Profit E-Magazine Issue 47

20

10

10 Weekly Roundup 14 Hong Kong-based investment bank returns to Pakistan’s capital markets. But why?

20 20 Sindh Bank and Summit Bank are merging. Who is the real buyer?

28 A matter of perception

28

32

32 That unmistakable Shezan touch 36 A decade after the global financial crisis: What has (and hasn’t) changed?

32

Executive Editor: Babar Nizami l Managing Editor: Farooq Tirmizi l Joint Editor: Yousaf Nizami l Business Editor: Agha Akbar Reporters: Arshad Hussain l Muhammad Faran Bukhari l Syeda Masooma l Ghulam Abbass l Ahmad Ahmadani Shehzad Paracha l Director Marketing: Zahid Ali l Regional Heads of Marketing: Muddasir Alam (Khi) l Zulfiqar Butt (Lhr) Mudassir Iqbal (Isl) l Layout: Rizwan Ahmad l Illustrator: ZEB l Photographers: Zubair Mehfooz & Imran Gillani l Publishing Editor: Arif Nizami l Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk

CONTENTS

welcome

MORAL COWARDICE For a minute there, we had hope.

To anyone who has hoped for a more tolerant Pakistan, where a person is judged not by their demographic markers, but by their capabilities and character, Information Minister Chaudhry Fawad Chaudhry’s defence on Wednesday, September 5, of the appointment of Professor Atif Mian to the Economic Advisory Council was a sight to behold. He confronted a religious bigot head on, and justified tolerance as being not just allowed, but required, by a vision for Pakistan that was adherent to the principles of Islam as understood and practiced by the majority of Pakistani voters and its government.

It was perfection. We should have known it would not last.

The vigour with which Chaudhry defended the appointment, and his cabinet colleagues backed him up, suggests that the belief in pluralism and meritocracy are sincerely held beliefs by him and much of the cabinet. So what changed?

Only one person could have caused this about-face: Prime Minister Imran Khan himself.

We do not concern ourselves with notions as to why the prime minister decided on the volte face of a controversial but thoroughly defensible position. Whether he did this under perceived pressure from the Tehreek-eLabbaik (TLP) – because there was no actual pressure – or under the influence of the hardright religious views of his wife, we do not care.

FROM THE MANAGING EDITOR

What we care about is the fact that decisions about who to appoint on the Council of Economic Advisors, a completely technocratic body, were made by the prime minister in a manner that reflects bigotry and abject moral cowardice. And as economist Asad Sayeed pointed out on Twitter, it had the perverse effect of also kicking off the council the only trained macroeconomist. The other university professors are mostly microeconomists, and Sakib Sherani is an economic analyst, not an economist (At Profit, we follow the convention: no PhD, no calling yourself an economist).

The central promise of the PTI was that it would improve governance in Pakistan by valuing merit and putting the right people in the right jobs. There is no more qualified a person to be on the Council of Economic Advisors than Atif Mian, a economics professor at Princeton who studies the macroeconomic consequences of excessive government debt.

If the PTI-led government is going to start violating its core promises this early in its tenure – after having initially showed at least a hint of a spine – what can we expect for the rest of their agenda? We suspect not much.

Farooq Tirmizi Managing Editor

9

Minister for Railways, Sheikh Rashid Ahmed

QUOTE

“We will add two trains to the network. They will run between Rawalpindi-Mianwali and RawalpindiLahore junctions from September 15”

“We can learn from Chinese experience in development particularly agriculture as we are basically an agrarian economy” Foreign Minister Shah Mehmood Qureshi

34pc

increase in energy-linked imports was recorded during July, the first month of financial year 2018-19, touching $1.25 billion. Energy-linked imports constituted 25 percent of the overall import bill in July. The increase in energy-linked imports was attributed to rise in demand, global oil prices and rupee depreciation. Total import of petroleum products and gases during FY18 in the same month stood at $947 million, according to data available from Pakistan Bureau of Statistics (PBS). And power production recorded 10 percent growth to 13,751 gigawatt-hour (GWh) during July this year against 12,9497 GWh in the same month of FY18, data available from National Electric Power Regulatory Authority (Nepra) revealed. Also, sales of domestically assembled cars increased 9 percent to 21,334 units in July on a year-on-year (YoY) basis, as per statistics available from Pakistan Automotive Manufacturers Association (PAMA). Liquefied Natural Gas (LNG) imports soared 144 percent to $332 million during July 2018 against $135.2 million in July 2017 due to the commencement of operations at various RLNG based power plants, said PBS. The country’s reliance on furnace oil for power generation reduced as it reflected in the import data.

Rs1.155t

is the amount of circular debt in the power sector including the loans and liabilities.

Also, the amount owed to Pakistan State Oil (PSO) has risen to Rs331.5 billion and this poses a risk to the smooth operation of the country’s power sector. And power division officials informed the cabinet that the previous PML-N’s government claim to have ended power outages was wrong, a senior official part of the presentation revealed. The cabinet was told due to a shortfall of 4,000 megawatt because of constraints in the national electricity distribution system was resulting in power outages across Sindh, Khyber Pakhtunkhwa and Balochistan. PM Khan directed the power division to prepare workable recommendations for uninterrupted electricity supply to the industrial sector and supply of electricity at affordable rates. Moreover, a power division official said a Rs160 billion surge in circular debt had been recorded due to a federal cabinet decision in December last year to permit electricity supply to all feeders, notwithstanding whether they served loss or profit-making areas.

10

4.8pc

of GDP is projected to be Pakistan’s current account deficit in FY19, according to ratings agency, Moody’s. The report from Moody’s said fallout from the correction in Turkish exchange rate and asset prices again highlighted the external vulnerability and sensitivity to an increase in the cost of debt of some emerging market and frontier market nations. Earlier in June, Moody’s had marked Pakistan and other emerging/ frontier markets like Argentina, Ghana, Mongolia, Sri Lanka beside Turkey as most susceptible to dollar appreciation. Also, the rating agency stated, “Out of these, Argentina and, to a lesser extent Pakistan’s currency have experienced marked depreciations against the dollar year to date.” According to Moody’s report, those economies most sharply hit by weakening exchange rates, lower capital inflows in 2018 share common characteristics of twin current account and budget deficits. Moody’s said, “Pakistan is facing elevated external pressures stemming from strong domestic demand and capital-import heavy investments related to the China-Pakistan Economic Corridor (CPEC). “We expect a current account deficit of 4.8% of GDP this year.

“CPEC is a great project for Pakistan. However, Turkish investors are not fully aware about its business prospects” Turkish Ambassador to Pakistan Ihsan Mustafa Yurdakul

QUOTE

$1b

are expected to be raised from first overseas dollar-based saving certificates within the next two months, pending completion of legal and regulatory formalities. Trapped in an external-payments crisis, Pakistan is exploring new ways to raise much-needed foreign exchange to bridge the gap between the inflow and outflow of cash. The country recorded an $18 billion current-account deficit during the fiscal year 2018. The deficit for the first month of the current fiscal year, FY19, was $2.2 billion, raising fears of dire economic consequences if corrective measures are not taken.

Rs3.84b

was collected in school fee in shape of taxes by the Federal Board of Revenue (FBR) in last financial year 2017-18. Increase in education costs and effective watch by tax officials helped in raising tax collection on school fee. Data on withholding tax disclosed the tax regulator collected Rs3.84 billion in FY18 against Rs3.1 billion in FY17. According to FBR officials, the rise in revenue collection was made possible by an increase in tuition fees by educational institutions in FY18. As per the tax law, the educational institutions need to subtract withholding tax at 5 percent on an annual fee of or over Rs200,000 as deposited by parents or guardian of parents. In the Finance Act 2013, the previous government introduced this provision of withholding tax on school fee to bring affluent individuals who can afford the higher fee for the schooling of their children into the tax net. Also, the tax is adjustable against the total liability in a year for a taxpayer who files yearly income tax return.

3pc

increase in profits for Standard Chartered Bank Pakistan (SCB) was recorded on a year-on-year (YoY) basis, touching Rs5.2 billion for the first half of 2018. SCB’s client revenues rose 10 percent YoY with a positive contribution coming from transaction banking, financial markets and retail deposits. Although administrative costs posted a YoY increase, the spending had been focused on SCB’s products, services and people to grow its operations. Also, net advances grew by 12 percent since the start of 2018 and all its businesses posted positive momentum in client income with strong growth posted in underlying areas. However, on the liabilities side, the bank’s total deposits posted seven percent growth, although current and saving accounts posted 9 percent growth since the beginning of 2018.

$4.01b

loans were obtained by Pakistan from neighbouring China during last financial year 2017-18.

Overall, the country borrowed $10.91 billion in last fiscal year from commercial banks, multilateral, bilateral sources and from raising bonds in the international market.

Pakistan has obtained $2.2 billion from three Chinese commercial banks, China Development Bank, ICBC China, and Bank of China apart from getting $1.8 billion from China on bilateral basis during the last fiscal year 2017-18. A report compiled by the Economic Affairs Division (EAD) disclosed that Pakistan obtained $3.7 billion from eight commercial banks. Bank of China has given $200 million, China development Bank $1 billion, Citibank $267 million, Dubai Bank 79 million, ICBC China $1 billion, Noor Bank PJSC $200 million, SCB (London) $200 million and Suisse AG, UBL, ABL has provided $770 million to Pakistan in last fiscal year.

$439.17m was borrowed by Pakistan in the first month of current financial year 2018-19. o keep its foreign reserves above the two months import bill.

Sources informed that overall, the country received $468.31 million in grants and loans in July 2018 from donors, commercial banks and multilateral institutions. Pakistan has to make a repayment of Rs601 billion in foreign loans during the current fiscal year 2018-9. Presently, the country’s reserves are moving around $10.2 million and the new government is struggling to maintain foreign reserves and keep the economy afloat. The minister for finance on Monday met with the Chinese ambassador and sources told this scribe that Asad Umar requested the ambassador to help the country on this issue.

BRIEFING

“We will look forward to providing support to implement urgent reforms needed to stabilise the economy” World Bank Vice President for the South Asia Region Hartwig Schafer

QUOTE

67pc

increase in profitability was observed on a year-on-year (YoY) basis by Pakistani fertilizer manufacturers, touching Rs8.6 billion in the second quarter of 2018. This was primarily due to higher gross profit margins of 29 per cent in the said period, up by 7ppts YoY coupled with an increase in revenue by 15 per cent YoY to Rs66 billion. Net sales of fertiliser companies depicted improvement due to increase in urea prices by 8 per cent YoY, and increase in DAP sales and prices by 14 per cent YoY and 20 per cent YoY respectively. The profitability analysis is based on a sample of 4 largest listed companies, namely Fauji Fertilizer (FFC), Engro Fertilizer (EFERT), Fatima Fertilizer (FATIMA) and Fauji Fertilizer Bin Qasim (FFBL).

