Introduction
An efficient financial system is assential for facilitating economic transactions and contributing to growth and stability of the economy. By achieving and sustaining macro-economic stability and by building better rule-based supervisory and regulatory systems, government can lay the foundations for smoothly functioning financial system.

Pakistan, like other developing countries, has been implementing financial sector reform as part of the overall economic liberalization programme since 1990 with a view to improving the effectiveness of monetary policy, by making a shift from the direct to indirect monetary control and greater reliance on market forces. The main financial liberalization policies were aimed at liberalizing interest rates, reducing control on credit, enhancing competition and efficiency in the financial system, and strengthening the supervisory framework of the State Bank.

Prior to undertaking financial sector reforms the hallmark of Pakistan's financial sector has been the direct controls on interest rates movements, domestic credit controls (bank specific credit ceilings and selective credit allocations), high reserve requirements, segmented financial markets, the absence of well-developed money and securities markets, underdeveloped banking system, and commercial banks serving as captive institutions. In particular, the policies of imposing ceilings on interest rates accompanied by directed and rationed allocation of credit to "priority" sectors at low interest rates had led to widespread "financial repression" in Pakistan. These policies were seen to impede financial 'deepening' which, in turn, had weaken an important set of impulses to foster economic growth.

Pakistan began to implement financial sector reforms at the end of 1989 with aims to (i) removing distortions and segmentation of the financial markets by creating a homogeneous market for government debt instruments in which all individuals and institutions could participate; (ii) switching from an administered interest rate setting to market based interest rate determination by initiating a regular auction programme of government debt; (iii) allocating credit in response to market forces by gradually eliminating the directed credit schemes and abolishing the subsidized credit schemes; (iv) creating and encouraging the development of secondary market for government securities which is absolutely essential for the success of auction programme of government debt; (v) strengthening the health and competitiveness of the banking system by re-capitalizing and restructuring the nationalized commercial banks, increasing their autonomy and accountability and allowing private banks to enter the market; and (vi) improving prudential regulations and supervision of all financial institutions.

Substantial progress has been made during 1990s in implementing banking sector reforms by conducting monetary policy with market-based instruments, liberalizing interest rates, restoring financial discipline through prudent lending, enhancing SBP's authority in banking regulation and supervision, by improving the capital base and management of the nationalized commercial banks, by stemming the hemorrhage caused by politically motivated lending and operating losses by reducing over staffing and excessive numbers of branches in the NCBs and DFIs through staff separation and branch closures policy, by improving transparency through better prudential regulations and financial disclosure standards.

Credit Plan, 1999-2000
Credit Plan for the fiscal year 1999-2000 envisaged monetary expansion at 9.4 percent (Rs 121.0 billion) with Net Domestic Assets (NDA) and Net Foreign Assets (NFA) of the banking system to grow by Rs 109 billion and Rs 12 billion respectively. Government sector was projected to realize a retirement of Rs 15.0 billion on account of net budgetary borrowings. Credit to the private sector and PSCEs was targeted to increase by Rs 104.5 billion after anticipated placement of Rupee equivalent of PSCEs, rescheduled foreign debt of Rs 14.5 billion.

Monetary and Credit Development
Monetary expansion during July-March 1999-2000 was recorded at 3.2 percent (Rs 40.5 billion), compared with 3.5 percent (Rs 42.1 billion) in the same period last year. Net Domestic Credit (NDA) of the banking system expanded by Rs 29.3 billion (2.2 percent), compared with an increase of Rs 11.8 billion (0.9 percent) recorded last year. Net foreign assets (NFA) of the banking system increased by Rs 11.2 billion, compared with a larger flow of Rs 30.3 billion during the same period last year. The increase in NDA mainly resulted from net credit expansion to the private sector, including PSCEs and rising government budgetary borrowings.

The Government budgetary borrowings from the banking system increased by Rs 72.8 billion on the gross basis. However, after they were adjusted for Rs 48.7 billion placed in special-debt retirement account, net budgetary borrowing showed a rise of Rs 24.1 billion, against a retirement of Rs 45.3 billion in the same period last year. Higher net bank borrowing appeared to have arisen on the back of lower payments into the Special Account with SBP, rather than due to an increase in gross borrowing for the period. The lower retirement appears to be in line with the lower quantum of external debt rescheduling applicable for the current fiscal year, compared to last year. Credit to government for financing its commodity operations registered a retirement of Rs 17.9 billion, compared with a retirement of 14.4 billion in the corresponding period last year.

