July 14, 2003	Monday	Jumadi-ul-Awwal 13, 1424

The Habib Bank Ltd (HBL) was the first public sector bank which published its annual report for the calendar year 2002.

According to balance-sheet,the pre-tax profit earned by the bank amounted to Rs4.088 billion which is almost double than year 01 pre-tax profit of Rs2.224 billion. The post-tax profit for 02 was Rs2.034 billion.

In his note, the bank President, has highlighted the following points:

(a) The profit was credited to the customers’ accounts on the 31 December, 02 instead of the 20th January, 03 as was the practice in the past.

(b) The credit take-off picked up to Rs53 billion during 2002 as compared to Rs28 billion in 2001.

(c) There has been significant drop in the intermediation cost from 3.9 to 3.3 per cent.

(d) Cash recovery of non-performing loans amounted to Rs three billion.

Before we embark on examining the P&L account/balance sheet items, let us have a brief resume of the above four points:

(a) Since the introduction of “Islamic” profit and Loss sharing (PLS) in 1984, it has been the general consensus that it is absolutely not an Islamic system. The authorities in every bank periodically decide the mark-up rate because in case the return to customers is actually to be paid on the basis of the income actually earned, it is not possible to determine the quantum of return payable to the customers so swiftly. In case, the amounts of the return were credited to the customers’ account on the very last day of the year, it confirms that the rate(s) of returns) were pre-determined by the Bank authority, and it was implemented on the December 31,2002.

(b) The credit take-off prima-facie looks fairly good and the loans being made available for the purchase of the consumer durables may be one of the factors for the increased credit. The bank has nominated a few branches for looking after the matters relating to the small and medium enterprises (SMEs) but successes, if any, in this regard have not been separately identified in the Annual Report. This matter is also being touched in para 4(D).

(c) The question of reduction in the intermediation cost has always been debatable. According to the State Bank (SBP), the weighted average intermediation cost of all the banks was 6.7 per cent in December, 02. The perception is that the intermediation cost of the National Bank, the Habib Bank and the United Bank is much higher because these banks have to make heavy provisioning against the non-performing loans (NPLs) and their administrative cost is also comparatively much higher. It is the lower intermediation cost of other banks that had helped in keeping the weighted average of all the banks at about 6 per cent.

The SBP calculates the intermediation cost as the differential between the lending and deposit rates. According to this formula, the intermediation cost of Habib Bank Ltd. for the year 2002 works out to 6.16 per cent as detailed below, Table 1:

Intermediation cost: (A-B) 6.16 per cent: The second method to determine the intermediation cost is to (a) calculate the amount of non-interest expenses proportionately allocable to the interest expenses [pertaining to the deposits] and (b) add the same to the interest expenses relating to the deposits (c) along with the amount of the provisioning charged to the P&L account during the relevant year. The percentage of these 3 items in relation to the amount of deposits will give the intermediation cost. This is worked out below Table 2:

3.2: It will be observed that the results under both the methods are almost the same. And these results are fairly comparable to the weighted average intermediation cost of all the banks compiled by the SBP. The quantum of the intermediation cost quoted by Habib Bank in its annual report is incorrect. However, for the sake of public information, the Bank should disseminate the formula which brings it to 3.3 per cent as at the close of the calendar year 2002.

4 : The annual report is lacking in transparency in many respects.A few areas are listed below:

(a) It has been claimed that cash recovery of non-performing loans of the order of Rs three billion has been made during 2002. But this heavy recovery is not reflected in the “cash flow statement”. Why? What are the other means to verify this claim?

(b) As per SBP instructions, non-realisable interest is credited to the suspense account. The suspense account may also be used for putting other transactions. Only the amounts of above mentioned interest may be quite substantial. But the broad details of the transactions put through the suspense account have not been reflected separately either in the Balance Sheet itself or in any attached notes.

(c) The branch adjustment account shows “nil” balance (Note 10). Have all the inter-branch transactions reconciled and settled? This rather seems impossible as numerous inter-branch transactions are always outstanding at any given point of time.

(d) It has been claimed that narrowing of the spread has curtailed the profitability of the bank by Rs3 billion but it was made good through the income of Rs3.3 billion from the increased deposits and reduction in the non-earning assets like NPLs. While we shall touch the item of NPLs separately, it may be added that income generates from lending/investment in securities and not deposits.

The above assertion is not corroborated by the results given in the P&L account because the interest income from the advances/ securities has come down from Rs26.738 billion in 01 to Rs23.956 billion in 02.

Had the assertion been correct, the interest earnings should have been contained at 01 level. It may be added that the volume of advances [including leasing and purchase/discounting of bills] remains at 01 level-2001 Rs167.225 billion/ 02— Rs167.523 billion [ c.f. balance sheet]. The level of advances during 02 also does not substantiate the bank’s claim that in the end 02, the credit offtake picked up at Rs53 billion. If at all the credit off-take position is deemed correct, the other side of the picture would be that the loan,retirement far exceeded the offtake.

(e) The quantum of advances remaining at 01 level, the bank may of course have earned quite a substantial amount through non-banking activities like investment in government papers e.g. Treasury Bills and Pakistan Investment Bonds (PIB). The investment in Treasury Bills has risen from Rs19.616 billion in 01 to Rs72.788 billion in 02 and in PIBs from Rs1.749 billion in 2001 to Rs 12.035 billion in 02. Thus the total increase in investment in government papers in 02 has been of the order of Rs 63.458 billion as compared to 01 and is much higher than the amount of additional deposits of Rs44.737 billion mobilized during 02.