Rs26b

are the total net assets of the voluntary pension fund industry, contributed by more than 25,000 participants. Private pension funds were introduced in 2007 under the Voluntary Pension System Rules, 2005 and at present, there are nineteen pension funds, out of which ten are Shariah compliant and nine are conventional. These funds are being managed by ten experienced pension fund managers. The pension funds provide participants with options to invest in securities and commodities.

Participants can choose allocation policies suiting their risk and return preferences, said in a statement issued by Securities and Exchange Commission of Pakistan (SECP). The total net assets of the voluntary pension fund industry are currently over Rs26 billion contributed by more than 25,000 participants. The fund managers, depending on the asset class, charge fees ranging from 0.5 percent to 1.5 percent per annum. Furthermore, the fund managers can charge sales load up to 3 percent of the contribution on direct sales and up to 1.5 percent of the contribution if an investor carries out a transaction online.

32.04pc

decline was recorded in gold imports of Pakistan during the first month (July) of financial year 2018-19. Pakistan imported gold worth $1.423 million during July 2018 against the imports of $2.094 million in July 2017, showing growth of 32.04 percent, according to latest PBS trade data. In terms of quantity, Pakistan imported 34 kilograms of gold during the month under review compared to the imports of 52 kilograms during last July, showing a decrease of 34.62 percent.

Meanwhile, on a month-on-month basis, the gold imports into the country, however, witnessed a positive growth of 1.35 percent in July 2018 when compared to the imports of $1.404 million in June 2018, the PBS data revealed. It is pertinent to mention here that the overall merchandise imports into the country during the month under review witnessed an increase of 0.6 percent by growing from $4.809 billion last July year to $4.838 billion.

14pc

increase in tax collection was witnessed during the first two months (July-August) of current financial year 2018-19, to touch Rs506 billion. During July-August FY19, provisional tax collection was recorded at Rs506 billion, said FBR officials and was 14 percent higher than the revenue fetched in the same period of last year (SPLY). Federal Board of Revenue (FBR) was able to surpass its two-month revenue collection target largely due to receipts of Rs31 billion under the tax amnesty scheme in July 2018. And tax collection in August went up slightly, rising 5.5 percent year-on-year (YoY) to Rs250 billion, but was less than the monthly aim of Rs281.5 billion.

12

$5.1b

is being paid by Coca Cola Co to acquire the world’s 2nd largest coffee chain Costa from Britain’s Whitbread Plc. Whitbread said in a statement that the deal, which will give Coke almost 4,000 coffee outlets in the UK and across Europe, had been agreed unanimously by the Whitbread board as in the best interests of shareholders.

Whitbread, which had been in the process of demerging its coffee business from its hotel chain, acquired Costa in 1995 for 19 million pounds when it had only 39 shops. For Coca-Cola, the deal adds to its efforts to move away from fizzy drinks towards more healthier options for increasingly health-conscious consumers. “Hot beverages is one of the few segments of the total beverage landscape where Coca-Cola does not have a global brand,” Coca-Cola CEO James Quincey said.

“Iran is Pakistan’s close partner in its efforts to establish peace” Iran Foreign Minister Javed Zarif

Rs500b

QUOTE

Rs35m

have been released for construction of Khazana Dam, the Senate was informed. Dr Babar Awan, advisor to the prime minister for parliamentary affairs answering the questions of Senator Muhammad Azam Khan Musakhel in Senate, he said that the PC-1 of Rs300 million has also been prepared and Rs 276 million has also been approved for constructing the dam. He said a sum of Rs300 million had also been allocated for Khazana Dam, Zimri District Musakhel in the Public Sector Development Programme (PSDP) 2017-18. Whil an amount of Rs. 50.00 million had also been reserved to construct Khazana Dam Zimri, District Musakhel.

Rs2.26t

was the country’s budget deficit (6.6 percent of GDP) in last financial year 2017-18. The Ministry of Finance in its annual consolidated and provincial budgetary operations report said budget deficit widened to Rs2.26 trillion in FY18, equaling 6.6 percent of GDP. FY18’s budget deficit broke FY17’s record of Rs1.864 trillion. The budget deficit for FY18 was Rs780 billion (2.5 percent of GDP) higher than the target approved by the last parliament in June 2017. And the budget deficit of 6.6 percent of GDP breached the limit approved limit of 4.1 percent set by the previous parliament. The record budget deficit for FY18 has been blamed on hasty expenditures by the provinces and federation as general elections loomed and a precipitous fall in tax and non-tax revenues. The budget deficit of 6.6 percent of GDP was the highest recorded during the five-year tenure of the previous PML-N government. Also, this doesn’t include around Rs2 trillion of liabilities not recorded in the budget books. These liabilities not recorded in the budget books are linked to the outstanding debt of gas, commodity and power sectors.

have been earned by oil refineries under the guise of “deemed duty” since 2002. This deemed duty was provided by the government as an incentive to make oil refineries upgrade their plants which would result in the production of environment-friendly and higher-grade fuel. Since 2002, the refineries have been collecting this deemed duty to install upgraded plants for oil refining, however, they have been able to obtain four extensions in the deadline for upgrading their plants. Currently, 7.5 percent deemed duty is being obtained on the sale of high-speed diesel to consumers. As per a decision of the Economic Coordination Committee (ECC) in March 2013, refineries including Pakistan Refinery Limited (PRL), Attock Refinery Limited (ARL) and National Refinery Limited (NRL) were stipulated to deposit their profits over 50 percent of the paid-up capital which includes the accumulated unused balance in a special reserve account. Instead of transferring funds to an escrow account, the special reserves were utilized in upgrading the refineries. The Senate Standing Committee on Petroleum held a meeting and was chaired by Senator Mohsin Aziz. Mr Aziz expressed worry over the protection being given by the government to the refineries and demanded to know where the money had been consumed. He highlighted deemed duty was provided for upgrading the quality of petroleum products, however, rued the heavy collection was made from poor oil consumers. The Senate committee chairman said, “Public money should be spent on people.” However, the petroleum secretary shared the government would resolve issues which had remained unaddressed over the last ten years. He emphasized the government will bring furtherance in oil and gas exploration activities in Balochistan during the next six months.

Rs50b

of investment has been attracted

by Sindh’s Special Economic Zones (SEZs) roughly Rs34 billion of investing solely in the 930-acre Bin Qasim Industrial Park (BQIP). And the remainder of the Rs16 billion of the investment went to SEZs in Khairpur Special Economic Zone (KSEC) and Korangi Creek Industrial Park (KCIP). Also, Rs15 billion of investment in BQIP has been made by Kia-Lucky Motors which already has commenced operations with completely built units (CBU) and will start manufacturing Kia cars soon. Sindh Board of Investment Director Projects Abdul Azeem Uqaili said in the SEZs, entities received three things which include a ten-year income tax holiday, second, they don’t require to pay duty on plant and machinery imported to establish a manufacturing unit.

BRIEFING

HONG KONG-BASED INVESTMENT BANK RETURNS TO PAKISTAN’S CAPITAL MARKETS.

BUT WHY? CLSA, a subsidiary of a Chinese state-owned company CITIC, has acquired a stake in Bank Alfalah’s securities trading arm Alfalah Securities

14

O

By Farooq Tirmizi

ne by one, the foreign firms are coming back to Pakistan’s capital markets.

On August 30, CLSA, the Hong Kongbased investment bank formerly known as Credit Lyonnais Securities Asia, formally announced that it has re-entered the Pakistani market after an absence of approximately 17 years, acquiring a 24.9% stake in Alfalah Securities, the securities brokerage and investment banking arm of Bank Alfalah. In doing so, it has become the second pure-play foreign investment bank to enter the Pakistani market since the re-inclusion of Pakistan into the MSCI Emerging Markets index.

EFG Hermes, the Egyptian investment bank, was the first.

Following CLSA’s investment in Alfalah, the company will be called Alfalah CLSA Securities. Both the current chairman of the board, former Engro CEO Aliuddin Ansari, and CEO Atif Khan will acquire a combined 12.6% share in the company. The remainder will be owned

by Bank Alfalah, with a small portion owned by the International Finance Corporation, the private sector investing arm of the World Bank.

While it may be tempting to see these two firms setting up shop in Pakistan as the start of a new trend, the reality is much more complicated. CLSA’s decision to enter the Pakistani market is motivated in part by its history in the country, and in part by its current ownership structure.

The investment bank founded by financial journalists

I

n many ways, CLSA is a creature of both the British era in Hong Kong as well as the boom in East Asia’s economies in the 1980s and 1990s.

Aliuddin Ansari, chairman of the board Alfalah CLSA Securities The company was founded in Hong Kong in 1986 as Winfull Laing & Cruickshank Securities by former business journalist Jim Walker. Walker was soon joined by two other former journalists: Gary Coull, as head of the dealing room, and Malcolm Surry, as head of research. All three had worked at the South China Morning Post; neither Coull nor Surry had any experience in securities brokerage.

In 1987, the company was acquired

by Credit Lyonnais, which at that time was one of the largest banks in France.

That gave the company its new name: Credit Lyonnais Securities (Asia), or CLSA. Although it was founded in Hong Kong, CLSA quickly expanded globally, eventually opening up offices in 17 cities across East Asia as well as in London and New York.

In 1992, the firm sent a young man from its London office named Ali Ansari (yes, the same one who went on to become CEO of Engro) to Karachi to create a presence in the Pakistani market, shortly after the government of Pakistan started liberalizing the financial services sector, including the capital markets.

By 1993, the company had been able to acquire a full brokerage licence and began its securities brokerage

IN SUCH AN ENVIRONMENT, IT MAKES SENSE THAT CLSA IS ENTERING PAKISTAN ONLY THROUGH A MINORITY INVESTMENT AND NOT THROUGH AN OUTRIGHT ACQUISITION OF A BROKERAGE FIRM. AFTER ALL, THE TRACK RECORD OF FOREIGN INVESTMENT BANKS AND SECURITIES BROKERAGE FIRMS IN PAKISTAN HAS NOT ENTIRELY BEEN PLEASANT

Atif Khan, CEO Alfalah CLSA Securities business in Pakistan. “We were always profitable in Pakistan. The profits were not huge, but it always made money for CLSA,” said Donald Skinner, group secretary at CLSA, in an interview with Profit.

“The other thing that Pakistan gave us was great talent. We were able to recruit some very good analysts who then went on to other parts of the business in other parts of the world,” said Skinner.

CLSA’s presence in Pakistan lasted until 2001, when the company closed up shop and departed Pakistan.

In the intervening years, CLSA’s parent went through several changes, going from being majority state-owned by the government of France to becoming fully privatized in 1999, to being sold off to Credit Agricole in 2003.