Bank credit to private sector including PSCEs increased by Rs 36.9 billion during the first nine months of the current fiscal year as against a credit expansion of Rs 70.6 billion in the comparable period of last year. While, credit to PSCEs showed an increase of Rs 7.5 billion compared with Rs 1.9 billion in the same period last year the private sector credit expanded by Rs 34.7 billion as against a credit expansion of Rs 68.8 billion in the comparable period of last year.

A number of factors were responsible for the weak off-take by the private sector. Firstly, the collapse in domestic prices of cotton has translated into a substantially reduced credit requirement for this sector as a whole. According to industry sources, a significant portion of purchases of raw cotton was deferred by textile units till December, 1999 in order to take full advantage of the price collapse. Secondly, as a result of low inflation, the overall credit requirement has remained low. Thirdly the commercial banks were also playing safe and were over-cautious in extending loan to the private sector. Other factors included imposition of margin restriction effective from October 14, 1999 on all import letters of credit except for certain essential items to save foreign exchange (the margin requirement was however, withdrawn with effect from October 28, 1999), higher turnover of repayments to commercial banks, lower unit values of exports in case of major export commodities depressing the demand for credit under export finance scheme etc.

Credit to autonomous bodies showed a retirement of Rs 11.2 billion against an increase of Rs 3.0 billion in the corresponding period last year. Other Items (net) of the banking system also exerted an expansionary impact of Rs 0.3 billion during July-March 1999-2000, compared with an expansion of Rs 1.0 billion in the same period last year. Causative factors of money supply (M2), during July-March 1999-2000 are given in Table 6.1.

(Rs. billion)

* Includes Rs 5.0 billion for restructuring of WAPDA
Source: State Bank of Pakistan

Components of Monetary Assets(M2)
The components of monetary assets (M2) are: (i) currency in circulation, (ii) demand deposits, (iii) time deposits, (iv) other deposits (excluding IMF A/C, counterpart), and (V) residents' foreign currency deposits.

i) Currency in Circulation:
Currency in circulation being the most liquid form of money supply have direct relation with price behaviour in an economy. During the 80s, annual average increase in currency in circulation was 15.5 percent which declined to 10.8 percent during 1990-99. Comparatively lower economic growth in the 1990s may have a direct link to lower flow of currency in circulation as compared to the 1980s. In July-March 1999-2000, currency in circulation increased by 18.9 percent (Rs 54.3 billion), as against 15.3 percent (Rs 41.8 billion) in the same period last year. As on 31st March 2000, currency in circulation constituted 25.9 percent of money supply, compared to its share of 25.2 percent in the comparable period of last year (Table 6.2).

Source: State Bank of Pakistan
a) Excluding inter-bank deposits, deposits of government and foreign constituents.
b) Excluding IMF A/C No. 1 & 2 and SAF Loan Account, Counterpart Funds and Deposit of foreign governments, central banks, international organizations and deposits of money banks.
Note: Figures in parentheses represnt growth.

ii) Demand deposits with scheduled banks
The scheduled bank's demand deposits increased by an annual average of 13.3 percent in the 90s, compared to 13.7 percent in the 1980s. In 1998-99, there was a un-precedented increase of Rs 148.1 billion in demand deposits. This may be attributed to the huge withdrawal from the FCA (Rs 158 billion) and converting part of them into demand deposits. During the first nine months of the current fiscal year, demand deposits grew by 9.4 percent (Rs 32.9 billion) as compared to an increase of 46.9 percent (Rs 94.2 billion) in the same period last year. The relatively slower growth in demand deposits can be attributed to base effect (because it is measured from a very large base) and some deposits flowing into the stock markets. The outstanding stock of demand deposits was Rs 382 billion as on end March 2000, representing 28.9 percent of the M2 stock. On the corresponding date of last year the demand deposits constituted 23.6 percent of M2.

