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New steps under COVID-19 hiatus invite challenging situation for banks

New steps under COVID-19 hiatus invite challenging situation for banks

Islamic banking must explore their role in the contemporary economy
Interview with Dr. Ayub Mehar — a renowned economist

PAGE: Tell me something about yourself and your organization, please:

Ayub Mehar: I am serving as ‘Professor’ in Iqra University Karachi and also ‘Economic Advisor’ of the Employers’ Federation of Pakistan (the largest representative body of the entrepreneurs and investors in Pakistan). Currently, I am also associated with the Asian Development Bank Institute on a project for Infrastructure Financing in CAREC member countries. Development Financing, Macroeconomic Policies, International Trade and Finance and Economic and Financial Modeling are areas of my research interests. I have completed several policy research studies for international financial institutions and think tanks including ‘Economic Integration in CAREC Member Countries: Financing Economic Corridors and Sovereign Bonds Market’, ‘Ineffectiveness of Environmental, Social, and Governance Policies and Incentives: Impact of Generalized Scheme of Preferences Plus on Central Asian and South Asian Countries’, ‘Impacts of the Patterns of Financing on Logistic Infrastructure in CAREC Member Countries’, ‘Impacts and Financing Infrastructure Development in Pakistan: Role of CPEC and FDI’, ‘Infrastructure Development by Liberalizing Economic Policies: The Straight Path of Economic Prosperity’, ‘Financial Cooperation in South Asia: Recent Development and Challenges’, ‘Political Economy of Subsidies’, ‘Magnitude and Determinants of the Flows of Investment among South Asian Countries: Considering Economic Prosperity without Politics’ and ‘South Asia in New Economic Order: Need of Accelerated Liberalization Process’.

In recognition of my expertise, the Technology Policy and Assessment Center at Georgia Institute of Technology acknowledged membership in the distinguished panel of international experts for Indicators of Technology-based Competitiveness, which is a project of the US National Science Foundation, United States Government.

PAGE: What are your views on the performance of the banking sector during the COVID-19 pandemic in Pakistan?

Ayub Mehar: The commercial banks in Pakistan have shown a rosy picture up to 31st March 2020. The estimated aggregate earnings after tax of all commercial banks was Rs46 billion on 31st March 2020 as compare to Rs39 billion on the same date last year. The aggregate advances of commercial banks have arrived at Rs8.1 trillion on 31st March 2020 from 7.8 trillion on 31st March 2019 showing around 4 percent growth in advances, while the aggregate deposits of commercial banks have arrived at Rs15.9 trillion from Rs14.1 showing 13 percent growth in deposits during the same period. Out of total domestic deposits of all commercial banks around Rs3 trillion are in fixed deposits, Rs6 trillion in saving accounts and Rs5 trillion in current accounts. The aggregate advances to deposit ratio is around 51 percent in Pakistan, which is quite safe and sound. Net Non-performing loans (NPLs) have been recorded at Rs.146 billion on 31st March 2020 as compared to Rs110 billion on 31st March 2020. NPL is much higher in local private banks as compared to the banks in public sector and foreign commercial banks. Moreover the share of local private sector banks in NPL is growing rapidly.

However, due to COVID-19 impact, the continuity of this trend does not seem possible as it has been noted in the government policies that banks and financial institutions have to play a leading role to combat the drastic effects of COVID-19.

According to SBP, the total debt and liabilities of Pakistan is Rs43 trillion at the end of March 2020 (which is 98% of GDP), out of this Rs35 trillion in debt and remaining are liabilities, while according to FRDLA definition the total outstanding debt is Rs31 trillion, which is 72 percent of GDP. It is notable that the definition of debt was revised in June 2017 in FRDLA and according to the new definition: “Total debt of the government” means the debt of the government (including the federal and provincial governments) serviced out of the consolidated fund and debts owed to the International Monetary Fund (IMF) less accumulated deposits of the federal and provincial governments with the banking system. This position shows the debt profile at the end of March 2020 and the effect of COVID -19 is not included in these statistics.

The domestic borrowing by federal government was Rs16.4 trillion for fiscal 2017-18. At the end of 2018-19, it was at Rs20.7 trillion, but at the end of March 2019 it was at Rs22.5 trillion. The borrowing for public sector enterprises is not included in this. It indicates that use of domestic savings to meet government expenditures. The government borrowing from commercial banks is also included in this.