In 2012, Credit Agricole sold a 19.9% stake in CLSA to CITIC Securities, China’s largest investment bank and a subsidiary of the state-owned CITIC Group. The next year, CITIC bought the remainder of CLSA. All in, the transaction cost CITIC $1.25 billion.

Why come back to Pakistan now?

I

n his interview with Profit, Skinner was careful not to label CLSA’s return to Pakistan as just another product of Chinese interest in Pakistan that stems from the China-Pakistan Economic Corridor (CPEC). He sought to highlight CLSA’s independence and its own reasons for wanting to return Karachi’s capital markets.

“CLSA is a unique institution in many ways. I’ve been at the company for 32 years. Our CEO Jonathan Slone has been here for nearly as long. Our

CAPITAL MARKETS

head of research has been with us for 28 years. So we are a firm with a long institutional memory and the positive experience in Pakistan [from the 1990s] is part of that institutional memory, along with the experience of working with Ali Ansari,” he said.

But in an interview with the Financial Times, Richard Taylor, the head of corporate finance and capital markets at CLSA, laid out a much more CPEC-related reason for wanting to expand into Pakistan. In an articled dated August 12, Taylor linked CLSA’s interest in Pakistan directly to its ownership by CITIC, and therefore their interests in CPEC: “Citic has a broad range of businesses… We see ‘Belt and Road’ opportunities with Citic in places like Pakistan and Bangladesh,” referring to the wider One Belt One Road (OBOR) initiative, of which CPEC is tangentially a part.

The Ali Ansari factor

B

ut while CPEC is probably playing a role in CLSA’s decision to re-enter Pakistan, a significant part of the decision may quite simply be Ali Ansari’s past relationship with the firm, and his and Atif Khan’s success in making Alfalah Securities a force to be reckoned with in Pakistani capital markets, particularly on the retail brokerage business.

Alfalah Securities earned Rs144 million in revenue from its retail brokerage business in 2017, according to Bank Alfalah’s financial statements. That

16

“CITIC HAS A BROAD RANGE OF BUSINESSES… WE SEE ‘BELT AND ROAD’ OPPORTUNITIES WITH CITIC IN PLACES LIKE PAKISTAN AND BANGLADESH” Richard Taylor, head of corporate finance and capital markets at CLSA number is a pittance compared to the Bank Alfalah’s overall revenues, but the growth in that business has been rapid.

In 2014, for instance, the retail brokerage earned Alfalah Securities less than Rs3 million in revenue.

The reason for the growth in the business appears to be a willingness of Alfalah to invest in making its securities brokerage firm – hitherto much more focused on institutional clients – friendlier towards retail consumers, particularly with respect to the adaptation of technology. For instance, Alfalah now offers one of the most robust stock trading apps on both iPhones and Android smartphones, which makes its services much more attractive to tech-savvy middle-class investors.

Hence it comes as no surprise that Alfalah Securities is beginning

to earn a profit on its retail business.

The company earned a pre-tax profit of Rs31 million on retail brokerage in 2017, the latest year for which financial statements are publicly available. In other words, it may simply be the fact that CLSA has an established relationship with a leading Pakistani executive who happens to be the chairman of the board of a well established brokerage firm that is on the verge of a serious take-off in its revenues.

The broader Pakistani securities brokerage business

T

he brokerage business as a whole in Pakistan, however, does not appear to be particularly healthy.

Brokerages make money when there is more trading on the stock

“CLSA IS A UNIQUE INSTITUTION IN MANY WAYS. I’VE BEEN AT THE COMPANY FOR 32 YEARS. OUR CEO JONATHAN SLONE HAS BEEN HERE FOR NEARLY AS LONG. OUR HEAD OF RESEARCH HAS BEEN WITH US FOR 28 YEARS. SO WE ARE A FIRM WITH A LONG INSTITUTIONAL MEMORY AND THE POSITIVE EXPERIENCE IN PAKISTAN [FROM THE 1990S] IS PART OF THAT INSTITUTIONAL MEMORY, ALONG WITH THE EXPERIENCE OF WORKING WITH ALI ANSARI” Richard Taylor, head of corporate finance and capital markets at CLSA exchange, and on that front, the data suggests the market is not particularly healthy.

Volumes on the Pakistan Stock Exchange are currently languishing at roughly the same levels as in the late 1990 and early 2000s, and are down by about 80% compared to the peak

reached in 2005 and 2006 under the freewheeling days of the Musharraf Administration.

The total value of trading on the PSX in 2017 was just over Rs3 trillion.

That may sound like a lot of money, but brokerage fees in Pakistan tend to be very low.

In fact, most estimates suggest that brokerage fees in Pakistan amount to no more than 10 basis points (a basis point is one hundredth of 1%) of the total value of shares traded. Assuming two-sided commissions on every trade (both the buyer and seller have to pay their respective brokers), that puts the estimated total value of brokerage

CAPITAL MARKETS

fees paid in Pakistan to just Rs6 billion ($57.5 million) in 2017.

There are 394 entities with trading rights entitlement certificates (TRECs), of whom the PSX estimates 228 are active in the brokerage business, who are all competing to earn commissions on trading activity that takes place on the stock exchange. That Rs6 billion in brokerage fee revenue has to be split among all 228 active brokerage firms.

The reason for these low volumes and low brokerage fees is the fact that a very small proportion of Pakistanis are actually invested in the market at all. Just over 282,000 people in Pakistan have any kind of capital markets account, according to data from the Central Depository Company of Pakistan, or just 0.14% of the total population. That compares very poorly even against Bangladesh, where investor participation is at 1.5% of the population, and far behind India, where participation is at 4.5% of the total population.

And that number in Pakistan is barely keeping pace with population growth: since 2012, the total number of people with a capital markets account has only risen by an average growth rate of 4.4% per year, which is only marginally above Pakistan’s population growth rate of 2.4% per year. That means that the proportion of the population that is invested in the markets is rising very slowly from an already very low base.

18

This low level of investment in the Pakistani population is despite the fact that Pakistan’s capital markets are a highly lucrative place to invest, even after accounting for the fact that a substantial portion of trading activity that takes place in the market may involve illicit activities on the part of the brokers.

The benchmark KSE-100 index has risen by an average annual rate of 21.5% per year for the last 20 years.

In absolute terms, this means that Rs1 million invested in a fund that matches the performance of the KSE-100 index 20 years ago would be around Rs49 million today. For foreign investors thinking about the effects of currency devaluation, the KSE-100 index has had an average annual return of 16.1% in US dollar terms during that same period.

A foreign institutional investor who invested during that same period, using an index-tracking strategy, would have had $19.6 million in 2018 for every $1 million invested in 1998.

Caution in the markets

I

n such an environment, it makes sense that CLSA is entering Pakistan only through a minority investment and not through an outright acquisition of a brokerage firm. After all, the track record of foreign investment banks and securities brokerage firms in Pakistan has not entirely been pleasant.

In the early 1990s, when Pakistan

began modernizing its capital markets and opening up to foreign investors under the first Nawaz Administration, a sizeable number of foreign firms entered the market, either through joint ventures or through outright purchase of a seat on the Karachi Stock Exchange.

Some of the American and larger European firms tended to prefer joint ventures and other types of partnerships. Merrill Lynch partnered with KASB Securities, Bear Stearns with Jahangir Siddiqui, UBS with Global Securities. Others preferred to buy a seat on the Karachi Stock Exchange in their own right, such as the European firm ING Barings, the Hong Kong-based Jardine Fleming. Virtually all of these firms left the market in the late 1990s or the early 2000s.

Jardine Fleming ended up selling its seat on the exchange to the American giant JP Morgan, which technically still owns the seat, though it has long since become dormant. Credit Suisse tried starting off small, with just a small research office in Karachi in 2008, but was unable to justify having a presence in the country and quietly close shop and left.

This is in sharp contrast to India, where a drive through some parts of Mumbai make it look like one is in the Indian outpost of Wall Street and the City of London: virtually anybody who is anybody in the capital markets has an office in India’s financial capital.

CAPITAL MARKETS

20

Allegations of money laundering and illicit payoffs continue to haunt this transaction, suggesting there may be more than a simple bank merger going on

D

Arshad Hussain and Farooq Tirmizi

rive down the old Victoria Road (now called Abdullah Haroon Road) in Karachi towards Saddar, about one kilometer down from Frere Hall, and you will get to a place that used to be called Victoria Market in the colonial era (and now has no real name), the kind of bazaar that would be commonly found in just about any part of Pakistan, with many small shopkeepers selling their wares – clothes, sporting goods, etc. – to lower middle class retail consumers who walk by.

Here, in a building labelled International Business and Shopping Center, is the ostensible global headquarters of a business that has billions of rupees in annual cash flow, and dealings with some of the largest businesses and political figures in Pakistan and the Middle East. It is called A-One International, and it is owned by a man named Tariq Sultan.

At least that is what the official bank documents say.

Tariq Sultan is no billionaire. He does not know any politicians or wealthy businessmen. He has absolutely no connection to the Rs4.5 billion worth of transactions that have allegedly taken place in his name.

He is the victim of the kind of identity theft that takes place in Pakistan’s banking

sector every day: his computerised national identity card (CNIC) has been used to create a benami (anonymous) account.

Benami accounts are commonly used in money laundering, and are illegal, but are such a common practice in Pakistani banks that many banks even have under-the-table procedures for how to handle them, often keeping forms that instruct branch employees to ignore the difference in the signature of the person who actually operates the bank account and the signature on the CNIC of the person whose identity is being stolen.

Sultan’s case, in other words, is more common than it looks. What makes his case unique, however, is the fact that the people using his identity to allegedly conduct these money laundering transactions are people who sit at the nexus of money and political power in Pakistan, and more specifically, in Sindh. And the account in Sultan’s name involves payments between parties who are about to engage in the largest bank merger in Pakistan this year.

The Sindh Bank merger with Summit Bank

I

n November 2016, the provincial government-owned Sindh Bank announced that its board of directors had decided to begin the process of merging the bank with Summit Bank, itself an amalgamation of three slapdash mergers that took place between 2009 and 2011.

MERGERS AND ACQUISITIONS

The merger makes a certain amount of sense from the perspective of Summit Bank: Sindh Bank is a bank that has a large branch network, a steady and growing deposit base, and surprisingly healthy profitability considering the fact that it is a state-owned bank and most government-owned banks in Pakistan tend to be financial basket cases.

However, from the reporting around the issue, it seems somewhat clear that the acquiring entity is Sindh Bank, and why they might want to acquire Summit Bank is less clear, other than the fact that Summit may be the only bank that Sindh Bank can afford to buy. Sindh Bank may be profitable, but it is still one of the smallest banks in the country.

What is astonishing about this turn of events is that, in 2010, when Sindh Bank was conceived and about to be launched, nobody could have anticipated this turn of events.