This also hints at the fact mentioned earlier that credit retirement during the year much exceeded the off-take. Another aspect of the matter is that the Treasury Bills are very short term - 6 to 12 month maturity. In the scenario of falling interest rates, the earnings on this instrument will substantially reduce during the second half of 03 which will dwindle the profits of the bank. Therefore, if the bank desires to maintain its 03 profits at 02 level, it will have to make serious efforts to diversify its investment portfolio.

(F) It was disclosed in Note No. 7.1 to the annual report for the year 2000 that the loans amounting to Rs6.953 billion were granted against no other security than the personal security of the debtors. In addition to that loans amounting to Rs17.382 billion were granted by the bank on the security of personal liabilities of one or more parties in addition to the personal security of the borrower. Such lendings prima-facie do not seem to be in accordance with the Prudential Regulations. But the annual reports for 01 and 02 are silent about this matter.

5: The bank’s accountants have given the P&L balance sheet a rosy picture through accounting methodologies. A few examples are as under: (a) The cost of exodus of staff’ incurred in 1997 was to be amortized over 4-5 years. The first instalment was charged to the P&L account for 1997. The remaining amount was taken to the balance sheet as of 31st, December, 1997 at the time preparation of final accounts for the year 1998 which resulted in the profit of Rs1.075 billion during 1998. Had it not been done, there would have been actual loss.

(b) During the year 2000, pre-tax profit was Rs1.075 billion which after payment of taxes stood at Rs609.5 million. This success was also achieved through accounting methodology. In this connection reference is made to Note No. 18 to the annual report of that year which reads:

“As mentioned in Note 3.5 , the bank has changed its accounting policy for accounting of investments in subsidiaries, associates and joint ventures to conform to the preferred treatment in the relevant international accounting standards.

The cumulative effect of the change in policy has been adjusted in the financial statements for the current year whereby the income for the current year before taxation is higher by Rs1066.848 million”.

During this year, an amounts of Rs139.919 million/Rs8.850 million were transferred to the P&L account from the pension / gratuity funds. Without adoption of these accounting methodologies, there would have been a net loss.

(c) The bank has made use of accounting methodology while preparing final accounts for the year 2002. The accumulated losses have been reduced by Rs2.730 billion [ from Rs11.662 billion in 01 to Rs8.932 billion in 02] but this reduction has occurred as per the undermentioned details:

(i) out of profit of the bank

Rs1.993 billion

(ii) Transfers from revaluation

of fixed assets: Rs 0.737bn

Rs 2.730bn

This time the bank has taken shelter under an amendment in the Banking Companies Ordinance which allows the companies to transfer the amount of incremental depreciation from the “revaluation of fixed assets” account to the accumulated losses account.

(d) Note No.8.4 mentions that the investment of the bank in the First Women Bank Ltd. (FWB) has been taken at cost and has not been accounted for under the equity method as the bank does not have significant influence over the entity. If bank’s investment in the FWB is in the shape of equity, it should have been accounted for accordingly. Whether the bank has little or more influence over the FWB is of little importance. The capital and reserves of FWB were almost entirely wiped out by losses in their forward dollar sales in 1996-97. In case this loss has not been fully recovered in the succeeding years, the statement of HBL’s investment in the FWB at cost would mean overstatement of assets to that extent. Table 3:

The deposits in foreign currencies [ excluding the domestic foreign currency deposits] i.e. overseas deposits amount to Rs 51.268 billion which constitute 15.62 per cent of the total deposits. This indicates that there is a harmony in the overseas deposits and lending.

7. The position of non-performing loans is as under:

Domestic: Rs 38.620 billion

Overseas: Rs 14.392 billion

TOTAL Rs 53.012 billion

The ratio of domestic non-performing loans to the domestic advances works out to 25.6 per cent while the overseas non-performing loans amount to 45.81 per cent of the overseas advances. The ratio of Bank’s total non-performing loans to the total advances works out to 29.08 per cent which is slightly higher than the ratio of 28.20 per cent in 01.

What does this indicate? The personnel posted abroad by the Bank do not exercise due prudence in carrying out the lending operations. Hitherto [and may be even now) postings abroad were/are made on the basis of influences including the political influences.

There are a few persons who had been successful in procuring overseas postings for more than 2-3 occasions while genuine and deserving officers fail to get even a solitary chance.

The induction of the so-called professional management since early 1997 also appears to have failed to resist the influences and hence no betterment has occurred in this respect.

The position of write-offs of loans and interest during the last two years is as under. Table 4:

It would be seen from the above that the process of write-offs continues and it is on the increase. The write-off of principal increased by over 9 times in 02 over that in 01 while write-off of interest increased by over 5.3 rimes.

The write-offs of the principal is accounted for in the P&L account either directly or by charge to the provisions against the non-performing loans. But the write-offs of the interest element is not accounted for in the P&L account.

In what manner, it is accounted for has never been explained by the banks or the Auditors or by the Institute of Chartered Accountants which is believed to be the overseeing authority for the Auditors.

Will any one of these please take a trouble to place the factual position before the public through the press.