It is interesting and notable point that share of top 5 commercial banks in Pakistan is more than 90 percent in the investment in government securities, which is the safest investment, while the share of these top 5 banks in advancing to corporate sector is less than 45 percent. These statistics are enough to understand the impact of COVID-19 on macroeconomic position of the country and the role of bank to handle the declining performance of macroeconomic indicators.

PAGE: What are your views on the robustness of banks in Pakistan in meeting COVID-19 challenge?

Ayub Mehar: Before responding this question, I think we should realize the impact of COVID-19 on the patterns of households’ expenditures. The requirement of social distance will badly affect the consumers’ buying, which will be ultimately transformed into declining in industrial, manufacturing and servicing activities. The massive unemployment is a natural consequence of declining economic activities, which will further damage the buying power of the consumers. The leading economists worldwide have recognized that this is the time when ‘Cash is King’. In current situation these views are based on the expected bad days in the near future. So, it was suggested to cut in households’ expenditures by 50 % and only buy essential items till Dec 2021.

In this scenario, the greatest challenge was to maintain the consumption-led economy of Pakistan, while the State Bank of Pakistan has pointed out the challenging situation for local consumption with falling income and sales levels. The State Bank and the Ministry of Finance have jointly adopted a policy to combat the bad impacts of COVID-19, however, this policy is entirely based on the banking sector.

There are four major components of this policy: (1) Reduction in prime interest rate, (2) reduction in the ‘Cash Reserve Requirement (CRR), (3) subsidized lending to the private enterprises to protect the employment of their workers and staff, and (4) moratorium in redemption of consumers debts. It is obvious that these steps will affect the performance and profitability of the banks and financial institutions. Now, we can analyze that how these step will affect the banking industry in Pakistan. At first stage, the State Bank has reduced the benchmark interest rate by 75 basis points, then 150 basis points in the next week, then 200 basis points and lastly 100 basis points. Now, the policy interest rate in Pakistan is 8%. It is expected that it will be at 7% in 2021. Similarly, the interest rate on 10 years government bonds was recorded last week at 8.3%, which shows a reduction of 530 basis points in a year. But, the impact of decline in prime interest rate by 5.25% was not fully reflected in Karachi Inter Bank Offering Rate (KIBOR), which is a benchmark of market interest rates. It indicates that banks are not in a position to provide lending at much lower interest rate because it affects their deposits. The deposits in commercial banks are public money and they expected appropriate return in the form of interest to cover meet their expenditures, while prices of commodities are going up. So, this step will discourage the depositors. The policy has favored to buyers instead of savers. It will negatively affect the performance and profitability of the banks. On the other side it is also notable that 8 percent is the seventh-highest policy rate in the world. The world average policy interest rate is 6.4%. But further reduction is not possible in case of Pakistan. The policy rate has always been on the higher side in Pakistan during the last 3 decades: the highest policy rate was 20.0% and the lowest was 5.75% during this period.

The SBP must maintain a positive real interest rate. It was also recommended by the International Monetary Fund (IMF). According to the criteria, the rate of inflation in Pakistan must be less than 7 percent. (If interest rate spread is one percent and lending rate is equal to prime rate of interest, which is a hypothetical situation). Obviously, it is not possible, so depositors/savers have to earn a negative rate of interest (in real term). Though the rate of inflation is declining because of rapid falling in aggregate demand, which is a drastic indicator.

The improving purchasing power of the peoples in this way will not be an appropriate strategy devised by the State Bank of Pakistan. In the present situation, the people will not take the risk to go for shopping and wait in the stores of non-essential commodities.


To combat the impacts of COVID-19 on banks liquidity and consumers’ purchasing power, the State Bank of Pakistan has reduced also the ‘Cash Reserve Ratio (CRR)’ from 15% to 10%. It is estimated that this change will transfer 300 million dollars to the commercial banks. Under Cash Reserve Ratio (CRR) a certain percentage of the total bank deposits have to be kept in the current account with the central bank which means banks do not have access to that much amount for any economic activity or commercial activity.