iii) Time Deposits:
The time deposits of the scheduled banks increased by an annual average rate of 23.4 percent during 1990-99, as compared to 10.9 percent in the 80s. Time deposits showing a growth of 15.5 percent in 1998-99 declined by 0.4 percent in the first nine months of the current fiscal year, mainly due to the closing of various lottery schemes. Notwithstanding the decline in the growth of time deposits, its share in M2 was 39 percent as on March 31, 2000 as against 38.4 percent in the corresponding date of last year.

iv) Residents' Foreign Currency Deposits (RFCD)
This scheme was introduced in February 1991. Within a span of 7 years, i.e; from 1991-92 to 1997-98, it became the most important component of money supply (M2). However, as a result of freezing of the RFCD in May 1998, a large scale conversion into local currency had taken place. The conversion continued in 1999-2000. During the first nine months of the current year, net conversion worth Rs 45 billion from this scheme has taken place as against Rs 127.6 billion in the first nine months of 1998-99.

While there is no standard method to measure financial deepening, the most widely used indicator is the ratio of M2 to GNP. This ratio indicates, how monetized is the economy and how important role its banks are playing in mobilizing deposits. This ratio has increased significantly over the years - rising from 36.5 percent in the 1980s to 42.4 percent in the first half and 44.3 percent in the second half of the 1990s. Other indicators of financial deepening such as the ratio of total deposits to M2 and the time deposits to M2 have all registered an impressive increase after the financial sector reforms. During the 1980s, the total deposits was 64.5 percent of M2 which increased to 65.7 percent in the first half and 76.3 percent in the second half of the 1990s. Furthermore, time deposits as percentage of M2 increased from 31.4 percent in the 1980s to 36 percent in the end June 1995 and further to 39.0 percent in the end March 2000. Total demand and time deposits was 54.7 percent of M2 in 1990-91 which increased to 60.6 percent in June 1995 and further to 67.9 percent in March 2000. This suggests that the financial sector reform over the last one decade has led to the financial deepening in the banking system.

Measures of Money Supply and their Behaviour
The annual trends of M1, M2 and M3 since June, 1991 to June, 1999 and upto March 2000 are given in Table 6.3 (see under).

During the first nine months of 1999-2000, M1 has increased by 13.4 percent (Rs 86.5 billion), as against an increase of 28.6 percent (Rs 137.6 billion) in the comparable period last year. On the other hand, M2 has recorded a growth of 3.2 percent during the period under review, compared to its growth of 3.5 percent last year, while M3 has increased by 5.9 percent as compared to 10.6 percent in the same period last year. Higher growth in M3 during 1998-99 and first nine months of the current fiscal year was due to increase in the net accrual of National Saving schemes. The main components of M3 are; outstanding stock of M2, outstanding deposits of the national saving schemes (NSS), outstanding deposits of National Development Finance Corporation (NDFC) and deposits of Federal Banks for Cooperatives. M3 is dominated primarily by M2 and deposits of the NSS. Since 1994-95, the share of NSS has been rising and became the main instrument of higher M3 growth. In June 1995, the shares of M2, NSS, and other two organizations (NDFC and Co-operative Bank) to M3 were 76.1 percent, 23.6 percent, and 0.3 percent respectively which have changed to 64.9 percent, 35.0 percent and a negligible 0.1 percent in March 2000, giving more weight to the NSS.

Source: State Bank of Pakistan & E.A. Wing, Ministry of Finance.
@ As from 23rd February, 1991 the Resident Foreign Currency Deposits are treated as part of Monetary Assets knocking them off as foreign liability.
* Cover the period of July-March.

Monetary Policy
A number of important steps have been taken during 1999-2000 to improve working of the money and banking sector and investment environment, including drastic reduction in lending rates by the leading commercial banks, downward adjustment of repo rate by the SBP and reduction in the deposit rates on national saving schemes. Various monetary and credit control measures taken during the current financial year are given in the box. 6.1.

