Why banks need structural change – Journal


Imagine yourself as the new Minister of Finance. Considering the unceremonious departure of your predecessor, you are unsure of your tenure.

Either way, you have great confidence in your abilities. You understand the issues and are committed to making structural changes that have lasting effects on the bottom of the pyramid rather than on the bottom line of the commercial banking sector.

Here are the facts: First of all, we are a monetary company with around Rs 6.5 trillion outside the banking system, one of the highest in the world. You need a plan to build that into the system in order to trigger a multiplier effect on bank loans.

Second, due to the country’s income and expenditure imbalance, you are forced to borrow via government securities (Pakistani treasury bills and investment bonds, commonly known as GDP) from commercial banks at a higher rate than the interbank rate offered by Karachi (Kibor).

Create a new investment license for the sole purpose of investing in treasury bills

Your borrowing from the State Bank of Pakistan (SBP) was recently halted under the International Monetary Fund (IMF) program. Your first challenge is that your loan is expensive.

Second, it continued to squeeze loans to the private sector. Over the past three years, banks have increased their public loan portfolios by 16% per year. Meanwhile, loans to the private sector have only grown by 6% per year.

Third, bank boards, intoxicated with the risk-free investments provided by the government, have completely neglected lending to the private sector. There is no real consumer, housing or SME loan. Banks act more like fund managers.

You have had enough of the trickle-down mechanism and want to intervene directly at the bottom of the pyramid. Your ambition is to borrow half of what you currently borrow from banks and move on to borrowing directly from the public, thus reducing borrowing costs and creating a finality that forces banks to do their job, to know how to lend.

Your first task is to wean yourself off the funds you collect from banks via treasury bills. You can only dictate the expected remedies after you have reduced your dependence on them. The Treasury bill is a 90-day discounted instrument, currently only available to banks designated as primary dealers (to provide liquidity).

In most cases, banks do not offer this high yield and risk free investment to their customers because they are offering a lower rate on their deposits.

As the instrument already has a denomination of Rs5,000, you are taking the bold step of bank disintermediation. You are creating a new investment license for the sole purpose of investing in treasury bills. The regulated entity will conduct a digital customer knowledge (KYC) exercise through the National Database and Registration Authority (Nadra).

The investment will be made digitally without any physical instrument issued. No liquidity will be provided to the end user as the term is 90 days. Unlike the bulk auction in which banks participate, the regulated entity will be allowed to buy on tap even for a single investment of 5,000 rupees. The interest rate provided on a savings account is around 5pc per year. The treasury bill instrument will provide a return of 6 bp over 90 days. You are intentionally providing a rate that is 1 pc lower than what you pay to banks. To soften the offer, you eliminate the 10% withholding tax for this category of investors and impose a cap of 1 million rupees per investor. Once you’ve reached 50% of your current treasury bill borrowing from banks, you move on to phase II of your plan.

Your first step is to reduce the yield on treasury bills offered to banks. At the moment you are supplying Kibor plus, which is around 7.59 pc. Since you have already diversified your sources of financing, you reduce your borrowing rate by one percentage point. This percentage point will translate into savings of Rs 46 billion in the first year alone. The benefit of this is that once you demonstrate an alternate source of funding, banks will need to start thinking about lending to the private sector.

Their current revenue-cost imbalance will force them either to reconsider lending to the private sector or to significantly reduce their staff.

Your second step now is to put a cap on the amount that banks can invest in government securities. You create a healthy ratio, which must be maintained between public and private loans.

Your third step is to impose a special tax on government-related income. You’ve been providing bank owners with a bunch of sauce for too long, and it’s time to recoup some of the profits they’ve made from you.

You know discussions like this have been conducted in the past without any action. You also know that bank boards will never change their position as long as risk-free government loans are available. The fact that your income-to-expense ratio will not change in the future is also at the forefront of your mind.

You bite the bullet. You think for the country and not for a political party. Structural change requires vision and the ability to execute. You think you have both.

The writer is a tech entrepreneur

Posted in Dawn, The Business and Finance Weekly, June 7, 2021


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