Cash Management in Pakistan

Pakistan shares an eastern border with India and a north-eastern border with China. Iran makes up the country’s southwest border and Afghanistan runs along its western and northern edge. The Arabian Sea is Pakistan’s southern boundary with 1,064km of coastline. The country has a total area of 796,095 sq km. From Gwadar Bay in its south-eastern corner, the country extends more than 1,800km to the Khunjerab Pass on China’s border. The population is about 154 million and the Pakistani Rupee (US$1 = PKR60 approximately) is the national currency.

Economic Overview

Pakistan’s economy delivered another year of robust growth in 2005-06, despite the devastating earthquake on 8 October 2005 and in the midst of an extraordinary surge in oil prices. With growth at 6.6% in 2005-06, the economy has expanded at an average rate of 7% a year in the past four years and over 7.5% a year for the last three, thus positioning itself as one of the fastest growing economies in Asia.

The vote of confidence of the international debt capital markets in Pakistan’s economic policy, reform agenda and outlook is evident from the successful launch of new 10-year and 30-year sovereign bonds totalling US$800m.

The Banking Industry and Regulatory Framework

The SBP has been pursuing a broadening of access of financial services to all segments of society as an important strategic objective. Learning from past experience, both within the country and elsewhere, a market-based approach has been adopted to broaden and deepen the country’s financial markets with the focus on agriculture, micro-businesses, small and medium-sized enterprises (SMEs), consumer and Islamic finance services.

Initiatives have been taken to develop these sectors, including extensive promotion, awareness and capacity-building campaigns, rationalisation of the regulatory environment, development of a legal framework for microfinance institutions to help the poor, and a focus on SMEs and Islamic finance issues.

Despite considerable progress towards its goal of fostering a sound and dynamic financial system, a number of areas still demand further attention. In this respect, SBP has kept its focus on consolidating reforms introduced in preceding years as well as taking initiatives to further strengthen the banking system’s stability and lift the regulatory and supervisory framework to meet international best practices.

The initiatives included raising minimum capital requirements to PKR2bn from 31 December 2005, announcement of a road map for the implementation of Basel II, restructuring of problem banks, introduction of a capital charge for market risk, and releasing guidelines on country risk management, internal controls and information technology security. The extensive focus on enhancing the supervisory capacity in recent years has helped SBP to achieve, either fully or largely, compliant status for 28 of the 30 Basel core principles for effective banking supervision. Compliance with the remaining two principles, on consolidated supervision, is likely to be achieved during the fiscal year of 2006.

The Taxation System

Federal taxes in Pakistan, like most taxation systems in the world, fall into two broad categories – direct and indirect.

Direct taxes primarily comprise income tax, along with a supplementary wealth tax. For tax purposes, income is classified as salaries, interest on securities, income from property, income from business or professions, capital gains, and income from other sources.

All individuals, unregistered firms and associations of individuals are liable to personal tax at rates ranging from 10% to 35%.

All public companies, other than banking companies, incorporated in Pakistan, are assessed for tax at a corporate rate of 39%. However, the effective rate is likely to differ on account of allowances and exemptions related to such factors as the industry, location and exports.

Clearing and Settlement Systems

As a custodian of the country’s payment system, SBP supervises the operation of the clearing house for member banks operating within its jurisdiction. Automated clearing services are provided by National Institutional Facilitation Technologies (NIFT) under the supervision of SBP in nine major Pakistani cities. A complete range of conventional clearing services, including overnight clearing, same-day high-value clearing and intercity clearing, is provided by NIFT. In other business centres, the process is manual.

Six local offices of the SBP’s Banking Services Corporation supervise the paper-based manual clearing and settlement process. Wherever a local office is not available, the National Bank of Pakistan (NBP) has been delegated this role under the supervision of SBP. Representatives of the member banks are required to attend the clearing house for receipt and delivery of clearing documents to and from each other. These clearing meetings are held twice a day, excluding a special clearing meeting in the afternoon that is meant only for returns of unpaid cheques or documents.

A local US dollar clearing system provides a low-cost and efficient clearing system for local instruments denominated in US dollar. This system has reduced the clearing time of US dollar cheques from three weeks to just four days and cut the cost to account holders. Banks and their branches in 11 cities use this facility.

