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MGT604 - Management of Financial Institutions - Lecture Handout 19

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12. Legal Reforms

Legal difficulties and time delays in recovery of defaulted loans have been removed through a new ordinance i.e. The Financial Institutions (Recovery of Finances) Ordinance, 2001. The new recovery laws ensures expeditious recovery of stuck up loans by the right of foreclosure and sale of mortgaged property with or without intervention of court and automatic transfer of case to execution proceeding. A Banking Laws Reforms Commission is reviewing, revising, and consolidating the banking laws and drafting new laws such as bankruptcy law.

13. Taxation

The corporate tax rates on banks were exorbitantly high in Pakistan thus adversely affecting their profitability and attractiveness as an avenue for investment and new equity injection. The Government has already reduced the tax rate from 58 percent to 44 percent during the last three years and it is envisaged that the rate will be reduced gradually and brought at par with the corporate tax rate of 35 percent in the next three years. This will in turn help in reducing the spread between the deposit rate and lending rate and benefit financial savers.

14. Agriculture Credit

A complete revamping of Agriculture Credit Scheme has been done recently with the help of commercial banks. The scope of the Scheme which was limited to production loans for inputs has been broadened to the whole value chain of agriculture sector. We have, with the grace of Allah, become a surplus country in food grains, livestock etc. and thus the needs of agriculture sector have also expanded. The SBP has included financing for silos, god-owns, refrigerated vans, agro processing and distribution under the cover of this scheme. This broadening of the scope as well the removal of other restrictions have enabled the commercial banks to increase their lending for agriculture by a multiple of four times compared to FY 1999-00 thus mainstreaming agriculture lending as part of their corporate business. Unlike the previous years when they were prepared to pay penalties for under performance they have set up higher targets for this year. The private commercial banks have also agreed to step in and increase their lending to agriculture.

15. E-Banking

The banks are being encouraged to move towards Electronic banking. There is a big surge among the banks including NCBs to upgrade their technology and on-line banking services. During the last three years there is a large expansion in the ATMs has been witnessed and at present about 500 ATMs are now working throughout the country. The decision mandating the banks to join one of either two ATM switches available in the country will provide a further boost. Progress in creating automated 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 online or automated. Utility bills payment and remittances would be handled through ATMs, Kiosks or Personal Computers reducing both time and cost. Investment in information technology is being undertaken by the banks to enhance efficiency, reduce transaction costs and promote E-Commerce. It has been estimated that a banking transaction through ATM costs one fourth as much a transaction conducted over the counter in a traditional branch –and the similar transaction over the internet costs a mere fraction of the traditional teller costs.

16. Human Resources

The banks have recently embarked on merit-based recruitment to build up their human resource base – an area which has been neglected so far. The private banks have taken lead in this respect by holding competitive 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 rigor in the banking industry and produce bankers of stature who will provide the leadership in the future.

17. Credit Rating

To facilitate the depositors to make informed judgments about placing their savings with the banks, it has been made mandatory for all banks to get themselves evaluated by credit rating agencies. These ratings are then disclosed to the general public by the SBP and also disseminated to the Chambers of Commerce and Trade bodies. Such public disclosure will allow the depositors to choose between various banks. For example, those who wish to get higher return may opt for banks with B or C rating. But those who want to play safe may decide to stick with only AAA or AA rated banks.

18. Supervision and Regulatory Capacity

The banking supervision and regulatory capacity of the Central Bank has been strengthened. Merit – based recruitment, competency – enhancing training, performance – linked promotion, technology – driven process, induction of skilled human resources and greater emphasis on values such as integrity, trust, team work have brought about a structural
transformation in the character of the institution. The responsibility for supervision of nonbank finance companies has been separated and transferred to Securities Exchange Commission. The SBP itself has been divided into two parts – one looking after central banking and the other after retail banking for the government.

19. Payment Systems

Finally, the country’s payment system infrastructure is being strengthened to provide convenience in transfer of payments to the customers. The Real-Time Gross Settlement (RTGS) system will process large value and critical transactions on real time while electronic clearing systems will be established in all cities.
These reforms will go a long way in further strengthening the Banking sector but a vigilant supervisory regime by the State Bank will help steer the future direction.

Commercial Banking in a Free Society

Although we can say a great deal about the institutions of a free society, and why they are desirable, speculating about the specific ways in which people will choose to organize themselves within such institutions is always a tricky matter

  • After all, the whole justification for the institutions of a free society is that only through its institutions can human beings discover progressively better ways of dealing with scarcity (of both goods and knowledge)
  • And thus improve both our material and non-material welfare. Our ignorance of the details of a free society is precisely why having a free society is so important.

The banking industry is especially suited for just this kind of analysis. If we want to know what commercial banking might look like in a free society, we need only turn to contemporary regulation and the historical record to begin to piece together a coherent story.

Private Deposit Insurance

  • Banks in a free society might choose to purchase privately supplied deposit insurance as a way to reassure customers. They might also enter into inter-bank mutual aid agreements, or be insured through clearinghouses.
  • Historically, banks have used these and other methods to convey trust to customers. Before deposit insurance banks would advertise their balance sheets and list the members of their boards of directors.
  • Providing this kind of information was a way to establish their trustworthiness 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 these ways, and discover new and imaginative ones, of creating the trust on which all banking systems rest.
  • Banks in a free society will be literally nothing special. What makes banking so unfree today is that banks are treated differently from other business enterprises.
  • The rule of law that would characterize a free society would demand that banks be treated no differently than other firms. If they are fraudulent or use force, then they need to face the consequences. Otherwise, any sort of voluntary arrangement banks make with customers will be allowed.
  • The result will not only be a more free banking system, but a more efficient, safe, and productive one.