Finance Project

How does the interest rate market operate In Pakistan? To understand the interest rate market and how it operates in Pakistan, we have to first understand what the interest rate means. Interest Rate: A rate which is charged or paid for the use of money. An interest rate is often expressed as an annual percentage of the principal. It is calculated by dividing the amount of interest by the amount of principal. Interest rates often change as a result of inflation and Federal Reserve policies. For example, if a lender (such as a bank) charges a customer RS 90 in a year on a loan of RS 1000, then the interest rate would be 90/1000 *100% = 9%. The charged or paid for the use of money are different in long term and in short term. Usually banks charge high interest rate in long terms debt as compare to short term. These long and short term rates depend on the lender and borrowers on the bases of their usage of money. But the lender is more concern while borrowing the money because he is not sure whether he will get the amount back or not and taking the risk taker. So before lending the money to any one, they will be an agreement between two parties i.e. between borrower and lender, which will assign that for how long the money will be lent and for how long period. What is the Maturity of an Interest Rate Security? One of the key features of any Interest Rate Security is its maturity. The maturity tells you when you should expect to get your principal back and how long you can expect to receive interest payments. (It is important to note that some interest rate securities issued by corporate have "call", or redemption, features that can affect the date when you’re principal is returned). Perpetual are securities without a maturity to date. Factors that determine the price of an Interest Rate Security? The price you pay for an Interest Rate Security is based on a variety of factors, such as prevailing market interest rates, credit quality, economic market of the county, maturity terms and tax status. Newly issued interest rate securities normally sell at or close to their face value. Prices of interest rate securities traded in the secondary market, however, fluctuate in response to changing interest rates. When the price of an interest rate security increases above its face value, it is said to be selling at a premium. When an interest rate security sells below face value, it is said to be selling at a discount. After having the clear view of interest rate, we might be thinking that who plays vital role in issuing the loans and how it all process works. In Pakistan, SBP(State Bank of Pakistan) is the central bank of the country and it take all the majors step regarding money. SBP can be act in many ways but regarding our project and subject we will emphasis on few of the main features of SBP.

Some of the main features of SBP: 1

Bankers' Bank The Bank also functions as the bankers’ bank. Banks are classified as scheduled and nonscheduled. The Bank maintains an updated list of all scheduled banks at its various offices. These banks are entitled to certain facilities from the State Bank and in return they have some obligations to it. State Bank provides the following three important services to the scheduled banks. a. It keeps the deposits of commercial banks, which primarily constitute the statutory reserves of scheduled banks. Scheduled banks are required to keep with the State Bank certain percentage of their demand and time liabilities. Normally, the statutory reserves are kept with the Bank free of any return. However, the Bank can offer some interest on certain fraction of these reserves. Scheduled banks also keep a certain amount of excess reserves with the Bank, which not only facilitate inter-bank payments but also provide buffer for statutory reserves in case of fluctuations in banks demand and time liabilities. b. The State Bank also provides extensive remittances facilities to banks at confessionals rate under the Remittance Facilities Scheme. This facility helps the flow of funds smoothly and efficiently between various centers in the country. The Bank provides this facility through the media of its own offices, the branches of National Bank of Pakistan acting as its agents, and treasuries and sub-treasuries holding permanent currency chests at places where the State Bank has no office. Telegraphic Transfers (T.T.), Mail Transfers (M.T.), Demand Draft (D.D.) and Government Draft (G.D.) are the principal instruments used for remittances. c. In order to streamline payments through the financial system, the Bank also manages the operations of clearing houses. In the five major cities, the functions of SBP clearing house has been handed over to a private agency namely National Institutional Facilitation Technologies Private Limited(NIFT) to the extent of sorting of payments instruments and preparing clearing schedules. Presently NIFT covers 80 percent of clearing services. However, the settlement of accounts is still undertaken at SBP. Lender of the Last Resort One of the important characteristics of a central bank is its being the lender of the last resort. The State Bank provides loan and re-discount facilities to scheduled banks in times of dire need when they find no other source of funds. These facilities are ordinarily provided by the Bank against government securities, trade bills, agriculture bill, etc. These loans are essentially short-term in nature and are advanced to enable the banks to meet their temporary requirements of funds arising out of seasonal expansion in trade, commerce, agricultural operations, and other economic activities. Advisor to Government The State Bank of Pakistan also acts as an advisor to the Government on financial and economic matters particularly with reference to their monetary aspects. The bank counsels the Government on loan operations and advises it with regard to the timings, terms and conditions and rate of return on these loans. The advice is also tendered on matters like agricultural credit, cooperative credit, industrial finance, exchange regulations, banking and credit control, mobilization of savings, 2