The State Bank of Pakistan (SBP) has taken a drastic action by allowing one-year moratorium on consumer loans’ principal. The borrowers have been allowed not delay the repayment of loans’ principal amount for one year. No bank or financial institution can reject their application for one year delay in payment of principal. They will not pay any extra amount for this delay. The name of such borrowers will not be included in the defaulter list or ‘Consumer Credit Information’.

Surprisingly, some banks are encouraging their clients to get benefit from this scheme. This scheme is applicable for consumer financing, credit cards, personal loan, and car financing etc. One possible impact of this scheme is to restrict the banks’ ability to reuse the money. The money collected from the existing clients is used for further financing. This step has been taken at time when depositors have been discouraged by lower interest rates.

The State Bank of Pakistan has introduced a risk-sharing mechanism to support bank lending to small and medium enterprises (SMEs) to support their employees. Under the SBP’s Refinance Scheme the organizations that commit to not lay off workers in the next three months can avail credit through banks for the three months of wages and salaries expenses at a concessional markup rate. For this scheme, the federal government has allocated Rs30 billion under a credit risk sharing facility for the banks spread over four years to share the burden of losses due to any bad loans in future. Federal government will bear 40% loss on principal portion of disbursed loans of the banks. By this policy more than 8 lakh employees have been protected up to the end of April 2020. Under this scheme commercial banks have sanctioned Rs23 billion to 209 companies (for 2 lakh 20 thousand employees) at 3% rate of interest, while application for Rs90 billion from 1,109 companies are under consideration. Naturally, this step may affect the profitability of commercial banks. Despite some demerits the leading bankers (like Andrew Bailey, Governor Bank of England) have urged banks to keep lending as reduction will lead to bankruptcies of different business which will come back to hurt the banks.

PAGE: Your views on the Digital Banking in Pakistan?

Ayub Mehar: It is a very positive aspect of the banking industry in Pakistan that share of digital banking is rapidly increasing in the country. It is an encouraging dimension for e-commerce. The growing usage of plastic money (credit card, debit card and ATM), initiation of e-card by some leading banks, payment of fee of the educational institutions, utility bills, and online shopping are the indicator that banking sector play a very positive role in the economy. It is not a valid argument that use of digital banking can increase the cost of banking. In fact it reduces the cost of banking by saving your time and travelling to the bank branches. It leads to branchless banking also. So far as risk and fraudulent activities are concerned, the digital banking can also reduce these risk and fraudulent activities. It improve connectivity among branches and clients.

Two important aspect of digital banking in Pakistan are: (1) Its size is growing rapidly, (2) It provided immediate help to the users of banking services by facilitation in transfer of payments via electronic modes.

PAGE: What are your views on Islamic Banking & Finance, Auto Finance, Housing & Mortgage, Personal Loan and Interest Rates in the country during the pandemic?

Ayub Mehar: The Islamic banks and financial institutions are an important ingredient of the financial markets and institutions in Pakistan. However their size is negligible in the aggregate financial markets of Pakistan. The size of Islamic banks in term of equity in aggregate banking sector of Pakistan is less than 6 percent. Total equity of Islamic banks is Rs112 billion as on 31st March 2020, while it is Rs1,692 billion for other commercial banks. The capital invested by Islamic banks as on 31st March 2020 is Rs362 billion and they financed Rs923 billion for various industrial, commercial and consumer activities. The size of their aggregate deposits was recorded at Rs1,626 billion at the same date. These statistics show that the share of Islamic banks is much lower in terms of their lending, investment and deposits. There are two important considerable points about the magnitude and role of Islamic banks and financial institutions in Pakistan: First point belong to their size.

Despite four decades of Islamization, the magnitude of Islamic financial institutions and banks is still much lower. We have to explore its causes. A country with more than 96 percent Muslim population has less than 6 percent share of Islamic banking. The second point is the common intuitive about Islamic banks and financial institutions that they promote a consumer economy. These institutions encourage car financing, consumer loans and personal loans etc. Their contribution is negligible in industrial financing. They do not finance R&D equities, plant, machinery and other productive assets. They do not finance for infrastructure and developmental activities. Even these institutions are not involved in venture capital activities. I think the experts of these areas will have think and explore their role in the contemporary economy.

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