BOX 6.1
Credit Control and other Measures, 1999-2000
i). The State Bank amended its Export Finance Scheme and effective from January 1, 1999 small and medium exporters and indirect exporters were made eligible for financing under the scheme. Further, the banks were instructed to keep charges for opening of Inland Letter of Credit (ILCs) at the minimum.

ii). The State Bank reduced Statutory Liquidity Requirements (SLRs) of banks from 15.0 percent to 13.0 percent and Cash Reserve Requirements from 5.0 percent to 3.5 percent on May 19, 1999. The liquidity ratio maintained by the NBFIs was also reduced from 14.0 percent to 12.0 percent with effect from May 26, 1999 in anticipation of rapid withdrawals from frozen FCAs following the unification of exchange rate regime. Having achieved the desired results, it was decided in July, 1999 to revert back to the requirements operative before May, 1999. Accordingly, effective from 12th July, 1999 the statutory cash reserve requirement was raised from 3.5 percent of their demand and time liabilities to 5 percent on weekly average basis subject to a minimum of 4 percent. The statutory liquidity ratio (SLR) of banks was also raised from 13 percent to 15 percent. The SLR of NBFIs was also raised from 12 percent to 14 percent.

iii). Banks and financial institutions were allowed to introduce viable new products to regain some of the outflows in the shape of withdrawals from frozen FCAs. In the process, some of the banks introduced lottery schemes which attracted criticism from various quarters. Accordingly, the State Bank decided on 13th July, 1999 to close down these schemes by 31st December, 1999.

iv) On 13th August, 1999, amendment was made in Export Finance Scheme to give option to the direct exporter either to establish an Inland Letter of Credit (ILC) in favour of the Indirect Exporter/Issue a Standardized Purchase Order (SPO) or make payment through cheques. The Indirect Exporter would, however, be able to have access to the Export Finance Scheme only if an ILC is established or SPO is issued by the Direct Exporter.

v) Effective from 14th October 1999 all import letters of credit were made subject to a minimum cash margin of 10 percent for industrial raw material, 20 percent for machinery of all kinds & their spare parts and 35 percent for all other goods. However, cash margin requirement was not applicable to essential imports. The minimum margin requirement for opening letters of credit for industrial raw materials was withdrawn with effect from October 28, 1999 and for machinery, all kinds and their spare parts w.e.f. 1st November, 1999.

vi). Investment banks including NBFIs were restricted to undertake repo transactions with scheduled banks against their holding of Government securities since June 26, 1996. It was decided on November 10, 1999 to withdraw these restrictions, effective from 15th November, 1999.

vii). The State Bank allowed banks and NBFIs with effect from 20th October and 27th October, 1999 respectively, to provide financing facilities against the shares of listed companies subject to a minimum margin of 50 percent for banks and 30 percent for NBFIs of their average market value of the preceding 12 months.

viii). With a view to bringing operational improvements in the money market, it was decided that with effect from 30th November, 1999 banks/NBFIs would enter into Master Repo agreement with their counter part before entering into repo transactions.

ix.) Effective from January 5, 2000, the annual rate of return on SBP financing facility to banks for meeting their temporary liquidity shortages and SBP 3-Day Repo facility against Government of Pakistan Market Treasury Bills and Federal Investment Bonds was reduced from 13 percent to 11 percent.

x). Banks and DFIs were directed on February 2, 2000 to strictly observe certain rules while making any donations/contributions for charitable, social, educational or public welfare purposes.

xi). Banks were required since September, 1996 to obtain prior clearance in writing from the State Bank before they grant on financing facility (whether fund-based or non-fund based) to Modaraba. However, effective from February 15, 2000, the above restriction does not apply as long as banks extend financing facility to Modarabas with a credit rating of at least B-3.

xii). On February 23, 2000, the SBP announced new rules for operating the Cash Management Accounts (CMA) by the investment banks. The investment bank would deploy the funds accepted in approved activities under these rules, acting as an agent of the customer.


Auction of Government Securities Eversince the introduction of open market operation (OMO) in 1990-91, the sales and purchases of Government securities have been increasing with the passage of time. In 1990-91, two instruments namely; Treasury Bills (TBs) and Federal Investment Bonds (FIBs) were introduced. The amount offered during 1990-91 was Rs 88.5 billion out of which Rs 65.6 billion was accepted.Short-Term Federal Bonds were introduced in 1996-97.

The Short-Term Federal Bonds (STFBs) with six month maturity were replaced by six month Government of Pakistan's Market Treasury Bills (MRTBs) w.e.f. 25th June, 1998 and their first auction was settled on 26th June, 1998. In addition, two more instruments viz 3-months (90 days) and 12 months (365 days), Government of Pakistan Market Treasury Bills were introduced, and their first auction was held on 13th July, 1998. The annual sales of government securities is given in Table 6.4.