Financial aspects of planning and development and similar other economic issues. State Bank of Pakistan also tenders advice to the Government on debt management issues. Monetary and Fiscal Policies Coordination Board (MFPCB) The State Bank also participates in economic policy making as a member of various government agencies and committees. In order to coordinate fiscal, monetary, foreign trade and exchange rate policies. The Board is responsible for ensuring consistency among macro targets and to determine, in consultation with the Federal Government, the limits of credit to be extended to the Federal and Provincial governments and review, on a quarterly basis, Government’s borrowings in relation to pre-determined or revised targets. The Bank is required to place before the Board its assessment regarding the impact of economic policies on monetary aggregates and recommendations for fixing the safe limits of monetary expansion and Government borrowings. In carrying out its assigned functions of coordinating fiscal, monetary and exchange rate policies and for ensuring consistency among macroeconomic targets of growth, inflation, fiscal, monetary and external accounts, the Coordination Board shall not take any measure that would adversely affect the autonomy of the State Bank of Pakistan as provided in the SBP Act. Inflation and interest rate: Central Banks around the world tend to focus on core inflation that excludes the impact of food and energy prices. Core inflation basically represents policy-induced inflation, be it fiscal, monetary or exchange rate. The persistence of relatively high core inflation compelled the State Bank of Pakistan (SBP) to change its monetary policy stance from ‘accommodative’ to ‘neutral’ to aggressive tightening. Money supply theory suggests that central banks can influence the rate of inflation by changing the rate of growth of the money supply through monetary policy instruments. An increase in interest rates, in turn, reduces demand for housing, consumer durables and investment goods and in principle, brings down inflation. The converse should have the opposite effect. The real world, however, is more complicated. The velocity of money, for example, tends to vary in ways that are not always easy to explain. Also, the money stock is not always amenable to central bank control, in particular, for an open economy. To overcome the shortcomings of monetary targeting, starting in the late 1980s, many countries with flexible exchange rates initially industrial, and later, emerging market countries began to adopt inflation targeting. Today, more than 40 countries aim at achieving low and stable inflation, but only 18 of them are classified as fully-fledged inflation targets with clear and credible commitments to an inflation target. The influence of interest on prices is not immediate as it acts via a complex transmission mechanism (i.e. a convoluted pipeline of economic variables), so that time elapses between the implementation of monetary policy and its expression in the price level. Monetary policy must take the lag in its effect into account, i.e. it must anticipate the trend of inflation in the future and act appropriately in the present. In other words, it must take the lead in attaining the target, not simply react to actual inflation. As per SBP, the impact of its monetary policy measures since 2005 has proved to be robust in containing inflation and that there is a clear need to continue the tight monetary 3

policy in view of persisting pressure on core inflation. SBP will continue to monitor inflationary pressures and if needed, may consider further tightening of the monetary policy to achieve price stability and ensure continued sustainable economic growth. To reduce inflationary pressures in the economy what SBP wants do is to change key interest rates including a further rise in the discount rate. The SBP increased the discount rate by 150 basis points in April 2005 to 9.0 percent and as a result of this increase weighted average lending rate has also increased from 6.78 per cent in April 2005 to 9.53 per cent in December 2005 - a rise of 275 basis points. Any further increase in the lending rate will also increase the cost of capital, thus pushing further inflationary pressures in the economy. This may also lead to default in consumer and other loans as they are on floating rate basis. The SBP will have to ensure easy credit to consumers and investors. At the same time it will have to ensure that inflation does not rise further due to its tight monetary policy. The main player that affect the intrest rate market KIBOR (Karachi inter-bank offered rate). KIBOR as a reference rate had been finalized by a group of senior bankers. Initially KIBOR of one-month; three-month and six-month would be used as a benchmark for all corporate lending in the local currency. The banks had agreed on extending the KIBOR tenures to one year by March 31, 2004 and then to three years by December 31, 2004 for using it to price corporate loans of similar tenures. "The main purpose of this plan is to introduce some uniformity in corporate lending rates". Suggestions: •

First, we believe that business is primarily the domain of private individuals and groups. Thus we have to significantly expand the space available to the private sector in running the economy of the country.

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Second, the role of the government is that of a regulator and umpire. It must not engage in any economic activity directly. It is not the business of the government to engage in business.

