from 49. 1 % in 1997 to 55. 6 % in 2005 and deposit to gdp ratio – an indicator of the level of financial savings – from 38. 7 % in 1997 to 43. 1 % in 2005. more significantly, equity market capitalization grew from merely 10. 3 % of gdp in 2000 to 37. 1 % of gdp in 2006. equity markets benefited from sizeable growth in banks and their performance. now banks constitute almost 25 % of market cap at karachi stock exchange and valuation of their shares is quite high with commercial banks ’ p / e ratio of around 10x in december 2006. despite significant improvement in financial indicators, relative to its regional comparators, pakistan ’ s financial market has a relatively lower depth and penetration ( see para. 24 below ). moreover, pakistan ’ s financial system continues to be predominantly bank based with the bond markets barely constituting 5 - 7 % of gdp and the low pension and insurance coverage. profitability and financial soundness of banks is impressive and pakistan ’ s performance indicators in this area are amongst the best in its regional peers. the profits of commercial banks crossed over $ 1 billion for the first three quarters of calendar year ( cy ) 2006. over cy2000 - september 2006, return on assets of banks rose from negative 0. 2 to 2. 1 and return on equity from negative 3. 5 % to 26. 1 %. banks ’ profitability has been driven by a combination of factors. these include ( i ) a rise in earning assets of commercial banks to 85 % in september 2006 which is significantly above the prereform period and a rise in advances to total assets from 49. 1 % ( cy2000 ) to 55. 1 % ( sep 2006 ), ( ii ) a decline in the total and operating expense to income with latter being half the pre - reform period, ( iii ) a rise in the sme, consumer finance and agriculture sector lending which constitutes over one third of total outstanding advances and typically is priced above the average lending rates and those prevailing for larger corporate clients, ( iv ) a high share of non interest bearing or low yield deposits, while share of fixed term ( above 6 months maturity ) deposits declined and ( v ) a substantial growth in service charges which are emerging as a new source of revenue as electronic banking is taking hold. a sbp study has highlighted that privatization has had distinct impact on profitability of the banking sector, though its impact on efficiency is relatively weak. this is

##rai tarakiati bank limited. sbp has established a dedicated development finance group to help improve the enabling environment for development financing and coordinate intervention and initiatives which could enhance outreach, while developing capacities across the board in banking sector and also providing specialized training in some sector areas. given the financial sector ’ s dependence on the banking sector, as evident from the low bond market to gdp ratio, efforts are underway to enable the development of alternate sources of long term funding. among others, an infrastructure finance taskforce is now deliberating the possibility of supporting establishment of long term infrastructure lending institutions and equipping them with the desired project appraisal and risk management capacities. there is scope for enhancement of efficiency in financial intermediation which should augur well for deepening and sustainability of financial sector. trends of over 16 years reveal that pakistan ’ s interest rate structure has been quite volatile and unstable. after a period of exceptionally high interest rates, which were a manifestation of the public sector banks ’ inefficiencies, misallocation of credit and reckless lending accompanied by large defaults, pakistan ’ s lending rate fell but the real lending rate was kept so low that, despite low inflation over 2000 - 2004, it virtually turned negative. aside from volatility in interest rate, pakistan ’ s banking system over 1990s maintained high spreads. subsequently, low interest rates pursued by central bank coupled with enhanced competition helped narrow spreads to 5. 39 % by december 2004. however, a reversal in trends was notable as spreads rose again to 7. 4 % by the end of november 2006 with commercial banks re - pricing their loans in line with the upward adjustment in sbp repo rate ( policy rate ) from 7. 5 % in april 05 to 9. 5 % in july 06 in the wake of growing inflationary pressures, without a concomitant rise in deposit rates. banking spread will eventually be aligned as competition deepens both for deposit and loan products. fall in cost / income ratios coupled with sizeable balances in savings or short term deposit accounts ( with less than 6 - months maturity ) or transactional accounts – which offer low returns below the inflation rate – should facilitate decline in spreads. however, a factor to consider here is the high administrative expense to total expense ratio because of rising remuneration of banking professionals and high operating costs. sbp is keen to evolve a more stable and positive real interest environment over longer run and as a starting point has incentivized banks,