Source: State Bank of Pakistan

During 1998-99, Rs 774.7 billion were offered for sale in the market. Of which, Rs 227.6 billion were accepted representing 29.4 percent of the offered money. Nineteen auctions of Market Treasury Bills were conducted during July 1999 to March 2000. Announced target for treasury bills of all maturities combined during this period was Rs 174.7 billion. Combined amount offered by participants was Rs 381.6 billion out of which Rs 118.2 billion were accepted. Weighted average yield on six months treasury bills came down from 10.25 percent prevailing in September, 1999 to 7.44 percent in March 2000. Reduction in yield was made possible by a combination of various actions including: (i) reduction in SBP Repo Rate from 14.0 percent to 11.0; (ii) frequent injection of funds in money market through short-term reverse repos under-taken in the open market operations of the SBP; (iii) acceptance of lower amounts in auctions to keep the money market comfortably liquid; and (iv) keeping auctions of Federal Investment Bonds (FIBs) suspended so as not to lock-up surplus funds of money market for long term.

Reforms and Development of Primary Market
Various steps were taken in the first half of 1999-2000 to strengthen the Primary market of treasury bills. Maturity periods were made more flexible in July, 1999 for three, six and twelve months market treasury bills by removing the rigidity of exact days. A fixed schedule of auctions was introduced in September, 1999 to ensure transparency and regularity for investors.

To increase the future volume of sales in auctions and remove the mismatch between dates of forthcoming auction settlements and repayment of treasury bills, maturity period has been specified as 84 days for three months, 182 days for six months and 364 days for twelve months. Tender Notice for Auctions containing necessary information are also being put on Reuter's pages besides being published in newspapers. Auction results are now released on the same day.

Reforms and Development of Secondary Market
Various steps were taken during July 1999 - March 2000 to strengthen and deepen the secondary market of government securities, specially treasury bills and FIBs. Active trading was witnessed in the inter-bank market of treasury bills as well as inter-bank market of FIBs. With the lowering of Treasury Bills yields, trading of FIBs continued to take place with sizeable premium, which brought down their effective yields to well below their fixed coupon rates. With the removal of restrictions in November, 1999 on repo transactions against government securities on NBFIs secondary market also strengthened, besides opening a channel for NBFIs to obtain funds from inter-bank money market.

The open market operations were conducted judiciously by the State Bank of Pakistan to keep the flow of monetary aggregates within targets, induce the commercial banks to extend credit to private sector, and keep the short term interest rates to the desired levels. Twenty-five open market operations were conducted during July 1999 - March 2000, out of which seventeen were two-way operations inviting simultaneous quotes for sale as well as purchases. A total of Rs 63.6 billion was mopped up through outright sales and repos of various tenors in one-way operations. To keep the money market liquid, specially during the second quarter i.e. October-December, 1999, a total of Rs 116.8 billion was injected through reverse repos of one months, two weeks or seven days maturities. Timely injection of short term funds kept the market comfortably liquid besides allaying the fears of banks about Y2K problem.

Interest Rate Structure
The advance rates in Pakistan were very high, compared with other regional countries. In June 1999, weighted average lending rate in Pakistan was 14.8 percent while it was 5.4 percent in Australia, 5.9 percent in China, 12 percent in India and 14 percent in Bangladesh. The higher lending rates is detrimental to a vibrant and promising private sector. In Pakistan, higher lending rates was one of the factors behind the emergence of a mounting debt and default culture, in the 1990s. Huge loan defaults have adversely affected profitability of the banks and availability of credit to the small but efficient investors and entrepreneurs. Due to delinquent loans and mis-management, mainly as a result of higher cost of lending, huge pre-tax losses were incurred by five major domestic banks, namely; National Bank Ltd., Habib Bank Ltd., United Bank Ltd., Muslim Commercial Bank Ltd. and Allied Bank Ltd. between 1996 and 1998, as against their pre-tax profit of about Rs 14.0 billion between 1993 to 1995. Their non-performing advances have increased by about Rs 30 billion between 1996-98. Downward adjustment of lending rates was therefore, necessary to improve the performance of the financial sector by removing the distortion and reviving the investors confidence.