The story of Sindh Bank

I

n later 2010, almost every provincial government had established a bank.

The government of Punjab was the majority owner of the Bank of Punjab, which it had created in 1989. The government of Khyber-Pakhtunkhwa had created the Bank of Khyber in 1991.

Even the government of Balochistan, Pakistan’s poorest province and smallest by population, had created its own bank, Bolan Bank, in 1992, which it then sold off in 2005. The bank was later renamed Mybank.

Ironically, the provincial government whose capital city is also the financial capital of the country and therefore chockful of financial talent was the one government that had not yet created its own bank. And so, in 2010, two years into the Pakistan Peoples Party’s (PPP) return to office in Sindh, the provincial government in Karachi undertook the task of creating its own bank.

Fairly or not, the PPP-led government in Sindh has a reputation for being corrupt even by Pakistani provincial government standards, and so when they submitted an application for a banking licence to the State Bank of Pakistan (SBP), there was an informal betting pool among a certain segment of the SBP staff as to when this new bank would require its first bailout.

The longest anyone was willing to bet

22

THE FIA IS ALLEGING NOT ONLY THAT SUMMIT BANK FAILED TO CATCH THE MONEY LAUNDERING GOING ON THROUGH ITS ACCOUNTS, BUT ACTIVELY FACILITATED IT THROUGH A PROCEDURE PUT IN PLACE BY THE BANK’S CEO HIMSELF AND ONE IN WHICH A LARGE PART OF THE BANK’S STAFF WAS ALSO INVOLVED. THE FIA ALSO ALLEGES THAT THE BANK KNEW EXACTLY WHO REALLY OWNED THE ACCOUNTS AND THAT THE TRANSFERS CONDUCTED THROUGH IT WERE FOR MONEY LAUNDERING PURPOSES it could last without a bailout was five years.

But, so far,, Sindh Bank appears to have confounded the sceptics. The bank has been profitable for every one of the seven full years it has been in existence and while its non-performing loan ratio (proportion of the total lending book that has defaulted on their loans) is high by international standards at 8.1% as of June 30, 2018, that number is positively respectable by Pakistani standards.

This is despite the fact that the bank has gone on a very rapid expansion drive and currently has 300 branches, and also owns its own microfinance bank.

Of course, it helps that nearly 60% of the bank’s Rs122 billion deposit base comes from the provincial government and that it deploys most of those deposits into federal government bonds.

Nonetheless, the bank does have a Rs75 billion loan book, and of that, over 83.3% goes towards private sector borrowers.

It is, of course, theoretically possible that Sindh Bank is able to hide its losses (most banks around the world can hide their losses quite easily if they choose to do so), though we have no reason to believe that they have done do. But the profitability numbers look better than one might expect from a state-owned bank. For the twelve months ending June 30, 2018, the bank had a net income of Rs1,046 million.

This represents a decline of 32.7% over the same period in the previous year, but is at least still a positive number instead of a loss. The return on equity (ROE), the key measure of bank profitability, however, was a paltry 6.3%

compared to the robust double-digit ROE figures enjoyed by most larger banks in Pakistan.

Summit Bank: the sausage limps on

Y

et even if Sindh Bank’s profitability numbers are somewhat below the Pakistani median, Summit Bank is doing significantly worse. In the nine years that it has been in existence, Summit Bank has posted a profit in precisely two years and has otherwise continued to hemorrhage money. For the twelve months ending March 31, 2018, the latest period for which financial data is available, Summit Bank had net losses of Rs1,359 million. Try as it might Summit Bank has just not been able to make money.

The reason, of course is that Summit Bank was always something of an orphanage for banks in Pakistan, having acquired what were previously the three smallest banks in the country that were effectively abandoned and left for dead by their previous owners: Arif Habib Bank (2009), Atlas Bank (2010), and Mybank (2011). None of those three banks was ever a viable bank on its own, and while the theory was that they might be more economically sustainable when put together, so far that hypothesis does not appear to be true.

The lack of profitability is not for a lack of trying. The founding CEO of the bank, Husain Lawai, made a valiant effort to make the bank profitable, undertaking several initiatives to improve the bank’s operations.

Of the 160 branches he inherited, in his first two years, Lawai had 47 of them moved. This, of course, had

the effect of increasing his cost base for those years. In 2010, the bank was spending Rs40 million per branch, a number that came down to Rs26 million per branch by 2013.

In addition to the inherited branches, in the first two years he also added another 26 branches, taking the number up to 186. However, he appears to have realized soon enough that trying to grow the bank too fast, without having fully stabilized it, was probably not a good idea and since then, the bank has only added seven more branches.

On the liability side, Lawai struggled with a critical problem: he effectively had hardly any retail deposits, only high-cost corporate ones (in 2009, the bank’s percentage of retail deposits was actually close to 0%). This resulted in a cost of deposits of 14.5%, the highest in the industry by a long shot.

So another order of business was to unwind those costly long-term deposits and get cheaper ones in their place.

The branch relocation helped with at least some new deposits, but Lawai had to do more. And so, in order to attract retail deposits, Summit Bank went nuts, formulating a three-pronged strategy: staying open later in the evenings than their competitors and on weekends, introducing co-branded and prepaid debit cards (then still unusual in Pakistan), and focusing on the remit-

tances business.

In areas of Karachi and Lahore with high net-worth depositors, the bank kept branches open till 8 pm. At the fanciest mall in Karachi, the branch stayed open till 11 pm, basically until the mall itself closed, to attract the accounts of the shops located there.

And at the Fish Harbour in Karachi, the branch stays open 24/7. And 77 of its 193 branches stay open on Saturdays and two on Sundays.

The bank also introduced a prepaid debit card and co-branded some of its debit cards with some of the best-known consumer brands in Pakistan.

And in order to ensure that it gets truly retail deposits, Summit Bank focuses heavily on the remittances business. Despite being only the 17th largest bank in Pakistan by assets, it is the seventh largest in terms of handling inward-bound remittances to Pakistan.

While the fee income on remittances is nice to have, the real advantage of the remittance business is having the deposit accounts of the families of expatriate Pakistanis, who tend to be slightly better off than similar families in any given geographic region.

It was a valiant effort, but clearly not enough to build a viable bank.

Lawai was able to eke out two years of profitability for Summit Bank – in 2014 and 2015 – which was enough for him

to declare victory and retire to the life of an emeritus presence in Pakistani finance. Summit Bank continues to struggle with massive losses in both 2016 and 2017 – Rs2.2 billion and Rs1.1 billion respectively, and the year 2018 is not off to a much better start either, with a loss of Rs328 million in the first quarter.

A home for money laundering?

S

o what does the merger of these two banks – struggling to varying degrees – have with the identity theft mentioned at the beginning of our story?

Well, the account in Tariq Sultan’s name is one of 29 allegedly fake accounts that are being investigated by the Federal Investigation Agency’s (FIA) State Bank Circle, the division of the country’s premier law enforcement agency that is responsible for investigating financial crimes. The FIA alleges that these accounts are being used for money laundering and illicit payments between politically connected businessmen and high-ranking politicians, including former President Asif Ali Zardari, and his sister Faryal Talpur, a current member of the Sindh Assembly and widely regarded as the de facto Chief Minister of Sindh.

The FIA’s investigation report

MERGERS AND ACQUISITIONS

– made available to Profit – reveals a pattern of flouting the law against money laundering on the part of Summit Bank employees, who appeared to be operating under direct orders from Husain Lawai, who served as CEO of the bank from 2009 through the beginning of 2016. Lawai and Zardari are old friends, and Lawai spent a considerable portion of the 1990s and 2000s in exile, fighting charges of money laundering on behalf of Zardari. He was exonerated of those charges in the UAE in 2002 and the charges against him in Pakistan were dropped in 2008.

But if the FIA’s version of events is accurate – and they have assembled considerable evidence that it may well be – it appears that Lawai is not done helping Zardari flaunt the law with respect to money laundering.

The account in Tariq Sultan’s name, for instance, was operated by another person entirely (and one not identified by name in the FIA’s charges), and was used to receive and make billions of rupees in payments to large businesses as well as well-connected individuals.

Here is how it worked: the person operating the account in Tariq Sultan’s name would come and conduct transactions with the operations manager at the DHA Khayaban-e-Tanzeem branch of Summit Bank in Karachi.

The operations manager would then pass on the documents as being verified to the relationship manager, who would then clear them and forward them to the branch manager.

The branch manager, knowing that the operations department of the bank may catch the forged signatures, would write on the documents “Referred by Husain Lawai” so as to let the bank’s staff know that the scheme was cleared by the CEO himself, and that any forgeries should not be questioned.

The use of the DHA Khayaban-e-Tanzeem branch is interesting in itself. For those unfamiliar with Karachi’s geography, this branch is 6.2 kilometers away from the market in which the business that owned the account supposedly resides. What makes it even more suspicious is that there is a Summit Bank branch on Elphinstone Street (now called Zaibunnisa Street) less than a 3-minute walk away from the shop in Victoria Market.

Why on earth would a busy shopkeep-

24

er go to a branch so far away when there was one virtually next door?

Incidentally, the bank maintained documents in its “know your customer” (KYC) records that indicated that they knew that the account for A-One International did not really belong to Tariq Sultan, but rather to the Omni Group, a sugar and real estate conglomerate supposedly owned by Anwar Majeed, a close associate of Zardari and widely suspected to be a businessman who acts as the front for the former president’s commercial interests.

In other words, the FIA is alleging not only that Summit Bank failed to

catch the money laundering going on through its accounts, but actively facilitated it through a procedure put in place by the bank’s CEO himself and one in which a large part of the bank’s staff was also involved. The FIA also alleges that the bank knew exactly who really owned the accounts and that the transfers conducted through it were for money laundering purposes.

So why would the bank facilitate this? The FIA alleges – with some evidence – that bank’s majority shareholder, Nasser Abdulla Hussain Lootah, a member of one of the oldest and wealthiest families in Dubai, may

“WE ARE HAPPY WITH THIS MERGER AS THE TOTAL BRANCH NETWORK OF THE BANK WOULD EXCEED TO 500 WITH A PAID-UP CAPITAL OF RS27 BILLION. THE BANK HAS NO AFFILIATION WITH ANY POLITICAL GROUP AND WE ARE NOT INVOLVED IN ANY MONEY LAUNDERING. ALL ALLEGATIONS ARE BASELESS AND WE ARE COOPERATING WITH THE INVESTIGATION TEAMS. THE MONEY LAUNDERING CASE WILL NOT AFFECT THE MERGER WITH SINDH BANK” Ahsan Raza Durrani, Summit Bank CEO have been a beneficiary of the money laundering himself.

Whose money flowed through the accounts

T

he FIA offers very detailed descriptions of exactly who received how much money from the accounts. For instance, in the case of the A-One International account, the FIA alleges that a series of transactions took place in the 10 months between June 3, 2014 and December 1, 2015 that involved up to Rs2,855 million entering the account and Rs4,145 million leaving the account.