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Third, markets should be left alone to determine price and output decisions. Interventions are justified only in the case of market failure or when the vulnerable groups of the society are being affected by major swings in market conditions.

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Fourth, external trade would be the main engine of growth, particularly in the emerging world trade regime exemplified by the WTO. Accordingly, our industry has to reorient to be competitive in the world market.

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Fifth, Pakistan would move toward greater openness and integration with the world markets and as such foreign investment will not only be provided a level playing field but would be given the necessary guarantees for its protection.

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Sixth, poverty is a major challenge our society is facing. The government not only has to play an active role in combating this problem, but the entire focus of economic planning would be redirected toward poverty alleviation. However, we believe that growth will be the primary instrument to achieve this goal.

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Finally, let me add the dimension of governance, which no one has addressed in the past. Besides devolution, reforms in civil services, tax administration, judiciary and police are all aimed at reconstructing the nearly demolished institutions of governance so that the state regains its efficiency and capacity to positively influence the lives of its citizens.

The following banks which we have selected for our project are:  Bank Al-Falah  United Bank Limited  National Bank of Pakistan  Prime commercial Bank Limited

Bank Al-Falah Bank Alfalah Limited was incorporated on June 21st, 1997 as a public limited company under the Companies Ordinance 1984. Its banking operations commenced from November 1st ,1997. The bank is engaged in commercial banking and related services as defined in the Banking companies ordinance, 1962. The Bank is currently operating through 104 branches in 36 cities. Chairman’s Messeage “Our core philosophy of honesty, transparency in customer dealing, product innovation, excellence in customer service and our commitment to being as responsible corporate citizen .”

Interest rates of last 5yrs: 2000/2001 9.5%(same in both yrs)

2002 9.5% no HF

2003 9.5%(cars) no HF 5

2004 9.5%(cars) 8.5% (revised)

2005 12.9% till june 12.5%(HF)

The following interest rate charge on leasing 1) House financing 2) Auto financing 3) Loan

House financing: House financing is a policy offered by bank- al falah in year 2004.Its a short term loan only for building new houses , renovations etc. The mark up charge on house financing is 12.5% and its duration is only one yr. They do not offer more than 1 yr. Car financing: Cars have become necessities these days and people want to have their own car that is why bank offers car leasing facility and they charge 12.5% for 3 yrs and 14.5 % for 5 yrs. They cannot lease the cars without insurance so they give the insurance facility. It varies from 4.25%, 4.50% and 5.0% on actual car price. The down payment of car leasing is 10% that is fixed for any brand of car. Installment Calculator Through this calculator we can calculate the car financing and we have taken this calculator from bank alfalah’s site (www.bankalfalah.com)

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Car Price Rs Minimum Down Payment Rs Down Payment Rs OR % Financing Period Mode of Payment Insurance Loan amount Your Monthly installment without Insurance is : 6,230 Rs Complete Installment Plan with Insurance Car Name Total Price Down Payment Alfalah's Participation Tenure Insurance Plan Markup Installment

: SUZUKI MEHRAN VX Non-Metalic : 315,000 : 31,500 : 283,500 : 5 Year : Insurance @ 4.25 % : 11.9% : 6,230 Rs

Down Payment Processing Charges Advanced First Month installment First Years Insurance Premium Registration charges Total Payable

31,500 4,000 7,234 13,388 0 56,122

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Year Number of Number Installments

Installment In Rupees

Insurance In Rupees

Net payable In Rupees

1

11

6,230

1,004

7,234

2

12

6,230

904

7,134

3

12

6,230

813

7,043

4

12

6,230

732

6,962

5

12

6,230

0

6,230

Extra information Mark up charge for all customers and account holders of bank alfalah are same. They are charging mark up for ALTO.CULTUS AND LIANA is 12% for 3yes and 14% for 5 yrs.

