Summ

er
2009
Institute of Business
Administration

Fazeel Sarwar
Fahd Masood
Saad Khan
Fawwad Haider

[MONEY MARKETS IN
PAKISTAN]
An insight to the low risk wholesale market in Pakistan
Introduction
The money market is a wholesale market for low risk, highly liquid, short-term debt instruments.
It serves as an avenue through which banks and financial institutions can offload their excess
liquidity or meet their short-term funding requirements. To the government an organized money
market represents a means for it to implement its monetary policies in a more efficient manner.
Moreover, it provides it with a liquid market for securities through which it can finance its own
borrowing requirements.

Trading in the money market only began in Pakistan in February 1991 with the switchover of the
Government from on-tap to auction system. As per the previous system interest rates on T-Bills
were fixed at 6% and anyone could buy as many of the securities as one liked through this on-tap
system.

The money market of Pakistan consists of the following submarkets:

• State Bank of Pakistan

• Inter-bank Market

• Bills Market

• Commercial Paper

• Certificates of Deposits

Although these are the main submarkets, the boundaries between the capital and the money
markets are blurred due to non-development of the secondary market in the country.
State Bank of Pakistan
According to the State Bank of Pakistan Act 1956, the main aim is to "regulate the monetary and
credit system of Pakistan and to foster its growth in the best national interest with a view to
securing monetary stability and fuller utilization of the country’s productive resources". This
requirement is fulfilled by the bank by maintaining stability in the interest rates and Forex rates.
Maintenance of the stability is carried by SBP by intervening in these two markets and taking
steps to keep the rates at a certain level.

The Monetary Policy

The primary objective of monetary policy is to control inflation through interest rate and
exchange rate management. Interest rate and exchange rate are the most important channels of
monetary transmission mechanism through which monetary policy actions affect inflation and
output in the economy. In interest rate channel, a rise in interest rate tends to decrease the
aggregate demand which, in turn, recedes inflationary pressures thus results in a tight monetary
policy stance. Exchange rate channel affects the general price level directly through changes in
imported inputs and output prices and indirectly through aggregate demand by changing the
pattern of spending in the economy. Implementation of the monetary policy is one of the core
functions of the SBP and it is the driving force of the money market in Pakistan.

The monetary policy is made by the Central Board of the SBP is comprised of the governor, a
bureaucrat from the ministry of finance, and seven directors, one from each province, nominated
by the federal government who represent agriculture, banking and industrial sectors.
In this report, our main focus would be on the maintenance of stability in the interest rates.
Following are the tools/instruments that SBP has in order to achieve it:

Cash Reserve Requirement (CRR)

CRR is defined as the requirement imposed by the SBP on the commercial banks to keep a
defined percentage of their demand liabilities in their SBP account as cash. Currently, the CRR is
about 5% on an average. The CRR is monitored every week on Friday and if it is found to be
below 5%, the bank has to pay a penalty. During the week, the CRR must not fall below 4% and
if it does, the bank then also has to pay a penalty.

Statutory Liquidity Requirement (SLR)

Commercial banks are required to keep some fraction of their assets in the form of cash,
Treasury Bills (T-Bills) or other approved securities. This fraction is called Statutory Liquidity
Ratio. Its main objective is to ensure that banks have sufficient funds in the form of liquid assets.
Currently this ratio (excluding Cash Reserve Requirement) is 15% of time and demand
liabilities.

Discount Rate
Discount rate is the rate at which the SBP lends to the commercial banks for their overnight
requirements. This rate is used for the Repo transaction mainly carried out by commercial banks
for their requirements. The current discount rate stands at around 11%. SBP can change the rate
as and when needed. There has been a downward trend in the repo rate as it has fallen from 15%
to 11% in a span of 2 years. Following are the repo rates as on 31st July 2009:

Open Market Operation (OMO)

OMO is a tool used by SBP to either inject money into the market during a liquidity crunch or to
withdraw money when there is excess liquidity. If there is a liquidity crunch in the market and
funds are trading close to the discount rate, the SBP is likely to intervene by injecting funds
through either a scheduled OMO or a special OMO which would eventually be expected to bring
about a slide in the rates through its effect on the demand and supply situation prevailing in the
market. Likewise, if there is surplus liquidity in the market, or if the SBP has its own borrowing
requirement, it may borrow funds from the commercial banks through an OMO thereby having
the opposite effect on market rates. OMOs are regularly conducted every alternate Thursday
whereas a special OMO can be announced any time during the week as and when the need arises.
The tenors for which funds can be injected through an OMO are usually 1 week, two weeks and
one month. On the other hand, funds are normally picked up in an OMO for 1-month, 3 months,
5 months or sale of T-Bills (the latter being a little less than six months). The reason for the sale
tenor not being exactly equal to six months is the fact that the SBP here floats a T-Bill that has
already been issued to it by the Ministry of Finance against the latter’s own borrowing from the
central bank.
Inter-bank Market
The inter-bank market of Pakistan contributes somewhat to the secondary money market. The
securities that are issued by the government are traded among the banks in the interbank market
and there are different type of transactions are carried out. The main purpose of the inter-bank
market is for the banks to fulfill their short-term liquidity requirements. If the banks have a
surplus amount to their reserve requirement, they lend and if they are short of the reserve
requirement, they borrow. Brokers have a very important role to play in the inter-bank money
market as they act as a medium among the banks and brokers are the ones through which the
inter-bank deals go through. The leading brokers include BMA, JS and Alfalah.