The list of who sent money and who received it is also fascinating.

There was, for instance, Rs750 million received from Bahria Town Karachi, the massive new suburb being built by real estate magnate Malik Riaz Hussain. There are several hundred million rupees received from sugar mills known

AFTER MERGING SUMMIT BANK WITH THE SINDH BANK, THE SINDH GOVERNMENT MAY FURTHER ENHANCE ITS INVESTMENT OF RS 10 BILLION IN THE BANK” Bilal Sheikh, the former CEO of Sindh Bank

to be owned by the Omni Group and Anwar Majeed.

The payments are particularly fascinating as well, such as the Rs2,492 million paid out to Nasser Lootah and several million rupees paid out again to companies controlled by Anwar Majeed, and one company directly owned

by Asif Zardari and Faryal Talpur (Zardari Group).

Who owns the bank?

T

he payment to Lootah in particular is interesting. The amount represents a sizeable amount of money being paid to the owner of the bank itself and raises several questions as to what the transaction was about and why it was conducted in such a suspicious manner.

There have been rumours circulating since the very beginning of the Zardari administration that something was off about the ownership structure of Summit Bank. The fact that it was

owned by Lootah, who previously had no businesses in Pakistan and still does not list his ownership of Summit Bank on his own group’s website, was seen as suspicious, raising questions that Lootah was perhaps acting on behalf of an undisclosed third party. That undisclosed third party was often speculated to be Asif Ali Zardari, though no hard evidence of his ownership of the bank ever emerged.

Those rumours are lent some degree of credence by the money laundering investigation by the FIA, which appears to have caught vast sums of money flowing back to Lootah, almost as though they were payback for having put up the money to buy the bank and shore up its capital reserves to the levels required under the law by the State Bank of Pakistan.

The A-One account, for instance, is just the tip of the iceberg. The FIA is investigating 28 other accounts, which saw suspicious transactions worth a total of Rs35 billion to various entities.

Of the total of 29 accounts, 16 were at Summit Bank, eight were at Sindh Bank, and five at United Bank.

A total of seven people’s identities were used to open these accounts, which the FIA believes were mostly fraudulent. Of the seven people who have been issued subpoenas, only three have responded, said FIA Director General Bashir Memon in a hearing at the Supreme Court of Pakistan.

Meanwhile, in connection with the investigation, the FIA is currently prosecuting Husain Lawai, Taha Raza, former head of corporate banking at Summit Bank, Anwar Majeed and his son Abdul Ghani Majeed, as well as former President Zardari and Faryal Talpur. The latter two were able to post bail and

MERGERS AND ACQUISITIONS

are thus not in jail during the ongoing investigation.

If the merger between the two banks were to go through, the owners of Summit Bank, whether it be Lootah or someone else, will become shareholders in Sindh Bank, a bank that will remain majority owned and controlled by the Sindh government.

One can see why a person who has strong political influence over the Sindh government currently and expects to retain that control over the next several years would be in favour of such a merger. And one can see why there may be questions as to whether such a merger is appropriate, which is where the Supreme Court’s investigation on the matter comes in.

The Supreme Court’s role

T

he FIA investigation was completely separate from the litigation surrounding the announced merger between Summit Bank and Sindh Bank, though it surfaced during the course of the suo motu hearings that took place in the court about the matter.

The court was investigating the matter after allegations surfaced that the merger may not be above board and since it involved public money in the form of the Sindh Bank’s ownership, the apex court decided to look into the merger. It was during those hearings that the FIA’s four-year -long ongoing investigation of money laundering came to light.

26

Meanwhile, the boards of directors at both banks appear to be moving ahead as though nothing has happened.

They have both approved the all-equity merger, which will see a share swap ratio of 8.37 to one, where Summit Bank’s shareholders will receive 1 share of Sindh Bank for each 8.37 shares of Summit Bank that they own. The merger is still subject to final approval both by the a meeting of the shareholders of Summit Bank as well as the Supreme Court, which has yet to issue a final ruling on the matter.

The court, however, does not appear to be in the mood to let the case go. On September 5, it ordered the creation of a joint investigation team (JIT) to investigate these allegations, which may well drag out the case even longer, and may well result in the merger not being approved.

mit Bank with the Sindh Bank, the Sindh government may further enhance its investment of Rs 10 billion in the bank.”

He added: “The Supreme Court never opposed the merger of the banks, but it asked us why we are merging Summit Bank with it. We replied to the SCP that after this merger Sindh Bank will be listed on stock market, we will have over 500 branches network and will have other businesses like Summit Bank.” “After completing necessary regulatory work, we will have to take final approval from the Supreme Court and Inshallah we will get it before September 30,” he claimed. “The merger process would be completed by the end of 2018 and we will also issue the initial public offering [IPO] of Sindh Bank before the end of 2018.”

The banks’ responses

A

S

ummit Bank CEO Ahsan Raza Durrani said: “We are happy with this merger as the total branch network of the bank would exceed to 500 with a paid-up capital of Rs27 billion.” He went on to add: “The bank has no affiliation with any political group and we are not involved in any money laundering. All allegations are baseless and we are cooperating with the investigation teams. The money laundering case will not affect the merger with Sindh Bank.”

Bilal Sheikh, the former CEO of Sindh Bank, said: “After merging Sum-

Where the investigation goes next

s may be evident from the CEOs’ statements, the banks themselves do not appear to see the Supreme Court investigation as being a significant hurdle in completing the merger. And there are some within the FIA who believe that optimism may well be warranted.

One FIA source familiar with the investigation told Profit: “This money laundering investigation was being used to rein in the Pakistan Peoples Party in the run up to the 2018 election.

Now that the election is over, the case will be shut down again.”

MERGERS AND ACQUISITIONS

T

By Arshad Hussain

PL-Life Insurance Company Limited, an under two-years old Life & Health insurance company in Pakistan, launched innovative Insurance products to increase its market share all over the country through creative marketing tactics.

“TPL-Life seeks to confront deep rooted hindrances in the sector - low public confidence, coupled with a deep seated mistrust of insurance companies,” said its Chief Executive Officer (CEO) Faisal Shahzad Abbasi.

“The company seeks to change expectations of the public of insurers, and create greater awareness of how insurance operates elsewhere in the world,” he said in an exclusive interview with the Profit Magazine.

“We are also focusing on increasing level of education with its associated awareness of legal rights, transformed claim payment and make insurance policy documents easy to understand to the general public,” Mr Abbasi informed.

Faisal Shahzad Abbasi has behind him 22-years experience, including his years in a foreign bank like ABN Amro, which later became Royal Bank of Scotland (RBS) in Pakistan. Prior to being appointed TPL Life’s CEO in 2016 his did a stint with Jubilee Life, where he served as group head, customer experience and marketing.

A subsidiary of TPL Corp founded by Mr

28

Jameel Yousuf, former chairman CPLC Pakistan, he also chairs TPL Life. Presently there are nine Pakistani insurance firms, including TPL-Life, in Pakistan.

The group had acquired Asia Care Health & Life, a local insurance company, in July 2016 and since then to get penetration in the Pakistani market the management was working on different products for the customers.

“For the last 23 months, our company was busy in developing different projects, and several processes of previous company were also restructured... And [we felt] now is the time to go public with our offerings,” said the CEO. Pakistan’s insurance sector, said he, must work to improve perception of the insurance providers as well as negatives that have plagued its image in our society. Also we need to address the negative concerns of the clients pertaining to insurance services.

“The company has launched health and life insurance products, and made these available in retail outlets, the company’s website/mobile app and banking channels etc,” said he, adding, “This is just the beginning of our efforts to bring in the much-needed change in life insurance sector.

With time, we will gain healthy market share and carve a niche for ourselves with our exclusive offerings and services.”

In a short span of time, he contends, the TPL-Life insurance has won the confidence of reputed corporates with its services and is continuing to do so with every passing month.

Easy for public

A

bbasi explained that TPL-Life Insurance has rolled-out a transparent mechanism to live by its promises to pay genuine claims promptly, and revamp its structures to ensure that aggrieved policyholder or claimant does not go through cumbersome processes or avenues for redress.

“The majority of those who purchase insurance products do so either because they require some form of protection, or are compelled either by law or other contractual provisions and conditions to buy insurance,” he said.

The CEO claimed that we made the acquisition and servicing of life insurance very easy with the tools like the mobile App and WhatsApp. People are very smart today, they pick up trends quickly, understand everything and can select the own products that they actually need.

“We have majorly bypassed paperwork or the middleman from the policies,” claimed Abbasi. “We are also trying to eliminate human intervention in life insurance transactions and encourage clients to do all transactions directly with available digital options.”

He said that the company has developed solutions to register clients digitally on Mobile Phones and web portals, which will greatly assist clients in choosing life insurance of their choice.

Health Insurance

T

he CEO said we are dealing with major microfinance institutions, banks and notable entities for their health insurance requirements.

“If you are insured with our company, you don’t need to rely on traditional methods to claim. You can get hospitalized in any of our panel hospitals and experience cashless health ser-

‘WE HAVE MAJORLY BYPASSED PAPERWORK OR THE MIDDLEMAN FROM THE POLICIES… WE ARE ALSO TRYING TO ELIMINATE HUMAN INTERVENTION IN LIFE INSURANCE TRANSACTIONS AND ENCOURAGE CLIENTS TO DO ALL TRANSACTIONS DIRECTLY WITH AVAILABLE DIGITAL OPTIONS’ Faisal Shahzad Abbasi, Chief Executive Officer, TPL-Life Insurance Company Limited vices for insured benefits” he claimed.

He further claimed that the company has also introduced instant health insurance product providing reimbursement of medical expenses, while the company had also launched digital OPD solution for corporates, by the name ‘OPD Sahulat’.

One of the focal areas is the underserviced healthcare sector, and that explains the initiative to make continuous efforts to enhance customer experience and bring innovation to improvise processes and one-to-one relationship with customers.

Investment Environment

L

ife insurance business is well regulated as far as investments are concerned. Client’s money is prudently managed and invested

‘ABBASI EXPLAINED THAT TPL-LIFE INSURANCE HAS ROLLED-OUT A TRANSPARENT MECHANISM TO LIVE BY ITS PROMISES TO PAY GENUINE CLAIMS PROMPTLY, AND REVAMP ITS STRUCTURES TO ENSURE THAT AGGRIEVED POLICYHOLDER OR CLAIMANT DOES NOT GO THROUGH CUMBERSOME PROCESSES OR AVENUES FOR REDRESS’

keeping in view the guidelines issued by the regulators. Since insurance is a long-term business, majority of investments are done in long to medium term secured assets, such as government bonds, T-bills etc Replying to a question, Abbasi further said that we do not invest internationally due to local regulatory restrictions.