Source: State Bank of Pakistan.

A number of steps were taken in the recent past to bring down the lending rates and increasing the flow of credit to the private sector at lower cost. This was also necessary due to persistent decline in the inflation rate since 1997-98. The low inflationary environment has been incorporated into the lending rate structure of commercial banks. Lending rates have fallen since early 1998-99 but have not matched the fall in inflation rates due to higher intermediation costs in the NCBs and the privatized banks, which includes provisioning for non-performing loans (NPLs) and burden of over staffing.

The State Bank of Pakistan lowered its repo rate twice during 1998-99 and 1999-2000. The repo rate was reduced from 14 percent in May 1999 to 11 percent in January 2000. As a follow up the five major banks also announced reduction in their lending rates by an average of 1.5 to 2.0 percentage points first in April, 1999 and again in January, 2000. Therefore, the monthly weighted average rate of return on advances (overall) declined to 14.4 percent in December, 1999 from 14.8 percent in June, 1999. The weighted average rate of return of Market Treasury Bills has also come down from 13.0 percent in June 1999 to 9.4 percent in March 2000 and further to 7.6 percent in May 2000.

To judge the effectiveness of the prevailing lending and deposit rates what is important is to look at the real rate and not the nominal rate. A higher real lending rate may increase the profitability of the banks and other financial institutions but it may be detrimental to the investment promotion activities. On the other hand, the higher real deposit rate should encourage mobilisation of deposits. Between June 1995 to December 2000 the weighted average nominal lending rate averaged 14.6 percent while the weighted average real lending rate averaged 5.8 percent. It may be noted that the real weighted average lending rate increased substantially during the last five and a half years - rising from 0.7 percent in June 1995 to 11.0 percent in December 1999. While nominal lending rate exhibited a rising trend during June 1995 to June 1998 it has declined thereafter; but the real lending rate on the other hand has registered a sharp increase over the periods, mainly due to declining inflation rate since 1997-98. The weighted average nominal deposit rate has remained, more or less, unchnged at around 8.2 percent since June 1995. The weighted average real deposit rate remained negative until June 1997 and it turned positive thereafter, mainly due to declining inflation rate.

Performance of Banks
There are 45 banks operating in the country, of which, 25 are domestic while 20 are foreign banks. Among 25 domestic banks, there are 4 nationalized banks, 2 privatized banks, 4 specialized banks and 15 private banks.

In 1994-95 total assets/liabilities of domestic and foreign banks were Rs 1647.6 billion, including Rs 1309.8 billion or 79.5 percent for domestic banks and Rs 337.8 billion or 20.5 percent for foreign banks. By 1998-99 these ratios changed to 84 percent for the domestic banks and 16 percent for the foreign banks, indicating that both assets and liabilities of the domestic banks have increased more than that of foreign banks. Between 1994-95 to 1998-99 branches of domestic banks have declined from 8326 to 7973 (a net decline of 353 branches), while during the same period foreign banks branches have increased from 74 to 85 (Table 6.6).

Source: State Bank of Pakistan

Total assets of all banks increased by 7.2 percent to Rs 1704.2 billion as of March 31, 2000, compared to Rs 1589.6 billion in the preceding year. Total deposits of all banks increased by 3.6 percent from Rs 1032.3 billion at the end March, 1999 to Rs 1069.5 billion at end March, 2000. Borrowing remained the major source of funds of specialized banks, which financed over 72 percent of their total assets as of 31st December, 1999. Total advances of all banks have increased by 10.4 percent from Rs 674.6 billion as of March 1999 to Rs 744.6 billion as of March 2000. Total investments by banks registered a decline of 16.0 percent from Rs 372.3 billion as of March, 1999 to Rs 312.6 billion as of March 2000 mainly due to decrease in return on Government Securities as well as reduction in Statutory Liquidity Requirement by the State Bank of Pakistan (Table 6.7).

*: pertains to end June, 1999.
Source: State Bank of Pakistan

The overall return on advances and investment of banks depicted a decrease from 13.5 percent in 1998 to 12.9 percent in 1999 as a result of the SBP and Government's endeavor to reduce lending rates of banks so as to encourage invest-ment in the country.

