Betting on service - An interview with Shaukat Tarin, Director, Silkbank Limited

In his conversation with BR Research Tarin touches his plans to expand Silkbank, the returns he eyes and how he intends to leverage on his strengths in the consumer assets segment. Tarin also shares his views on Pakistan's macro economic situation, the turnaround of public sector entities and the taxation system. Below are edited transcripts of the conversation.
BR Research: You did a great job at deposit mobilization while you were at HBL in the 90s, can we expect something similar now?
Shaukat Tarin: Definitely, we are coming up with products that are innovative. The problem is that our deposit base is highly skewed towards costly time deposits. Therefore, we are introducing unique and innovative customer centric products to increase our current and saving account deposit base.
Our motto here is that we need to differentiate ourselves on service, because nobody else can replicate consistent service quality. After HBL, other banks also created Crorepati schemes that were quite successful. But, when we created a service culture at Union Bank, not many institutions could match our service delivery.
We are striving hard to create a similar culture at Silkbank. We are putting in a lot of resources to help change the mindset of our employees in the way they serve customers, reduce problem occurrence and ensure a quick and timely resolution.
BRR: What kind of innovation can Silkbank offer?
ST: There is no magic wand; we are working in many different areas to re-engineer and improve processes.
On the liabilities side, we have to establish ourselves as a bank that provides excellent service. Our cost of doing business has to come down. Our cost of funds will not be as low as that of the large commercial banks, but we aim at bringing our average cost of funds down to below 6 percent from the existing 8 percent.
On the asset side, we need to mobilize consumer lending. Others are afraid of doing that right now, but we know how to do it. We've done it at Citibank and Union, so we are confident we can do it here as well. We can improve our yield on the asset side by 2 or 3 percent on the entire book, together with reduction in the NPLs.
These initiatives will take us to a 5 percent spread. Then we also have to work on our intermediation costs; they cannot be more than 200-250 basis points, because I'm left with nothing to play with if my intermediation costs are any higher. As we go along, our 4-5 year strategy is to improve our spread by making sure our yield on assets continues to increase.
BRR: What are you focusing on to achieve higher spreads?
ST: Our focus is to improve the CASA ratio which has now gone up to 35-40 percent. We want to take this up to 60-70 percent in the next couple of years. That's one front. Our cost of funds has already dropped by nearly 1 percent during this year. And we would like to drop our costs by another 1 to 1.5 percent in the next year.
On the assets side, as we liquidate our non-performing loans, and introduce new products in consumer and SME segments, our asset yield will enhance by another 1 to 1.5 percent.
So, overall we are looking at about 3 to 3.5 percent growth in yield in 12-18 months, which in my opinion is not bad, considering where we started.
My objective is to achieve a net spread of about 5 percent in 3 years, if by that time we haven't gone through a merger or an acquisition. On top of that we expect about 1 percent through other income. That combined should enable us to create a 20 to 25 percent return on equity.
BRR: Is Silkbank looking to merge or acquire another bank?
ST: It is early days right now. We are not looking at potential partners at this point. First stage for us is to become profitable. And our target is to report profits next year.
Once we are profitable, scaling up the balance sheet will be our next priority, not only organically but also through a merger or acquisition of another bank. If it is a smaller bank, we could acquire it but if it is a larger bank then we would merge.
BRR: How will you be better than other banks that saw a lot of bad assets in the current economic crisis?
ST: Local banks lost because they were not prepared; those that were prepared did well. But no one can deny the fact that all over the world, 60-70 percent of a bank's assets are in the consumer segment. So we can't be much different. After all, we have 170 million people who are potential consumer loan customers.
We believe we know this market and we also know that bankers are shy of advancing loans to the consumer market. So we will cherry pick the best customers and provide them with products that they need and an unmatched level of service.
BRR: Any specific products?
ST: We are going to do personal loans, credit cards, and home equity loans.
BRR: Is home equity the same as mortgage finance?
ST: Home equity is overdraft against a property. It's a product well suited for small business owners looking for financing. We will start there and as inflation eases off and interest rates come down, we will develop products for mortgage finance as well.
BRR: Rental yields are too low, is that the reason why mortgage financing doesn't pick up in Pakistan?
ST: Yes, if mortgage rates go beyond 12 percent, it ceases to remain a business proposition and people prefer to pay rent. But, if the difference between the rent and mortgage payment is minimal, the mortgage option will make more sense.
BRR: Commercial banks are used to collateral based lending, how are SMEs going to get funding, most of them are too small to have any collateral?
ST: It's gotten even worse now that the State Bank requires banks to write off 60 percent of bad loans from the SME sector if it is not paid within 90 days. This rule was implemented during Dr. Akhtar's tenure and I feel it needs to be removed if banks are to lend to small businesses.
I believe that before this rule was changed, banks had started lending to SMEs. My own sense is that banks will revert to lending to SMEs once the rules of the game are rationalised.
All over the world, governments play an instrumental role in supporting the SMEs. When I was the Finance Minister, we announced credit enhancement incentives and venture capital in the budget to support this segment.
BRR: DFIs are a dying business in Pakistan whereas banks are focussing on short term deposits. How can long term infrastructural financing be generated in this environment?
ST: DFIs should not be dying businesses. We set up Joint Venture Investment Banks to fulfil this role, but unfortunately they have become commercial banks when they should have focused on creating a bond market. They were supposed to finance long term projects and to do that, they needed a bond market.