Technology-based future plans

T

he TPL-Life Insurance’s purported objective is to bring innovation how life insurance is perceived and serviced in the market. It is striving to introduce new product concepts, including recently-launched raft of plans including specialised cover for bikers named ‘Shehsawar’, mosquito/water shield; complete end-to-end paperless hospitalisation cover for fatal diseases dengue, typhoid, Naeglaria etc, ‘Body Guard’, and Instant life cover against accidental risks, including terrorism and a host of flexible life and health insurance solutions at affordable rates.

TPL-Life pioneering of instant scratch card concept life and health insurance backed by technology and ease of enrolment is a source of pride for the company..

“A client can go to a shop and purchase an insurance scratch card and get himself insured via single SMS ” he further elaborated; “There is no need for further documentation and acquir-

INSURANCE

ing life insurance for oneself is literally a one-minute process”.

One of the company’s most successful product is ‘Shehsawar’, costing only Rs 350. “If the client got into an accident from a motorcycle anywhere in Pakistan, the company will pay upto Rs50,000 in hospitalisation charges, and Rs500,000 if there was a casualty.”

Millions of people in Pakistan riding on motorcycles, especially in Karachi. Often we hear news of unfortunate bike accidents resulting in injuries and death. ‘Shehsawar’ was specially designed to cater to this market segment.

The Company’s CEO said, “every biker should have this card to get insured with the company especially in wet conditions and foggy weather.”

The drivers of other vehicles can acquire insurance through “Body Guard’ – the other scratch card product, also covering accidental death caused by terrorism.

For customers’ ease, these products are also available on company’s website – www.tpllife.com. “We had a great response for our online products during the last year’s ‘Big Friday campaign’, managing to sell 1600-1700 scratch cards over seven days.”

Similarly, TPL-Life has also launched scratch card to give insurance cover to individuals on medical grounds like mosquito and water borne diseases etc. The company is giving health insurance cover to indvidual for only Rs 250 for one year. In Pakistan dengue epidemic is a major public threat since 2005, following millions of people at risk, till 2016 almost 71,649 dengue cases are reported with 757 deaths.

All over the country, the TPL-Life has selected over 300 hospitals including 140 hospitals in Karachi. These hospitals are providing immediate medical cover to our clients.

He said, we have also introduced OPD facilities through digital medium for our corporate customers. Our customers can get appointments date from any doctor, get medical tests done, can have video consultation with doctors.

Regulatory reforms

T

he CEO TPL-Life Insurance Company said, “Pakistani insurance companies are working gradually towards product innovation.” He further claimed that there is a need

30

SALIENT PRODUCTS WATER SHIELD

TPL Life’s exclusive product, the first of its kind in Pakistan, helps clients in the fight against water borne diseases. These very common ailments can affect the best of us with life threatening situations.

The heavy costs associated due to hospitalisation cause financial troubles, TPL Life has launched this exclusive product that helps you during such troubling times. The company is giving insurance cover to client in Rs250 for one year.

SHEHSAWAR

The TPL Life – Shehsawar Plan is an exclusively designed Insurance Plan for the Shehsawars i.e. Motor Bikers of Pakistan and offers two – fold protection to the Shehsawar i.e. Motor biker against Death or Bodily Injuries due to a Motor Bike Accident. Cash payment of Rs. 500,000 in case of Death due to an Accident as a result of a Motor Bike Accident 50,000 in case of Hospitalization due to a Motor Bike Accident

HYPER SHIELD

Pakistan’s first coverage for mosquito and water borne diseases. TPL Life’s exclusive product, the first of its kind in Pakistan, helps you in the fight against mosquito and water borne diseases. These very common ailments can affect the best of us with life threatening situations. This product also assists you in the battle against mosquito borne diseases, which is a serious problem with potentially dangerous consequences. The heavy costs associated due to hospitalization can cause you financial troubles, TPL Life has launched this exclusive product that helps you during such troubling times.

HOSPITAL CASH ASSIST PLAN

Life is unpredictable and follows no fixed pattern where sudden Illness / Disease or Accidental bodily injuries can visit you uninvited and sometimes leave you financially hurt and highly stressed. With TPL Life – Hospital Cash Assist Plan you can be in control of situations like these. TPL Life–Hospital Cash Assist Plan guards you and your family against the trauma that you face because of increased financial burden during hospitalization. The cover provides you with fixed benefit for each day of hospitalization irrespective of the actual medical cost. Thus, provides you with complete protection & takes care of additional expenses which are other than – Hospitalization. Cash payment of Rs5,000 or Rs10,000 per day, depending on the variant, against each day of legit hospital stay.

BODYGUARD

Accidents and terrorism are unfortunately a risk that still lingers on in this country. Life is unpredictable as it is and with all these additional risks, it is imperative that one should have an assistance that safeguards one against such risks. Keeping this in perspective, TPL Life has designed TPL Life–Bodyguard Plan to help protect an entire family whatever the contingency. for swift guidelines formulation for the fast developing digital world involving financial transactions.

He said SECP and the SBP are very supportive and attentive to the developing landscape of insurance domain worldwide and specially Pakistan.

He said that the insurance sector should come forward with tech savvy

modern products like other business and it would have to work hard to remove the hardships between clients and companies. The sector should explore launching new initiatives on digital media to bring in more clarity and enhance confidence of the customers.

The regulators are supportive but we have to take initiatives to do more.

INSURANCE

Ijlal Chaudhry

Director Shezan Bakers and Confectioners

Q & A THAT UNMISTAKABLE TOUCH

Not the most highbrow or fashionable of either the bakeries or restaurants, Shezan has the kind of consistency and reliability that makes it stand out and rub shoulders with the best of the best in business 32

I

By Muhammad Faran Bukhari

n the mid 1970s, with the second constitutional amendment declaring Ahmadis non-Muslim, Chaudhry Mehrud-din switched businesses, forsaking his automobiles showrooms for the then trend-setting Shezan Restaurants and Bakeries – buying them over from a family then recently-afflicted with insecurity owing to being just declared a minority.

Despite over four decades and a half having passed, and the ‘new’ owners staunch Sunni faith, the uncalled for ‘stigma’ of being an Ahmadi business has stuck for the unscrupulous to exploit and hurt, even set to arson.

Profit sat down with Mehr-uddin’s grandson, presently running the family business as a director of the company, Ijlal Chaudhry for an insightful tete a tete regarding Shezan, and how despite many a hurdle it has prospered.

‘I CALL THE PUNJAB FOOD AUTHORITY (PFA) A BOOGEYMAN… WHENEVER THEY COME MY HEART SKIPS A BEAT. WE CURRENTLY DO NOT HAVE ANY SUCH ISSUES. THE PFA HAS GIVEN US THE ALL CLEAR STATUS SINCE ITS LAST 10 INSPECTIONS’

Profit: How did Shezan start off?

Ijlal Chaudhry: Before partition my grandfather had an automobile business, Deens Rent a Car Service, with two branches in Lahore, one at the Faletti’s Hotel and the other one at the Railway Station. Cars in those days were not a common sight, so automobile business was thought to be very prestigious. Later we branched into car showrooms as well. Up till the early 1980s, we remained in that business.

In the 1970s, Bhutto declared Ahmadis non-muslims. Shezan International, the original proprietors of Shezan Restaurants, were by faith Ahmadis. We started to wrap up our business. Two restaurants at the lower mall named Shezan Continental and Shezan Clay Oven served Pakistani and Continental food. At that time, Pakistani food wasn’t being served as at fine dining places. So seeing had huge potential, we jumped on the opportunity and bought them.

We also wanted to buy Shezan International’s factory at Lahore’s Bund Road, but with repeated assurances from the government of Pakistan, they decided to hold onto it.

Profit: Do you currently have any link with Shezan International?

IC: It was a one-time deal, so we don’t pay them any franchise fee or annual rental. The reason that our logo is so similar to that of Shezan International is because restaurants were started by them. Apart from using the name we do not share any link.

Profit: How did the Shezan bakery and confectionary business start?

IC: When we bought the restaurants, they had a small bakery inside. However, if anything is served from inside a restaurant, sales tax of 16 per cent, value added tax at one percent with special excise duty on top. So, we decided to separate the two.

At that time United bakery, Rahat Bakery and a few other family-run bakeries were in the market. In the beginning, we opened a branch in Abid Market and got a really good response. Within a year we opened a second branch in the Liberty Market, still an up and coming shopping destination at the time. After we got a good response there too, it was just one branch after another.

Starting off, we did not one think that it would turn into a chain of bakeries. However, today we have around 25 bakeries, with a couple more in the pipeline.

Q: How has the Ahmedi controversy regarding Shezan International impacted your business? Is that the reason you have the Islamic Kalma written outside all your branches?

IC: When the first riots against the Danish cartoons took place, people came and set our Mall Road branch on fire. Whenever riots occur, people specifically target our restaurants and bakeries. We have experienced it multiple times.

We even had a fatwa granted in our favour from Jamia Ashrafia that is present at all our outlets. The cleric at the Jamia asked us to prove our faith before issuing the fatwa. My family showed him the picture of my uncle’s marriage in which the clerics father was himself seen conducting the ceremony.

One should rise above religion and see that we are after all a brand that is recognized globally. We have put up the Kalma outside all our outlets, we have the fatwas present at

FOOD

all our shops, we have a very good relationship going on with Jamia Ashrafia so we cannot do much more about it.

Q: Shezan International Limited complained in a written statement that religious discrimination against its products is rampant in markets across Pakistan. “We have observed in different areas that (a) number of groups consisting of four to five people… go from shop to shop to convince and threaten (Muslim retailers that they should not) continue their business with Shezan. Have you experienced anything similar? Do you think think a competitor could have been involved?

IC: We have gotten death threats. Lots of people have suggested us to change the name of our business. I am personally against changing the name or the logo. It is very easy to get people riled up in areas that are a little away from the city center. We face lots of problems when we open branches in such areas. In Samanabad, we actually caught someone giving money to people in order to convince them to not buy anything from us.

Q: With a large number of players operating in the business, currently the market seems to be very competitive.

How do you see your competition?

IC: Shezan, Gourmet and Cakes & Bakes are currently the big three players in the market. I can name you a few other bakeries as well which came and disappeared. For example, Krisco started off but didn’t last. People think it is very easy to replicate what we are doing, but it is not. These bakeries are what I call flashes in the pan. They come, disrupt the market a little, and then they leave.

Q: What went wrong with Nirala?