The profitability of banks showed significant improvement during 1999. In absolute terms, the profit (after tax) increased from Rs 1.5 billion in 1998 to Rs.9.3 billion in 1999. The major increase in profit was attributed to specialized banks where loss of Rs 6.2 billion (after tax) was converted into profit (after-tax) of Rs 1.4 billion. The overall average cost of deposits and borrowings decreased from 8.4 percent in 1998 to 7.6 percent in 1999. The corresponding overall average cost of advances and investments declined from 13.5 percent in 1998 to 12.9 percent in 1999. This resulted in the increase of average spread to 5.3 percent in 1999 from 5.1 percent in 1998.

The NCBs and privatized banks continued to close their loss making branches keeping in view the requirement of reducing unnecessary expenditure and loss to the banking institutions. The banks have so far closed 788 branches/booths under the branch rationalization programme including 103 branches/booths closed during the year ended 1999. The request of private commercial banks for opening of new branches are, however, considered in the light of the parameters laid down in the branch licensing policy in force. These bank's opened seven branches and closed four branches during 1999. A foreign bank namely Trust Bank Limited has been merged with Metropolitan Bank Limited through an Amalgamation Order issued in February 2000. At present there are 7961 branches of scheduled banks functioning in the country.

Privatization
The role of State Bank of Pakistan in privatization of financial institutions is of advisory capacity. However, so far Bankers Equity Limited (BEL), Habib Credit and Exchange Bank (Bank Al Falah), Muslim Commercial Bank Limited (MCB), and Allied bank Limited (ABL) have been privatized while process has been initiated for early privatization of other NCBs and Public Sector Development Finance Institutions (DFIs). The First Women Bank Limited (FWBL) has also been privatized but its sale was subject to conditionalities laid down vide an interim order passed by the Lahore High Court in writ petition filed by Women Action Forum. The said writ petition is still pending adjudication in the Lahore High Court.

Non-Performing Loans and Recovery
The non-performing loans (NPL) are defined as loans overdue by at least 90 days. No interest/mark up is accrued on non-performing loans. Total NPL of all commercial banks amounted to Rs 173.4 billion as on 31st December, 1999, compared to Rs 151.8 billion in December, 1998 indicating an increase of 14.2 percent during the year. The share of nationalized/privatized banks in total NPL of the banking industry was 59.4 percent as on December 31, 1999 compared to 74.6 percent as on December 31, 1998, while their share in total advances of banking industry was 56.0 percent and 58.2 percent, respectively. The HBL was the major victim as its NPL amounted to Rs 42.1 billion as on 31st December, 1999 constituting 24.3 percent of total NPL of the banking industry. The NPL of private banks grew at a rapid rate of 99.8 percent to Rs 14.1 billion followed by specialized banks at 99.6 percent to Rs 48.1 billion.

Cash recovery to NPL of the banking industry improved from 11.1 percent in 1998 to 16.5 percent in 1999. Out of total loan defaults of all commercial banks amounting to Rs 185.2 billion as of 12th October, 1999, total cash recovery upto 15th March, 2000 amounted to Rs 12.0 billion.

Small Loan Scheme
To arrange equitable distribution of bank credit among various sectors of the economy with particular regard to the needs of the sectors neglected in the past, a Small Loans Scheme was prepared. The scheme came into force from December, 1972. Initially arrangements were made that the National Credit Consultative Council will fix specific targets for the small loan to be achieved by the banking sector. However, this system was discontinued in June, 1995 and now banks are free to extend credit in this sector according to their own lending policies. Under the Scheme two type of loans are provided. Loans and advances, including bills purchased and discounted given by any bank for business purposes, not exceeding Rs 300,000/- per borrower, including those to dependent member of his family would be treated as "Small Loan". Loans and advances given to industrial units, including cottage industries, which have fixed assets (excluding land and buildings), the original value of which did not exceed Rs 20 million would be treated as "Small Loan".

The losses incurred by the banks on account of loans and advances, including bills purchased and discounted under the said scheme carry guarantee from SBP and 50 percent of any bonafide loss (principal amount only) which a bank has proved to the satisfaction of SBP, to have incurred in any transaction of loans and advances, are reimbursed to the banks.

Total disbursement and outstanding posi-tion of loans provided under this scheme as on December 1999 was Rs 4.5 billion and Rs 15.0 billion respectively.