Real-time Gross Settlement

The real-time gross settlement (RTGS) system known as the Pakistan Real-time Interbank Settlement Mechanism (PRISM) is at an advanced stage of installation. It will automate the current interbank settlement systems for large-value payments at SBP and will minimise risks such as credit and liquidity risks inherent in an end-of-day settlement system. Its implementation will make the payments systems much more efficient and resilient, offering transactional features that are hard to achieve under the current settlement systems. PRISM is based on the Society for Worldwide Interbank Financial Telecommunication (SWIFT) technology and includes functions for queue management, gridlock resolution and connecting with other global networks.

PRISM will not only automate interbank fund transfers but will also allow settlement of government securities transactions in primary and secondary markets. After the system’s implementation, settlement of securities between participants will be on a delivery rather than payments basis, thus reducing the risk in securities trading by minimising the settlement lag.

SBP will also be able to settle open market operation (OMO) transactions through PRISM. The system will also bring more efficiency in intercity and intracity clearing between banks, as NIFT will be doing the clearing on a multilateral basis and the results will be settled on a real-time basis in PRISM. Commercial banks making time-critical third-party funds transfers on behalf of their customers will also benefit.

Cash Management Accounts Payable Outsourcing

The cash management business in Pakistan has grown considerably in the past few years. One reason for this is that foreign banks quickly realised the benefits and subsequently took the lead in capturing substantial transactional volumes – though they were mainly restricted to regional or global mandates and deals with local branch offices of global relationships. One key strength of foreign banks was, and still is, the ability to provide automated information reporting and accounts payable outsourcing to their customers – solutions that, for some time now, have been seamlessly integrated with the clients’ enterprise resource planning systems. In this respect, such interface development and host-to-host connections are increasingly becoming commonplace. Because of these developments, dial-up proprietary systems are in demise, taken over by more robust, functionally enriched Web-based platforms.

Accounts Receivable Outsourcing

On the collections side of the business, the market is still mostly plain vanilla, with large local banks taking the lead primarily due to their extensive branch networks. Solutions usually offered include expeditious collections from collection sites to a concentration account, with the provision of simple management information or, at times, just the usual bank statement. However, some local banks now have Internet banking – but mainly for information or balance reporting purposes only – and the status of respective accounts are made available to customers over the Web.

Local banks usually price their collection solutions at a discount, keeping in view the expected net interest income on collection and operating account balances, particularly in the prevailing high interest rate environment, but with cost blackouts and incorrect or incomplete cost estimation specifically relating to the costs of handling transactions in upcountry branches. Furthermore, in some financial institutions, cash management business units still have to emerge as empowered, revenue generating product partners to the corporate banking relationship side, managing their own profit and loss as in the case of cross subsidising products for which the requisite transfer pricing procedures and arrangements have yet to be put in place.

Bank Account Structures

Opening a foreign currency account is subject to the condition that it is not used for:

• Any foreign exchange borrowed under any general or specific permission given by SBP, unless otherwise permitted.
• Any payment for goods exported from Pakistan.
• Proceeds of securities issued or sold to non-residents.
• Any payment received for services rendered in or from Pakistan.
• Earnings or profits of the overseas offices or branches of Pakistani firms and companies, including banks, or investments abroad of resident Pakistanis.
• Any foreign exchange bought from an authorised dealer in Pakistan for any purpose.

Liquidity Management

Liquidity management is still in its initial stages of development in Pakistan. Figure 3 shows the status of liquidity management possibilities in light of current regulations. In a nutshell, almost all key foreign banks, along with certain large local ones, now have cash management business units firmly in place. Presently, each cash management service provider has the basic infrastructure for sales management, product development and client management.

Outlook

The market is becoming increasingly competitive in terms of new cash management mandates. Pakistan-based multinationals are coming up with requests for proposals, both local or as part of a proposed regional or global structure. Local blue chips are shopping around to get the best deals, in terms of cost and efficiency and an acceptable level of technical sophistication. Even SMEs are now migrating to efficient and effective cash management solutions, coupled with basic Internet-based account enquiry systems, which key local banks can now effectively cater to. A fundamental shift is expected with improvements in the country’s clearing infrastructure through the planned implementation of RTGS, followed by automated clearing house by SBP. This presents opportunities as well as challenges for foreign and local banks alike.