Capital Control and Rupee Convertibility: Pakistan

Capital Control and Rupee Convertibility: Pakistan

An open capital account for a country means that capital may flow in and out of the domestic economy without impediments. In Pakistan there is a vibrant foreign exchange market including interbank foreign currency market and a network of registered exchange companies and resilient central bank. Open capital accounts facilitate investment and growth of the economy and stabilize consumption pattern and output of the economy. Currently monetary easing in developed countries like US and UK has led to lower interest rates which enabled capital flight to developing counties where interest rates are higher. Occasionally large capital outflow or inflow can have non-desirable economic outcomes including banking and currency crisis.

The following is the characteristics of Pakistan’s capital accounts:

       Residents or nonresidents can open Foreign Currency Accounts (FCA) at commercial banks with remittances from abroad, foreign travelers’ cheques, or foreign currency in cash, but not with income from export or similar activities.
      
       Nonresidents or foreign firms may open domestic currency accounts that are fully convertible into foreign currency, so long as foreign funds are channeled through the banking system.
      
       Nonresidents may acquire listed securities with remittances from abroad with no restrictions on the repatriation of capital gains, dividends, or receipts from the disposal of such securities.
      
       Nonresidents are free to trade in registered corporate debt instruments and bonds listed on the stock exchange, federal investment bonds, or Pakistani investment bonds as well as market treasury bills.
      
       Branches of foreign banks and foreign-controlled investment banks may also engage in these activities.
Currently, the only notable restrictions on the capital account relate to the limits on the amount of domestic currency that a traveler may physically carry overseas (PKR500 to India and PKR3,000 to other
countries) and on the amount Pakistani residents may hold in overseas bank accounts (a maximum of USD1,000 in all countries other than India, Bangladesh, Afghanistan, and Israel, where Pakistani residents may not own any bank accounts.)

The state bank of pakistan reduced its policy rate: the effect on the banking system and banks profitability

State Bank of Pakistan has reduced its policy rates to 12% which was 13.5% earlier. The policy or the discount rate is the rate of interest charged by state bank of Pakistan to supply reserve currency to its scheduled/commercial banks. Usually the bank borrows from interbank money market for meeting their short term cash requirements, nevertheless, the commercial banks move to central banks when the interbank money market is tight. The decline in the policy rate cannot be described as switch in the interest rate regime due to fears of inflation.

The effect of policy rates on the profitability of the banking system depends on the performance of the business sector. If reduced interest rates lowers credit risk, and spur economic activities both business and investing, and reduces business uncertainties, then the bank’s profitability will increase otherwise the bankers profitability will be reduced.

  

The banks make profit by taking credit, market, and operational risks. The policy rate will affect both market risk and credit risk in the economy; however, it is not the sole determinant of these risks. Other factors such as business condition, political and economic conditions, have much greater effect on these risk factors. Recently the banks have taken a greater exposure to government securities and therefore their revenue is likely to fall. The banks will shift some of their assets from government securities to loans or credit portfolio.

The lower interest rate is less likely to reduce the interest rate spread income for the banks. The lower interest rate will also increase the overall deposits of the banking system and will likely to increase both investment and loan activity of the banks. Those banks with healthy equity capital are more likely to make profit from expanding economic activity.

What is Islamic about Current Accounts? Deposit products of Islamic banks.

Current Accounts:

These deposit products are based on the principle of loan contracts whereby the depositors will receive payments on demand while the banker can utilize this money for the purposes of lending and investing activities in riba free modes of banking.

Like conventional banking, Islamic banks are also involved in money creation process and maintaining payment system in the economy. There exist simultaneity issue in money creation process; in one way, each unit deposited in the current account in Islamic bank, the banker under normal circumstances extend 60% of it in lending activity whereas the remaining in investing activities so each unit deposited brings almost twice money in the system, the Islamic banker convince both his depositor and its investor/borrower that they both own the same money at the same time.

Now look at the other way of the relationship, when someone ask one unit of money from Islamic banker, the banker need not do anything else, it simply bring money out of blue albeit managing some cash almost 5% of loan amount from interbank Islamic money markets.

Generally the current account works on the principle of loans without interest payments (qard hasan) however, these loans are utilized by Islamic bankers in Islamic modes of finance, and nonetheless, Islamic bankers generally do not lend money on this principle.

For all practical purposes current accounts are considered as money. Excepting its function as unit of account which is done by reserve currency/ legal tenders, the current accounts act as object of exchange in trading activities such as buying goods with currents accounts, they also are means of payment both productive and non-productive and for gift purposes such as payment of civil servants. In case of bank run as it happens in the conventional banks anywhere in the world, the Islamic banker will also be unable to make its current accounts liquid. What is Islamic about Islamic bank current accounts? It is their use of money in halal mode of finance or investing activities and the use of profits of Islamic banks for Muslim cause.

Financial Analysis of Allied Bank Ltd

About the Allied Bank:

Allied Bank Limited was the first bank to be established in Pakistan. It started out in Lahore by the name Australasia Bank before independence in 1942; was renamed Allied Bank of Pakistan Limited in 1974 and then Allied Bank Limited in 2005. In August 2004, because of capital reconstruction, the Bank’s ownership was transferred to a consortium comprising Ibrahim Leasing Limited and Ibrahim Group.

Registered Office

8-Kashmir / Egerton Road,

Lahore - 54000

Pakistan

Website

www.abl.com

Key Financial and Operating data: (year ended Dec 2010)

Total Assets: 449,931,526,000

Net Assets: 35,974,857,000

No. of Ordinary Shares (As of Dec 2010): 782,100,834

No. of Branches: 809

Profit or Loss per Share (Half Year Ended June 2011): Rs 5.85

Market Price per Share (As of 23/9/2011): Rs 60

Credit Rating As of June 2011

Ratings By PACRA

Short Term: A1+

Long Term: AA

Income Analysis:

               

The bank has shown a steady rise in its spread income during the period 2005-10. The bank earned 5-7% spread income on its average deposits outstanding during the period 2005-2010.The gap between net spread income and net income has widened during 2005-10 owing to increased non-interest administrative expenditure and reduced income from non-core banking operations. There exists wide fluctuation in the growth in net income. The bank has history of burning capital in earlier 20s. however, the bank has sustained a healthy income per share recently to the tune of 5-10 Rs per share.

Return and Efficiency:

 The bank returned a healthy profit on its net assets amounting to no less than 25% over the period 2005-2010. It also managed to keep its administrative expenses well below its spread income on its deposits.

Risk, Liquidity and Depth of Banking Operations:

The banks risk profile remained above average over the years 2005-2010. Its ratio of total assets to the net assets remained 15 to 16; which seems to be high. Nonetheless, the bank has started decreasing its leverage otherwise it needs to increase capital. The liquidity of the bank’s asset profile is trending upward, recently, owing to the higher proportion of liquid investments as compared to the ill-liquid loan portfolio. Greater proportion of investment in liquid asset may imply a higher level of illiquidity and risk of loan portfolio. Historically, the bank’s ability and willingness to extend loan was above average, however, its economic capital may not support its growing loan portfolios.

Conclusion:

Overall financial performance of the bank remained satisfactory. The bank needs to improve capital so that it can increase its banking operation i.e. accepting deposits and extending loans.