Call Market
The Call market allows banks to lend or borrow funds up to their credit limits without any
collateral. The credit limit is based upon the amount of reserve requirement of an individual
bank, and consequently on its assets. The participants in the call market are commercial banks
and Development Finance Institutions (DFI’s) such as Micro Finance Banks etc.

Each bank has a trading desk which handles the banks interests in the money market. Banks
usually deal in the call market to bridge the difference between their deposits and loans. Banks
are required to hold an adequate amount of liquid assets, such as cash, to manage any potential
withdrawals from clients. However, if a bank can't meet these liquidity requirements, it will need
to borrow money in the interbank market to cover the shortfall. Some banks, on the other hand,
have excess liquid assets above and beyond the liquidity requirements. These banks will lend
money in the interbank market, receiving interest on the assets.
The borrowing and lending is based on interbank interest rates, such as the KIBOR, which is set
daily based on the average rates on loans made within the Karachi interbank market. Following
is the KIBOR rate as on 31st July 2009

http://sbp.org.pk/ecodata/kibor/2009/Jul/kibor-31-Jul-09.pdf
Repo Transaction
Repos are basically a means of raising funds by selling government approved securities at a fixed
rate, with the intention of repurchasing them at a specified future date. For the party selling the
security (borrower of funds) the transaction is referred to as a repo whereas for the party
purchasing it (lender of funds), the transaction is referred to as a reverse repo. Funds transacted
through repos do not fall under the category of demand and time liabilities and therefore 5% cash
reserve is not required for them. Presently this type of transaction is the most common among
financial institutions because of its flexibility, simplicity and security of principal. The following
table shows the Repo rates as on 31st July 2009.

% ON 1W 2W 1M 2M 3M 4M 5M 6M 1Y
Bid 13.00 11.50 11.25 11.50 11.50 11.45 11.40 11.40 11.40 11.50
Offer 13.50 12.50 11.60 11.70 11.70 11.70 11.65 11.65 11.65 11.55

http://www.bmatoday.com/fi.asp?cdte=7/24/2009

Security lending/borrowing
If a bank is falling short of securities it may either lend funds by entering into a reverse repo or it
may simply borrow them from another bank under a securities lending agreement. In such a
transaction the borrower of securities borrows funds in call from another bank and then lends to
the same bank in repo at a spread, which becomes the cost of securities. For instance, if a bank
falls short of securities it might borrow T-bills from another bank for a certain period and this
follows a call transaction which constitutes to this borrowing/lending process.
Bills Market

Market Treasury Bills (MTBs)

MTBs are basically short-term securities issued by the SBP as collateral for borrowing money on
behalf of the government. The tenors of these bills are 3 months, 6 months and 12 months and
are issued at a discount with a par value of Rs 100. MTBs are injected into the market by the
SBP through an auction or an open market operation. The auction takes place every alternate
Wednesday. The auction is announced two days before as a tender notice in Newspapers and on
Reuters. Sealed bids are submitted by the participants a day before and a report is generated
through the computer which is opened on the auction day at 11.30 AM and result is published as
a Press Release, which states the face value and discounted value of amount offered and accepted
along with accepted cut-point and weighted average yields. The participants of the bid include 10
banks that are authorized by the SBP as primary dealers:

• HBL
• MCB
• NIB
• CITI
• STANDARD CHARTERED
• NBP
• UBL
• RBS
• PAKOMAN
• JS BANK
Following is a snap-shot of the Treasury bill auctions conducted and their results in the year
2009:

http://www.sbp.org.pk/reports/quarterly/fy09/third/Money-Banking.pdf

It is seen that in recent times, the 12-month tenor is mostly accepted MTB and then the 2nd most
accepted is the 6-month T-bill. This all depends on what bids the SBP receives and also on what
is the monetary policy stance and how the future liquidity scenario is to be brought forward. The
recent increase in 12-month tenor bids reflected that the market anticipated a cut in the policy
rate and the banks incorporated it into their bids well before the monetary policy statement
issued by the SBP.

http://www.sbp.org.pk/reports/quarterly/fy09/third/Money-Banking.pdf
http://www.sbp.org.pk/reports/quarterly/fy09/third/Money-Banking.pdf
Conclusion
According to what we have found out, there is a lot of growth prospect in the money market of
Pakistan. It is regulated by the SBP in an extremely effective manner and no one is allowed to go
out of the way in terms of the regulations that have been imposed. Currently, the country is on its
way to an economic recovery and the conditions have started to improve. As a result of this, the
money market mechanism is also coming back to its stabilization phase. An evidence of this is
the reduction of the policy rate to 14% in the last monetary policy statement. However, there are
a lot of things that need to be restructured in the money market of Pakistan. There is a perception
that people tend to merge the money market instruments with the capital market instruments.
This surprisingly includes the leading banks of our country as the capital market traders are
sitting at the money market desk which is not appropriate. The SBP should take actions in order
to draw a clear line between the capital and the money markets.