Investment Banking

Dr. Tariq Hassan

Mr. Rashid Mansur
Distinguished guests
Ladies and Gentlemen
Assalam Aleikum
I am pleased to be here today at this luncheon hosted by the Investment Banks
Association of Pakistan . I would begin by appreciating the IBAP for providing an
effective platform for investment banks to address their collective issues and
participate in the industry reform process. I would particularly appreciate the
Association for arranging such informal gatherings which allow us to openly
share our views and concerns .
Investment banking is an important pillar of the financial sector and particularly
the NBFC regime in Pakistan . It took its roots in 1987, however, its still at a
nascent stage. Today, investment banks in Pakistan are providing a full array of
capital market products and advisory services to their clients. The industry is
comprised of a variety of companies which are actively and efficiently serving
institutional, corporate, government as well as individual clients.
Subsequent to the transfer of regulatory authority over investment banks from
SBP to SECP in December 2002 , and promulgation of the NBFC Rules, the SECP
has undertaken a two pronged approach. One is to liquidate the investment
banks which were in financial trouble and the other is to develop and strengthen
the existing ones into healthy NBFCs. Currently there are 13 investment banks
among which only 9 are licenced ; the remaining are in liquidation proceedings.
Within the NBFC sector, investment banking is at the higher end in terms of the
specialized services they provide, particularly the capital market product and
advisory services.
Due to the inherent design of the NBFC Rules, the investment banks have
strengthened their balance sheets by obtaining leasing and other licences
allowed to NBFCs under NBFC Rules. This has allowed them to move a step
ahead in terms of risk diversification as they are able to operate as multiple
product entities. Some of the leasing companies have also followed and obtained
investment banking licences. Such product diversification helped these NBFCs to
not only increase their spreads but have given them a higher capability of risk
diversification. These are compact, highly innovative, financial institutions which
now, through the NBFC Rules, have the power to change their operating plans
with changes in market dynamics.

Speech delivered as Chief Guest at the lunch hosted by Investment Banks Association of Pakistan in Lahore on 21 Decem ber
2005.

Chairman, Securities and Exchange Commission of Pakistan; SJD/LL.M., Harvard Law School.

There is still, however, a pressing need to promptly improve the financial health
and performance of NBFCs. The development of the sector is critical to enhance
domestic resource mobilization and to foster competition in the financial sector.
A number of Asian countries, including India, Sri Lanka and Bangladesh have
achieved rapid savings growth outside the banking system by developing the
NBFC sector.
In Pakistan, this sector faces severe competition from commercial banks,
development finance institutions (DFIs), brokerage firms, introduction of Islamic
banking services and accountancy firms offering corporate financial services. The
commercial banks with availability of low cost funds and strong balance sheets
and brokerage firms indulging in underwriting and capital market advisory
activities make the NBFCs environment difficult; the sector is calling for a
paradigm shift to embrace the universal licensing regime. Despite the
competition, NBFCs have immense importance in the economy and they meet
the credit gap in the borrowing profile.
In order to further strengthen the sector, particularly in the face of this
competition, the SEC P would like to move towards integ ration through instituting
a Universal Non-banking regime. This will include a universal license, under
which the NBFCs can undertake all the activities allowed to them simultaneously
without the need for applying for separate licences. In case if one activity is
being concentrated , the NBFC will have the choice to decide for obtaining one
s ingle-activity based licence. Capital requirements for such a universal nonbanking licence are currently being worked out.
Significant benefits that would emanate for NBFCs from this model are:

Economies of Scale:

Bankers regularly argue that 'Bigger is better' and usually point to

economies of scale as a major reason. Exploitation of scale economies can
save costs in overhead, back office operations, information technology,
and investment banking-type operations.

Economies of Scope:

Economies of scope arise in multi-product firms because costs of offering

various activities by different units are greater than the costs when they
are offered under one roof. Cost economies can derive from access to
information, management of the client relationship, distribution and
marketing economies, reputational and pecuniary capital economies, and
risk management.
Economies on the consumer side include the potential for lower search,
information, monitoring, and transaction costs; the potential to negotiate
better deals; and the potential for lower product price in a competitive
market.

Absolute Size and Market Power:

Universal banks are able to extract economic rents from the market by
application of market power. Banks can obtain more information about
firms through the various products the banks offer and potentially can
develop a longer-term relationship.

Risk Diversification:

There are potential risk-reduction gains fro m diversification in universal

financial service organizations, and these gains increase with the number
of activities undertaken. Additionally, diversification provides stable
income streams and spreads credit risk across various functions. It also
has th e potential benefit of cross selling leading to higher revenues.
However, these benefits are accompanied by various challenges which include
the impact of failure of a large institution on the economy; bureaucratic and
inflexibility in procedures; conflicts of interest; deployment of capital; and from
the regulatory point of view, monitoring and supervision.
Ladies and Gentlemen:
With this move towards Universal Non-banking, the SECP would also like to see
various industry associations merge into one single NBFC Association. I have, on
various occasions, urged the individual associations to work out the modalities
for this since it will enhance the ir capacity in terms of resources for technical
expertise and research. I hope that the new office bearers of the Investment
Banks Association will bring new vitality to the organization.
I would take this opportunity to reiterate the three essential ethical principles for
investment banks:
Integrity: Whether you are offering an investment opportunity or providing a
helping hand in project financing, it is quite necessary that you should remain
honest to your clients. Quoting a higher than the actual rate of return or not
disclosing all the hidden service charges not only breaches the mutual trust but
may also harm investor confidence, the very crucial factor in the whole business
cycle. Therefore, the Investment Banks, while appreciating their due importance
in the economy, should not only profess to be honest with their clients but also
demonstrate due honesty and integrity.
Prudent Person Rule: Prudent Person Rule requires that a person acting on
behalf of its clients should act in the same manner as he would act in his own
case. As financial intermediaries and as entities operating discretionary and nondiscretionary investment accounts for their clients, it is the utmost responsibility
of investment banks to ensure that in their financial dealings, the interests of
their clients are not compromised. They should make all the endeavours to earn
the maximum return for their depositors and on the converse, minimize cost for
their borrowers and companies seeking financial advisory.
Avoiding Conflict of Interest: Major Investment Banks are part of big
conglomerate groups and, as such, it is imperative for them to ensure that while
their clients repose their trust and confidence in them, they should not act in any
such way that may prejudice their clients interests in favour of their own groups

interests. This can only be achieved if investment banks keep themselves at

arms length from financial interests of their parent group. Several regulatory
measures, including restriction on investment in connected persons, also aim for
the same objective.
Before concluding, I would urge the NBFC sector to develop a strong compliance
culture. Transparency of compliance with regulation is necessary to succeed.
They must go beyond the technical rules to develop voluntary standards of
ethics and compliance that go further than current law to protect the industrys
reputation and avoid any appearance of conflicts of interest.
I would also urge the sector to prepare a supportive human resource
development plan to identify new skill requirements for an enhanced competitive
international financial services market. It is not just within the NBFC sector, but
also in comparison to commercial banks that investment banks are at the higher
end due to their involvement in capital market mobilization. The human resource
plan should therefore be adequately supported by Codes of Ethics and Conduct
and Fit and Proper Tests.
The SECP is of the view that a well developed NBF C sector is an important
component of developing a broad, efficient financial system and, consequently,
of providing a sound base for economic growth and prosperity. The sector as a
whole, and particularly the investment banking sector, needs to be more
innovative in the development of products and activities . You need to move
beyond what the commercial banks are involved in develop your own niche; I
assure you that the SECP would fully support initiatives for the development of
the market and provide the necessary regulatory framework for it.
Thank you.