What to do now? I planned two organizations for infrastructure funding while I was Finance Minister. They are still on the drawing board like so many other projects. They just need to be pushed through by the government.
BRR: What do you feel the scope is for private equity and venture capital in Pakistan?
ST: We need to pass the Corporate Rehabilitation Act (CRA) quickly. Once this law is approved, we can set up a Resolution Trust Corporation to consolidate our industry. This will propel the private sector to follow suit.
As of right now, there are no incentives that the government offers to the private sector. As Finance Minster, I had proposed the creation of two funds in the budget of Rs2.5 billion each for SME Capital & Credit Support, with the recommendation that this number should be doubled every year. However, the last budget was silent on both accounts.
BRR: What is your view on the banking industry's consolidation and how many banks do you think should there be in Pakistan?
ST: It's a moot point. I don't agree with those who say there should only be 10 banks, like Malaysia. The number of banks can be more, if they can find a market.
Moreover, we should not have MCR. We should have capital adequacy ratios that are risk weighted. The central bank can start assigning higher CARs to different institutions. Mergers will happen, because larger banks have a clear advantage in cost of funds and the smaller banks will be unable to compete.
BRR: Could small banks cater to niche markets where large banks aren't as focussed?
ST: If they want to survive with their current size, they have to specialize. If they are conducting businesses that are primarily off balance sheet then they can survive. But if they come into mainstream banking then they have to deal with the cost of funds.
BRR: What is the sustainable size for a bank in the medium term?
ST: A Rs200 billion balance sheet and 150 plus branches.
BRR: Your view on the public private partnerships for public sector entities?
ST: I am of the firm belief that public sector entities are national assets. So strategic privatisation which gives management control to the private sector is what I am in favour of.
But then, who is going to do it. The ministries have their own vested interests and they want to use them for various purposes. So my plan was that the cabinet committee should appoint directors who would in turn appoint competent management.
In three years time, 26 percent of the company would be sold after cleaning up the balance sheets and operations. Thus, the country could retain about three quarters of the assets and future generations could benefit.
Now, I believe even that would not work. We need to have a holding company, similar to Malaysia's Khazana, which brings together all the public sector corporations under one umbrella, even the profitable ones. It should have a private sector board with a limited mandate to turn these companies around, make strategic sales to the private sector and self--destruct in three years. It should report directly to the Prime Minister's office.
BRR: How do you think the current economic problems can be fixed from a policy perspective?
ST: We need to have a well thought out economic plan, like the nine point agenda we proposed for an equitable and sustainable economic growth in the country. To start with, everybody has to pay taxes.
We need to raise the tax-to-GDP ratio to 15 percent in 5 years and 20 percent in 10 years. Then we have to cut our expenses and losses in public sector companies. This will give us the financial space to spend on development of the social sectors such as poverty reduction, education & health. This will also improve agriculture, manufacturing as well as energy sectors. The surplus will also allow us to support, infrastructure, capital markets and administration. There are no shortcuts.
The other challenge is that we have to now develop long term funding for the economy. We had laid the ground work for the development of a long term bond market for the country. The State Bank can play an instrumental role, where it can guarantee some of these bonds which will become benchmarks. Then people will be able to use them to fund long term assets, such as 30-year mortgages.
If long-term borrowing rates are brought down to 8 to 10 percent by SBP, banks will be able to provide competitive mortgages to people and you will see a dynamic change. Other countries have employed this model as well, such as Cagamas of Malaysia and Fannie Mae and Freddie Mac of the US.
BRR: What is your view on the latest developments on taxation?
ST: RGST is a step in the right direction. It broadens the tax net. More importantly, we have to increase the tax coverage to include people who are currently not paying taxes.
Measures such as the flood tax are squeezing the same pool of people. I don't see why agriculture is still exempt, by just saying that it's a provincial tax. Provinces are run by the same political parties, so it is only a matter of implementation, the laws are already there. There are two taxes, one based on production index and second on income. Why is it that the provinces are not collecting taxes? Not collecting tax on agriculture means 65 percent of the population and 22 percent of the GDP is not paying any taxes.
Then, you move on to the service sector, which is 55 percent of the GDP and contributes only 18 percent to tax revenue. So 37 percent of the service sector is not paying taxes. That is a huge area for improvement, where both collection and coverage can be enhanced.
Stock market investors are now being taxed on capital gains; I think real estate transactions should also be brought into this fold. During my tenure, we introduced CVT on real estate and I argued that it was a regressive tax. Now that NFC has been signed, we can make taxation on real estate transactions progressive and tax capital gains.
Finally, all the taxes are being collected at the federal level and the provinces only collect 0.7 percent of GDP in taxes. With the new NFC, it is imperative that the provinces improve on their tax collection as well.
Profile: Shaukat Tarin
A business graduate, who majored in finance, Tarin started his career in 1975 with Citibank, with which he had almost 22 years of association, both locally and internationally. He also served at leading positions at renowned banks in the country such as Habib Bank, Union Bank (later sold to Standard Chartered Bank) and Saudi Pak Commercial Bank. Tarin has also been the Chairman of Pakistan Banks Association and Chairman of the Karachi Stock Exchange
Tarin had also been instrumental in various governmental positions, having served as the Finance Minister in 2009-2010. One of his noteworthy achievements was the successful consensus on the 7th National Finance Commission Award. He was awarded then Sitara-e-Imtiaz and Quaid-e-Azam, Gold Medal Award for his services.
Tarin currently serves as a Director of Silkbank Limited.