July 1-Dec. 31, 2001 — of current fiscal 2002 suggests, “foreign banks failed to perform up to their standards,” says the latest review of financial operations, done by the State Bank (SB). “However, as these banks are more exposed toward foreign currency accounts, the conversion effect of lower exchange rate resulting in lower rupee value is more prominent for this group. In addition, anecdotal evidence suggests that restrictions of foreign currency deposits, under SB’s Foreign Exchange Circular 25, that limited their growth to just 20 percent of their rupee deposits, hampered the growth of foreign banks.” it says.

A considerable blame for this situation rests on the government’s freezing of $11 billion private foreign currency accounts (FCAs) in May, 1998 in the wake of Islamabad’s nuclear explosions. The freeze was applied in order to prevent a run on the banks for withdrawal of private dollar deposits. The foreign banks, too, must own part of the blame as they had become complacent during most of the 1990s — the decade of freedom of forex — and had rested their laurels too much on dollar deposits. They had not endeavored enough to mobilize rupee deposits. Pakistanis had too much confidence in placing their dollar deposits with foreign banks, rather than trusting their domestic counterparts. Now, four years on, the effects still linger on.

Added to the problem is the recent appreciation of the rupee against the dollar. It followed Sept. 11 terrorist attacks that, in turn, led Western aid donors to provide Pakistan with considerable new financial assistance, and postponement of repayment of the already owed debts. These inflows and reliefs led to appreciation of the rupee against the dollar — a phenomenon that nearly wiped out the kerb market in dollars.

The spread between the kerb and the interbank dollar rate, which is almost the official rate for all practical purposes, for months has been reduced to less than a rupee. The kerb rate at the weekend was Rs.65.25/60.35 to a dollar while the interbank rate was Rs.60.14/60.16.

Why was the kerb market, that had flourished for years, and operated closely with money changers in Dubai was hit? It happened because the State Bank reduced buying dollars from the kerb to repay foreign debts that donors rescheduled. During July-March period of fiscal 2002, SB reduced purchases from the kerb to $1.1 billion from $1.6 billion in the like period of fiscal 2001. As dollars in the interbank market also became cheaper, SB increased its purchase to $1.5 billion in July-March 2002, up from $850 million in the same period last fiscal. At the same time, an environment of a closer monitoring, by banks and government, of private forex transfers from abroad, also adversely hit the kerb.

Compared to foreign banks, “nationalized (state-owned) and private banks, out-performed the other groups,” says SB while analyzing the financial results of the bank for the first half of the current fiscal. It said, “private banks have been performing well in deposit generation; growth was higher this year, especially during the second quarter,” — October-December, 2001. With the increase in the opportunity cost of dollar holdings, people started depositing in these banks as they are offering relatively better returns. Much more important is to note the deposit growth for the nationalized banks.

Large branch network and the shifting focus on rupee banking provided them an advantage over other groups — including foreign banks. It is a stylized fact that these banks are considered safer under certain conditions with the explicit government guarantees at the back.

The deposits of nationalized banks, during the first half of fiscal 2002 rose 38.9 percent, compared to minus 10.1 percent in the like period of last year. The private banks saw their deposits rise 26.5 percent, up from 23.5 percent, during the same two periods. But, foreign bank deposits rose a paltry 1.3 percent in the first half of fiscal 2002, down from 8.7 percent in the like period of last year. As of now, foreign banks have 16 percent share of all deposits. At the same time, the three big state-owned banks, National, Habib and United hold 48 percent of deposits.

Two semi-privatized banks have 21 percent, while the remaining 15 percent deposits are with smaller private commercial or investment banks. Overall, deposits of all banks in the first half of fiscal 200, totaled Rs.70.9 billion, up from Rs.24.8 billion in the first half of last fiscal. In the second quarter of 2002, the deposits went up to Rs.80.0 billion, compared to Rs.8.5 billion in the second quarter of 2001. This was possible, because of what SB describes as “extraordinary foreign exchange inflows that overshadowed the expected poor performance of the bank system.”