November 19, 2002	Tuesday	Ramazan 13, 1423

KARACHI, Nov 18: Commercial banks suffer from lack of profitability, both in terms of return on assets and on equity, says an IMF report.

Fund officials hold “the state-owned banks’ situation” mainly responsible for the financial performance of the banking sector as a whole.

However, the financial results of private banks also do not show any improvement.

“In spite of high spreads between the lending and deposit rates (close to six per cent),” the report says that “private banks’ profitability has declined and also remains low by international standard.”

The decline has been explained by the impact of the freeze of foreign exchange deposits in 1998 and the related elimination of schemes that provided safe and high returns to banks.

And the banks liquidity has also been enhanced by a low economic growth rate and lack of opportunities to lend to the private sector.

The IMF report maintains that the available data do not permit a clear assessment of banks’ exposure to risks of macro-economic shocks. The dollarization of the banks deposits have been considerably reduced, 14.5 per cent in June 2002 from 19.6 per cent a year earlier and more than 40 per cent in 1998 but continues to expose the banks to significant foreign exchange risks, since capital mobility is relatively high in Pakistan, although several prudential regulations imposed by the central bank limit these risks.”

“Maturity mismatch for some banks that hold large amounts of long-term government bonds and the high concentration of loans in the textile industry are two possible risks which warrant attention,” cautions the Fund.

It may be added here that Dr Mohammad Yaqub, a former governor of State Bank, hired by the IMF, recently held meetings with the top bankers on the performance of the banking sector.

The IMF staff report completed on October 18, 2002 further observes that “the credit risks remain high but limited to state-owned banks.” The ratio of non-performing over total loans stabilized at 19.6 per cent from 19.5 per cent in 2000 and 22 per cent in 1999. Strict classification rules enforced by the SBP pushed the ratio up, largely off-setting a stepped-up drive to loan recovery.

Pakistan initiated in-depth structural reforms in the banking sector in early 1990s to reverse the previous trend of bank nationalization, state control and directed credit. Later, confronted with increasing credit risks and governance issues, banks modernization was speeded up, including privatization, an overhaul of the legal and accounting framework, a strengthening of the financial supervision and a shift to market-oriented policies. The IMF quotes SBP study that suggests a”modest impact of these reforms on the soundness of the banking sector.”

The capital adequacy ratio was on average equal to 11.4 per cent; four commercial banks were below the prudential minimum of eight per cent.

IMF officials are confident that the authorities are pursuing policies that would bring in more decisive improvements in the banks’ financial soundness in the medium term. Measures include (a) the SBP’s UBL recapitalization (Rs8 billion) (b) consolidation of banks’ outstanding tax refund claims on CBR (Rs22 billion) and claims on KESC (another above Rs22 billion) into treasury bonds. Some Rs26.5 billion assets of state-owned banks that have been sold for Rs5.1 billion and were in arrears as of August 2002. The banks also took cost saving measures initiated in 2001 including the closure of non-profitable branches and government-financed golden handshake programmes. About 7,000 staff were declared redundant since June 2001 for a total cost of Rs7 billion.

According to the report, there are major challenges facing the commercial banks.

The financial system remained fragmented by tax distortions, including discriminatory income tax rates against banks. Tax rates have been reduced from 58 per cent to 50 per cent but are still above the corporate tax of 35 per cent, which applies to other financial institutions such as leasing companies and investment banks. Banks’ specific provisions against nonperforming loans should be tax deductible. Tax distortions also discourage mergers between banks, as well as investment in pension funds.

Similarly, the regulatory and judicial framework needs further reforms. Distortions affecting deposit collection or credit allocations prevent bank’s fair competition with other financial institutions.

The banks should be given more opportunities to diversify their loan portfolio, through legal steps to improve solvable demand for credit in housing and agriculture, as well measures to improve corporate governance and companies’ financial disclosure.