December 31, 2001	Monday	Shawwal 15, 1422

Commercial banks improved their performance in 2001 compared to the previous year but with the future clouded by shrinking business and the emerging interest rates scenario. The head of a leading private bank says the banks did well in the first half of the outgoing year but suffered setbacks after September 11.

In the second half, the cost of deposits and the rate of advances fell. With exports and imports dropping, the fee-based business and margin on foreign exchange transactions was down. However, the overall performance of the banks was better than in the year 2000.

He sees the cost of funds and lending rate coming down further and adds that there is no growth in foreign or local investment and unemployment is on the rise.The economy has been hit by international recession and the fall-out of September 11.Being a service industry, the banks cannot escape its impact.

Private banks have outperformed both the nationalised commercial banks (NCBs) and foreign banks for the second year in a row, says the bank CEO. Since the freezing of foreign currency accounts, the foreign banks are stated to be shy in doing business in Pakistan. They are not aggressive and their numbers are shrinking. At least two smaller foreign banks, according to market reports, are up for sale.

The NCBs are busy in restructuring for privatization, trying to shed their fat and make their staff business and commercial oriented. It means a culture change, not so easily accomplished. Their focus is more on consolidation rather than growth and expansion.

In the current environment, there is opportunity for growth of small private banks. And they are working hard to seize the opportunity. Compared to the NCBs, these smaller banks offer better return to depositors and lower lending rates to the borrowers to increase their market share. Two weaker banks have however suffered collapse. One has been liquidated and the management of the other has changed hands.

Financial analysts say the most significant change beginning next year, that would impact on performance of commercial banks, would be the interest rate scenario. The exchange rate is stable and there is no need or pressure to jack up interest rate to support the rupee. The interest rates have plummeted in industrial economies hit by recession.

The State Bank has reduced discount rate by four per cent and is trying to persuade the commercial banks to slash lending rates. With a low inflation rate,(below 5 per cent) there is still room to cut discount rate. And the return on national saving schemes(NSS) is expected to be brought down to the level of yields on Pakistan Investment Bonds from January 1. The lowering of yields on NSS may encourage commercial banks to reduce deposit rates and consequently the lending rates. The State Bank is annoyed with the commercial banks for not slashing interest rates.

Currently, the spread between average deposit and lending rates is seven per cent, explained by nationalised commercial banks by mountains of debts and higher intermediation costs. The mandatory credit rating of banks has made the banks more cautious about the health of their balance-sheet, say central bank officials.

In Pakistan, financial analysts point out there is perverse relationship between cut in interest rate and profit margins. In developed economies, interest cuts push demand for credit and improve bank profit. In this country, it is the reverse, they add.

Bankers however argue that economic activity in Pakistan is not very sensitive to interest rate. It is a minor variable when compared to the other factors like taxes, utility charges, etc, that impact on the process of manufacturing.

Financing foreign trade is a lucrative business.Fees and charges on letters of credit for import and export and foreign exchange buying and selling would shrink with contraction in foreign trade. On this score, the outlook for banks is “negative” for 2002. The good news is that the government is committed to reduce tax on bank incomes gradually to 35 per cent.

The growth was not sustained by banks in the quarter of current fiscal ending September 30,2001. They preferred to deploy funds in less risky avenues like investment in government securities and TFCs as well as placement in financial institutions. The trend is believed to have continued in the next quarter.And to quote PACRA, for most banks, the asset quality of the loan portfolio has almost remained unchanged in first half 2001.

To improve the profitability of the NCBs, the process of restructuring of nationalised commercial banks and for privatization, will be quickened to complete the closure of excess bank branches. As of end October 2001, 650 branches of HBL, UBL and NBP have been closed and the remaining 1150 branches of an estimated 1800 non-profitable ones are targeted to be shut by March 2003. The NCBs still dominate the market with 53 per cent of the deposits and 46 per cent of the advances. The World Bank’s Banking Sector Restructuring and Privatization Project (BSRP) finances 70 per cent of the severance payments granted to 25,000 employees of the closed branches, for an estimated total of $340million. A part of the operation would be financed through a bridge loan from the SBP to the nationalzed banks. But such quasi-fiscal operations will cease with the next budget. The government will finance part of the restructuring cost by selling shares of the ABL, the NBP and the MCB on stock exchanges. United Bank is to be privatized by May 2002.

In the outgoing year, the government reached the conclusion that the DFI concept is dead;that corporates should go to the capital market to raise debts and should not depend on banks for long term project financing.The NDFC whose negative worth was estimated at $370 million, was merged with the National Bank of Pakistan. The non-viable non-bank financial institutions are being liquidated through mergers and acquisitions. The RDFC and SBFC are being merged into a new entity, the Micro-Finance Bank which is expected to go into operation on January 1. PICIC is being turned into a financial super-market with leasing and banking already initiated. PICIC has acquired the Gulf Commercial Bank and named it PICIC Commercial Bank.

The banks worldwide are losing business to fund managers who arrange finances for the corporates through equity and bonds. Fee-based income of the banks is rising as a proportion of interest income from lending. The commercial banks are diversifying their business. For example, the Citibank is planning to offer investment advice and a wider menu of investment options to millionaires in Asia to manage their wealth by themselves.

The State Bank is working on a proposed amendment in the Prudential Regulations to promote consumer banking specially for financing of consumer durables. A similar action has already been taken to facilitate housing finance.

The banks now do not get mandatory credit targets for different sectors of the economy but indicative targets. They would be allowed to operate purely on commercial considerations.The central bank would be able to exert moral pressure on banks to provide credit to priority sectors but would not be able to impose penalties, if indicative targets are not met. This would impact favourably on profitability.