United Bank Limited UBL has assets of over Rs. 300 billion and a solid track record of fourty six years - in addition to the convenience of over 1000 branches serving you throughout the country and also at several overseas locations. United Bank Limited is one of the largest commercial bank in the country. With almost forty six years of good standing to its valued clients, it has stood the test of time, producing assets of over Rs. 300 billion. We offer our services through a wide network of over 1000 domestic branches ll over Pakistan and 15 verseas branches s part of global network. The following interest rate charge on leasing  UBL drive  UBL address  UBL personal loan

UBL drive UBL Drive is a unique auto financing product which offers you features, options and flexibility unmatched by any other bank, because at UBL, You come first. They deal in new cars and used cars and you can make your installments by yourself. They do charge markup on cars: 8

3yrs ------------- 12.5% 5yrs-------------- 12.9% 7yrs--------------13.5% UBL address: You have always dreamt of having a permanent address. Now you can turn your dreams into reality with UBL Address - the unique offering that makes you the owner of your home while remaining within your limited income. They charge fixed rate on 20yrs and they are charging different rates according to the duration of loan. 5yrs------------11.25% 7yrs------------13.60% 9yrs------------14.50% UBL personal loan Personal loans mean loans for small businesses etc 3yrs------------9.5% 5yrs------------11.55% 7yrs-------------13.45% National Bank of Pakistan: National Bank of Pakistan maintains its position as Pakistan's premier bank determined to set higher standards of achievements. It is the major business partner for the Government of Pakistan with special emphasis on fostering Pakistan's economic growth through aggressive and balanced lending policies, technologically oriented products and services offered through its large network of branches locally, internationally and representative offices. Overseas Branches

Domestic Branches

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16 Overseas Branches 4 Representative Offices 1 Subsidiary 1 Joint Venture

29 Regional Offices 1,189 Branches 130 Online Branches 4 Subsidiaries

 NBP home finance National Bank of Pakistan (NBP) has announced the launch of a housing scheme to cover all sections of the society with monthly income starting from as low as Rs. 5000/- per month*. *(Conditions apply) Branded as 'NBP Saibaan' (Housing for all), the scheme offers a maximum loan of Rs 10 million in accordance with the debt burden criterion. Loans are available for Home Construction, Home Purchase and Home Improvement. For Home Improvement Loans the maximum amount is Rs. 2.00 Million. Home Construction and Home Purchase loans can be repaid over a period of 20 years, whereas the repayment period for Home Improvement loan is 15 years.

Prime Commercial Bank limited: 10

Prime Bank is the vision of a group of Pakistani professionals with extensive domestic and international banking and finance experience. Prime Bank came into existence on September 30, 1991 with presence in all the stock exchanges of the Pakistan. Some of the foreign investors belong to a highly regarded, very sizeable and well-diversified business group of Saudi Arabia During the initial years, Prime Bank’s strategy was focused on continuing improvement of internal procedures and operating structures, to ensure a greater control over the quality of its operations. After initial consolidation Bank has and continues to focus on expansion, through catering the needs of different segments of the country and by extending its branch network. Commercial Banking activities were initiated at the time of inception. During 1993, two more business divisions i.e. Corporate Banking and Financial Services were added. By 1996, Prime Bank’s countrywide network of seventeen Branches was in place. Under the Bank’s on going branch expansion program thirty-two new branches have been added during the years 2001, 2002, 2003 and 2004 while thirteen more branches were opened during 2005. This raised the total number of branches to sixty-two focusing primarily on the middle market commercial banking segment, consumer banking initiatives as well as agricultural, housing, financing of small and medium sized enterprise and Islamic banking. Total Assets of Prime Bank during the period from December 1992 to December 2005 have grown at an annual compound rate of about 23 percent to Rs. 53.8 billion. Within this period, Shareholders’ Equity grew from Rs.371 million to Rs. 3.4 billion, Deposits to Rs. 38.9 billion and Advances (net) to Rs. 25.5 billion. Profit before tax grew from Rs. 40.6 million to Rs. 765 million for the year ended 31st December 2005. After fourteen years of well controlled, yet sure and successful operations, the Bank is now poised to move forward rapidly to be at the cutting edge of financial services combining highly efficient delivery systems with continuous product innovation. Therefore, development of superior Human Skills and the latest Information Technology platform are the cornerstones of Prime Bank’s overall strategy to be in the exclusive club of winning banks of the future. Branch network: A growing nationwide network of 63 branches.

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Features: • • • •

Financing from 300,000/- upto 40,000,000/Markup as low as 12.50% Balance Transfer Facility (BTF) available as low as 11.50 % Tenure from 3 years to 20years

Markup Rates Base Rate

SBP Discount rate +1%

Home Purchase / 12.50% Renovation Home Construction 15.00%

Features: • • • • • • • • •

Financing from Rs 10,000/- to Rs 500,000/No down payment No processing charges No hidden cost No insurance cost Free doorstep delivery Quick approval Monthly installment as per your convenience (12, 18, 24 & 36 months) 5% BONUS on timely payment. (For LG Products only)*

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