IC: When you are doing business you do not waver away too much from your core competence. If my core competence is in the bakery business, I would

‘STARTING OFF, WE DID NOT ONE THINK THAT IT WOULD TURN INTO A CHAIN OF BAKERIES. HOWEVER, TODAY WE HAVE AROUND 25 BAKERIES, WITH A COUPLE MORE IN THE PIPELINE’ Ijlal Chaudhry, Director, Shezan Bakers and Confectioners not go into textile, because I don’t know the technicalities of that business. It is only when you have reached a certain level, then you can afford to invest left and right. Kind of like what Gourmet did. Even then you will not be directly involved. You will have a management team, who will manage the other businesses you wish to tap into.

Q: There have been a number of instances in the past where bakeries have been fined or sealed because of unhygienic food production or practices. What is your take on this?

IC: I call the Punjab Food Authority (PFA) a boogeyman… Whenever they come my heart skips a beat. We currently do not have any such issues.

The PFA has given us the all clear status since its last 10 inspections. We did have some issues in the beginning.

There were a few things that we were completely unaware about and hence we had to re educate ourselves.

It was a case of, your idea of cleanliness being different from my idea of cleanliness. So, we had to invest a lot of capital into our production unit to meet the criteria set by PFA. We

‘THE BAKERY INDUSTRY IS A CHANGING. EVERYTHING IS MOVING TOWARDS THE DIGITAL DOMAIN. THE CUSTOMER WANTS CONVENIENCE. SO, WE ARE ADDRESSING THIS ISSUE AND ARE WORKING ON AN APPLICATION, THROUGH WHICH THE CUSTOMERS WILL BE ABLE TO GET FOOD DELIVERED AT THEIR DOORSTEPS’ 34

didn’t fight them, but asked them to teach us what they actually want.

Q: What is the growth pattern in the industry like?

IC: The growth of some of our own products is directly related to the population while some are inversely related to the population. For example, cakes have seen a down trend, the reason being that some ladies have done courses from abroad and have started their own home-based baking and cooking businesses. So consumers are able to get good quality and personalised products from them. So, that market has become stagnant but we are trying to recoup it again.

Our problem is that the perception that people have of Shezan is that it is a boring bakery. We are trying to change that. Over the last couple of months, I sat with my chefs down and made them watch YouTube tutorials to teach them what they need to cook. It is like teaching an old dog new tricks.

Q: In the future, where do you see the industry heading to?

IC: The bakery industry is a changing. Everything is moving towards the digital domain. The customer wants convenience. So, we are addressing this issue and are working on an application, through which the customers will be able to get food delivered at their doorsteps. We are also coming up with the idea of ‘design your own cake’. It’s an interactive application that we are coming up with. Hopefully, it will be ready by the end of this year.

FOOD

A decade after the global financial crisis:

WHAT HAS (AND HASN’T) CHANGED?

By Susan Lund, Asheet Mehta, James Manyika, and Diana Goldshtein

T

he world economy has recently returned to robust growth.

But some familiar risks are creeping back, and new ones have emerged.

It all started with debt.

In the early 2000s, US real estate seemed irresistible, and a heady run-up in prices led consumers, banks, and investors alike to load up on debt.

Exotic financial instruments designed to diffuse the risks instead magnified and obscured them as they attracted investors from around the globe.

Cracks appeared in 2007 when US home prices began to decline, eventually causing the collapse of two large hedge funds loaded up with subprime mortgage securities. Yet as the summer of 2008 waned, few imagined that Lehman Brothers was about to go under— let alone that it would set off a global liquidity crisis. The damage ultimately set off the first global recession since World War II and planted the seeds of a sovereign debt crisis in the eurozone.

Millions of households lost their jobs,

36

their homes, and their savings.

The road to recovery has been a long one since those white-knuckle days of September 2008. Historically, it has taken an average of eight years to recover from debt crises, a pattern that held true in this case. The world economy has recently returned to robust growth, although the past decade of anemic and uneven growth speaks to the magnitude of the fallout.

Central banks, regulators, and policy makers were forced to take extraordinary measures after the 2008 crisis.

As a result, banks are more highly capitalized today, and less money is sloshing around the global financial system.

But some familiar risks are creeping back, and new ones have emerged. In this article, we build on a decade of research on financial markets to look at how the landscape has changed.

1. Global debt continues to grow, fueled by new borrowers 2. Households have reduced debt, but many are far from financially well 3. Banks are safer but less profitable 4. The global financial system is less interconnected—and less vulnerable to contagion 5. New risks bear watching

1

Global debt continues to grow, fueled by new borrowers

A

s the Great Recession receded, many expected to see a wave of deleveraging. But it never came.

Confounding expectations, the combined global debt of governments, nonfinancial corporations, and households has grown by $72 trillion since the end of 2007. The increase is smaller but still pronounced when measured relative to GDP. Underneath that headline number are important differences in who has borrowed and the sources and types of debt outstanding. Governments in advanced economies have borrowed heavily, as have nonfinancial companies around the world. China alone accounts for more than one-third of global debt growth since the crisis. Its total debt

has increased by more than five times over the past decade to reach $29.6 trillion by mid-2017. Its debt has gone from 145 percent of GDP in 2007, in line with other developing countries, to 256 percent in 2017. This puts China’s debt on par with that of advanced economies.

Growing government debt

P

ublic debt was mounting in many advanced economies even before 2008, and it swelled even further as the Great Recession caused a drop in tax revenues and a rise in social-welfare payments. Some countries, including China and the United States, enacted fiscal-stimulus packages, and some recapitalized their banks and critical industries. Consistent with history, a debt crisis that began in the private sector shifted to governments in the aftermath (Exhibit 1).

From 2008 to mid-2017, global government debt more than doubled, reaching $60 trillion.

Among Organisation for Economic Cooperation and Development countries, government debt now exceeds annual GDP in Japan, Greece, Italy, Portugal, Belgium, France, Spain, and the United Kingdom. Rumblings of potential sovereign defaults and anti-EU political movements have periodically strained the eurozone.

High levels of government debt set the stage for pitched battles over spending priorities well into the future.

In emerging economies, growing sovereign debt reflects the sheer scale of the investment needed to industrialize and urbanize, although some countries are also funding large public administrations and inefficient stateowned enterprises. Even so, public debt across all emerging economies is more modest, at 46 percent of GDP on average compared with 105 percent in advanced economies. Yet there are pockets of concern. Countries including Argentina, Ghana, Indonesia, Pakistan, Ukraine, and Turkey have recently come under pressure as the combination of large debts in foreign currencies and weakening local currencies becomes harder to sustain. The International Monetary Fund assesses that about 40 percent of low-income countries in sub-Saharan Africa are already in debt distress or at high risk of slipping into it.

Sri Lanka recently ceded control of the port of Hambantota to China Harbour Engineering, a large state-owned enterprise, after falling into arrears on the loan used to build the port.

ECONOMY

sive industries toward more asset-light sectors, such as health, education, technology, and media, their economic systems appear to run on ever-larger amounts of debt. In another shift, corporate lending from banks has been nearly flat since the crisis, while corporate bond issuance has soared (Exhibit 2).

The diversification of corporate funding should improve financial stability, and it reflects deepening capital markets around the world. Nonbank lenders, including private-equity funds and hedge funds, have also become major sources of credit as banks have repaired their balance sheets.

2

Corporate borrowing in the era of ultra-low interest rates

A

n extended period of historically low interest rates has enabled companies around the world to take on cheap debt. Global nonfinancial corporate debt, including bonds and loans, has more than doubled over the past decade to hit $66 trillion in mid-2017. This nearly matches the increase in government debt over the same period. In a departure from the past, two-thirds of the growth in corporate debt has come from developing countries. This poses a potential risk, particularly when that debt is in foreign currencies. Turkey’s corporate debt has doubled in the past ten years, with many loans denominated in US dollars.

Chile and Vietnam have also seen large increases in corporate borrowing.

China has been the biggest driver of this growth. From 2007 to 2017, Chinese companies added $15 trillion in debt. At 163 percent of GDP, China now has one of the highest corporate-debt ratios in the world. We have estimated that roughly a third of China’s corporate debt is related to the booming construction and real-estate sectors.

38

Households have reduced debt, but many are far from financially well

Companies in advanced economies have borrowed more as well. Although these economies are rebalancing away from manufacturing and capital-inten-

U

nsustainable household debt in advanced economies was at the core of the 2008 financial crisis.

It also made the subsequent re-

cession deeper, since households were forced to reduce consumption to pay down debt.

Mortgage debt

B

efore the crisis, rapidly rising home prices, low interest rates, and lax underwriting standards encouraged millions of Americans to take out bigger mortgages they could safely afford. From 2000 to 2007, US household debt relative to GDP rose by 28 percentage points.

Housing bubbles were not confined to the United States. Several European countries experienced similar run-ups—and similar growth in household debt. In the United Kingdom, for instance, household debt rose by 30 percentage points from 2000 to reach 93 percent of GDP. Irish household debt climbed even higher. US home prices eventually plunged back to earth starting in 2007, leaving many homeowners with mortgages that exceeded the reduced value of their homes and could not be refinanced. Defaults rose to a peak of more than 11 percent of all mortgages in 2010. The US housing collapse was soon mirrored in the most overheated European markets.

Having slogged through a painful period of repayment, foreclosures, and tighter standards for new lending, US households have reduced their debt by 19 percentage points of GDP over the past decade (Exhibit 3). But the homeownership rate has dropped from its 2007 high of 68 percent to 64 percent in 2018—and while mortgage debt has remained relatively flat, student debt and auto loans are up sharply.

Household debt is similarly down in the European countries at the core of the crisis. Irish households saw the most dramatic growth in debt but also the most dramatic decline as a share of GDP. The share of mortgages in arrears rose dramatically when home prices fell, but Ireland instituted a large-scale mortgage-restructuring program for households that were unable to meet their payments, and net new lending to households was negative for many years after the crisis. Spain’s household debt has been lowered by 21 percentage points of GDP from its peak in 2009—a drop achieved through repayments and sharp cuts in new lending. In the United Kingdom, household debt has drifted downward by just nine percentage points of GDP over the same period.

In countries such as Australia, Canada, Switzerland, and South Korea, household debt is now substantially higher than it was prior to the crisis.

Canada, which weathered the 2008 turmoil relatively well, has had a real-estate bubble of its own in recent years.

Home prices have risen sharply in its major cities, and adjustable mortgages expose home buyers to rising interest rates. Today, household debt as a share of GDP is higher in Canada than it was in the United States in 2007 .

Other types of household debt

L

ooking beyond mortgage debt, broader measures of household financial wellness remain worrying.

In the United States, 40 percent of adults surveyed by the Federal Reserve System said they would struggle to cover an unexpected expense of $400. One-quarter of nonretired adults have no pension or retirement savings. Outstanding student loans now top $1.4 trillion, exceeding credit-card debt—and unlike nearly all other forms of debt, they cannot be discharged in bankruptcy. This cycle seems likely to continue, as workers increasingly need to upgrade their skills to remain relevant. Auto loans (including subprime auto loans) have also grown rapidly in the United States. Although overall household indebtedness is lower since the crisis, many households will be vul-

nerable in future downturns.

3

Banks are safer but less profitable

After the crisis, policy makers and regulators worldwide took steps to strengthen banks against future shocks.

The Tier 1 capital ratio has risen from less than 4 percent on average for US and European banks in 2007 to more than 15 percent in 2017.1 The largest systemically important financial institutions must hold an additional capital buffer, and all banks now hold a minimum amount of liquid assets.

Scaled back risk and returns

I

n the past decade, most of the largest global banks have reduced the scale and scope of their trading activities (including proprietary trading for their own accounts), thereby lessening exposure to risk. But many banks based in advanced economies have not found profitable new business models in an era of ultra-low interest rates and new regulatory regimes.

ECONOMY

Return on equity (ROE) for banks in advanced economies has fallen by more than half since the crisis (Exhibit 4).2 The pressure has been greatest for European banks. Their average ROE over the past five years stood at 4.4 percent, compared with 7.9 percent for US banks.

Investors have a dim view of growth prospects, valuing banks at only slightly above the book value of their assets. Prior to the crisis, the price-to-book ratio of banks in advanced economies was at or just under 2.0, reflecting expectations of strong growth. But in every year since 2008, most advanced economy banks have had average price-to-book ratios of less than one (including 75 percent of EU banks, 62 percent of Japanese banks, and 86 percent of UK banks).

In some emerging economies, nonperforming loans are a drag on the banking system. In India, more than 9 percent of all loans are nonperforming.

Turkey’s recent currency depreciation could cause defaults to climb.

The best-performing banks in the post-crisis era are those that have dramatically cut operational costs even while building up risk-management and compliance staff. In general, US banks have made sharper cuts than those in Europe. But banking could become a commoditized, low-margin business unless the industry revitalizes revenue

growth. From 2012 to 2017, the industry’s annual global revenue growth averaged only 2.4 percent, considerably down from 12.3 percent in the heady pre-crisis days.

sour during the 2008 crisis and raising profitability.

4

Digital disruptions

T

raditional banks, like incumbents in every other sector, are being challenged by new digital players. Platform companies such as Alibaba, Amazon, Facebook, and Tencent threaten to take some business lines, a story that is already playing out in mobile and digital payments.

McKinsey’s Banking Practice projects that as interest rates recover and other tailwinds come into play, the banking industry’s ROE could reach 9.3 percent in 2025. But if retail and corporate customers switch their banking to digital companies at the same rate that people have adopted new technologies in the past, the industry’s ROE could fall even further.

Yet technology is not just a threat to banks. It could also provide the productivity boost they need. Many institutions are already digitizing their back-office and consumer-facing operations for efficiency. But they can also hone their use of big data, analytics, and artificial intelligence in risk modeling and underwriting—potentially avoiding the kind of bets that turned

The global financial system is less interconnected—and less vulnerable to contagion

O

ne of the biggest changes in the financial landscape is sharply curtailed international activity.

Simply put, with less money flowing across borders, the risk of a 2008-style crisis ricocheting around the world has been reduced. Since 2007, gross cross-border capital flows have fallen by half in absolute terms (Exhibit 5).

Global banks retrench

E

urozone banks have led this retreat from international activity, becoming more local and less global. Their total foreign loans and other claims have dropped by $6.1 trillion, or 38 percent, since 2007 (Exhibit 6). Nearly half of the decline reflects reduced intra-eurozone borrowing (and especially interbank lending).

Two-thirds of the assets of German banks, for instance, were outside of Germany in 2007, but that is now down to one-third.

Swiss, UK, and some US banks have reduced their international business. Globally, banks have sold more than $2 trillion of assets since the crisis.

The retrenchment of global banks reflects several factors: a reappraisal of country risk, the recognition that foreign business was often less profitable than domestic business, national policies promoting domestic lending, and new regulations on capital and liquidity.

The world’s largest global banks have also curtailed correspondent relationships with local banks in other countries, particularly developing countries. These relationships enable banks to make cross-border payments and other transactions in countries where they do not have their own branch

40

operations. These services have been essential for trade-financing flows and remittances and for giving developing countries access to key currencies.

But global banks have been applying a stricter cost-benefit analysis to these relationships, largely due to a new assessment of risks and regulatory complexity.

Some banks—notably those from Canada, China, and Japan—are expanding abroad but in different ways.

Canadian banks have moved into the United States and other markets in the Americas, as their home market is saturated. Japanese banks have stepped up syndicated lending to US companies, although as minority investors, and are growing their presence in Southeast Asia. China’s banks have ramping up lending abroad. They now have more than $1 trillion in foreign assets, up from virtually nil a decade ago. Most of China’s lending is in support of outward foreign direct investment (FDI) by Chinese companies.

Foreign direct investment is now a larger share of capital flows, a trend that promotes stability Global FDI has fallen from a peak of $3.2 trillion in 2007 to $1.6 trillion in 2017, but this drop is smaller than the decrease in cross-border lending.

It partly reflects a decline in corporations using low-tax financial centers, but it also reflects a sharp pullback in

cross-border investment in the eurozone.

However, post-crisis FDI accounts for half of cross-border capital flows, up from the average of one-quarter before the crisis. Unlike short-term lending, FDI reflects companies pur-

suing long-term strategies to expand their businesses. It is, by far, the least volatile type of capital flow.

Global imbalances between nations have declined Ben Bernanke pointed to the “global savings glut” generated by China and other countries with large current account surpluses as a factor driving interest rates lower and fueling the real-estate bubble. Because much of this capital surplus was invested in US Treasuries and other government bonds, it put downward pressure on interest rates. This led to portfolio reallocation and, ultimately, a credit bubble.

Today, this pressure has subsided—and with it, the risk that countries will be hit with crises if foreign capital suddenly pulls out.

The most striking changes are the declines in China’s current account surplus and the US deficit. China’s surplus reached 9.9 percent of GDP at its peak in 2007 but is now down to just 1.4 percent of GDP. The US deficit hit 5.9 percent of GDP in its peak at 2006 but had declined to 2.4 percent by 2017.

Large deficits in Spain and the United Kingdom have similarly eased.

Still, some imbalances remain. Germany has maintained a large surplus throughout the past decade, and some emerging markets (including Argentina

ECONOMY

and Turkey) have deficits that make them vulnerable.

5

New risks bear watching

M

any of the changes in the global financial system have been positive. Better-capitalized banks are more resilient and less exposed to global financial contagion. Volatile short-term lending across borders has been cut sharply.

The complex and opaque securitization products that led to the crisis have fallen out of favor. Yet some new risks have emerged.

Corporate-debt dangers

T

he growth of corporate debt in developing countries poses a risk, particularly as interest rates rise and when that debt is denominated in foreign currencies. If the local currency depreciates, companies might be caught in a vicious cycle that makes repaying or refinancing their debt difficult. At the time of this writing, a large decline in the Turkish lira is sending tremors through markets, leaving EU and other foreign banks exposed.

As the corporate-bond market has grown, credit quality has declined.

There has been notable growth in noninvestment-grade “junk” bonds. Even investment-grade quality has deteriorated. Of corporate bonds outstanding in the United States, 40 percent have BBB ratings, one notch above junk status. We calculate that one-quarter of corporate issuers in emerging markets are at risk of default today—and that share could rise to 40 percent if interest rates rise by 200 basis points.

Over the next five years, a record amount of corporate bonds worldwide will come due, and annual refinancing needs will hit $1.6 trillion to $2.1 trillion.

Given that interest rates are rising and some borrowers already have shaky finances, it is reasonable to expect more defaults in the years ahead.

Another development worth watching carefully is the strong growth of collateralized loan obligations. A

42

cousin of the collateralized debt obligations that were common prior to the crisis, these vehicles use loans to companies with low credit ratings as collateral.

Real-estate bubbles and mortgage risk

O

ne of the lessons of 2008 is just how difficult it is to recognize a bubble while it is inflating. Since the crisis, real-estate prices have soared to new heights in sought-after property markets, from San Francisco to Shanghai to Sydney. Unlike in 2007, however, these run-ups tend to be localized, and crashes are less likely to cause global collateral damage.

But sky-high urban housing prices are contributing to other issues, including shortages of affordable housing options, strains on household budgets, reduced mobility, and growing inequality of wealth.

In the United States, another new form of risk comes from nonbank lenders. New research shows that these lenders accounted for more than half of new US mortgage originations in 2016. While banks have tightened their underwriting standards, these lenders disproportionately serve lower-income borrowers with weaker credit scores— and their loans account for more than half of the mortgages securitized by Ginnie Mae and one-third of those securitized by Fannie Mae and Freddie Mac.

China’s rapid growth in debt

W

hile China is currently managing its debt burden, there are three areas to watch. First, roughly half of the debt of households, nonfinancial corporations, and government is associated, either directly or indirectly, with real estate. Second, local government financing vehicles have borrowed heavily to fund low-return infrastructure and social-housing projects. In 2016, 42 percent of bonds issued by local governments were to pay old debts.

This year, one of these local vehicles missed a loan payment, signaling that the central government might not bail out profligate local governments. Third, around a quarter of outstanding debt in China is provided by an opaque shadow banking system.

The combination of an overextended property sector and the unsustainable finances of local governments could eventually combust. A wave of loan defaults could damage the regular banking system and create losses for investors and companies that have put money into shadow banking vehicles.

Yet China’s government has the capacity to bail out the financial sector if default rates reach crisis levels—if it chooses to do so. Because China’s capital account has not been fully liberalized, spillovers to the global economy would likely be felt through a slowdown in China’s GDP growth rather than financial contagion.

Additional risks

T

he world is full of other unknowns. High-speed trading by algorithms can cause “flash crashes.” Over the past decade, investors have poured almost $3 trillion into passive exchange-traded products.

But their outsized popularity might create volatility and make capital markets less efficient, as there are fewer investors examining the fundamentals of companies and industries. Cryptocurrencies are growing in popularity, reaching bubble-like conditions in the case of Bitcoin, and their implications for monetary policy and financial stability is unclear. And looming over everything are heightened geopolitical tensions, with potential flash points now spanning the globe and nationalist movements questioning institutions, long-standing relationships, and the concept of free trade.

The good news is that most of the world’s pockets of debt are unlikely to pose systemic risk. If any one of these potential bubbles burst, it would cause pain for a set of investors and lenders, but none seems poised to produce a 2008-style meltdown. The likelihood of contagion has been greatly reduced by the fact that the market for complex securitizations, credit-default swaps, and the like has largely evaporated (although the growth of the collateralized-loan-obligation market is an exception to this trend).

But one thing we know from history is that the next crisis will not look like the last one. If 2008 taught us anything, it’s the importance of being vigilant when times are still good.

Courtesy: www.mckinsey.com

ECONOMY