September 04, 2006	Monday	Sha'aban 10, 1427

Almost all commercial banks have now published their half-yearly accounts for 2006. Compared to growth of 99 per cent in profit in the first half of 2005 over the first half of 2004, growth in the sector’s profit over 2005 has been only 68 per cent. Indeed, that is so but percentages and averages often camouflage the realities reflected by absolute figures.

Averages and percentages based on questionable calculations often mislead. That’s why, in spite of analysts’ claims (such as the current estimates of inflation and poverty), people find ground realities vastly different from the analysts’ carefully calculated but deceptive indicators. This is also true of the assessment of the January-June 2006 performance of the banking sector. Given the large base effect, in absolute terms, profit growth has once again been enormous, although percentages paint a different picture.

Over the comparable figures of 2005, the earning assets (loans, investments, lending to banks) of one big bank rose by just Rs10. 86 billion while its 6-month gross mark-up income rose by a whooping Rs4.82 billion. Among the big five, the most ‘rational’ rise in comparable figures was Rs60.351 billion and Rs6.747 billion.

These figures, which show the range of the absolute rise in mark-up incomes compared to the rise in the earning assets, convey the earning strategy of the banking sector.

The other side of the picture is that in spite of Rs60 billion rise in its deposit base over June 2005, the half-year profit paid by one of the big banks rose by only Rs1.98 billion reflecting a rise of slightly over 0.8 per cent per annum on the average of its closing deposit figures at the end of the first half of 2005 and 2006. Based on the same formula, in case of another big bank (whose deposit base rose by Rs27 billion over 2005), profit payment on deposits rose by just 0.63 per cent per annum. Based on the 2006 half year figures, the annualized return on equity of the big five rages between 21.45 and 50.74 per cent.

A deception that sector-wide indicators create is that they hide the impact of market mechanics on banks of different sizes. During 2004 and 2005 bank profits were criticized for being unfair since depositors were grossly under-paid. But the reaction failed to cause an across-the board change in the attitude of banks’ management. In absolute terms, profit paid on deposits has risen but smaller banks offered far larger increases in returns (nearly thrice in case of one small bank) compared to the big banks.

The differences between big and small banks, however, can’t paper over the fact that sector-wide mark-up spread (difference between average profit rate earned on loans and that paid deposits) has gone up from 7.21 percent to 7.42 percent per annum.

The rise in spread, even though just quarter of a per cent, suggests that banks continue to earn higher profits compared to the past years. It also shows that SBP advice about rationalising mark-up spreads is not being heeded.

This analysis reduces to a bit of intelligent guesswork because bank financial statements don’t disclose separately the profit paid on each deposit category although disclosure of profit payment on savings accounts – the largest chunk of the deposit base – is significant for measuring a bank’s sense of social responsibility. Return paid on this segment is one of the factors that affect the level of poverty.

A further complication arises because profit paid on bank borrowing (usually higher than that paid on deposits), is lumped together with the profit paid on deposits; using this figure you end up with a rate higher than the rate paid on deposits.

A closer look at the results posted by individual banks indicates that borrowers are still being charged higher mark-up rates on loans, and depositors continue to be under-paid.

It would be unrealistic to expect that banks shouldn’t earn profits but the point worth pondering is ‘how much’. Should banks focus on enriching their shareholders at the expense of the society, or should they earn what is fair in keeping with their role of an intermediary? Why is it that bankers are placing shareholder value above the stakeholder value, and what are the regulators doing about it? These questions need to be answered.

Banks justify high mark-up spreads on a variety of grounds including the risk emanating from a weak legal system that doesn’t come to their rescue quickly enough to recover loans from defaulters. There is a grain of truth in this argument but, undeniably, the legal system has improved because loan losses are falling. Besides, isn’t this one of the tall claims bankers make? This risk therefore isn’t as high as the factor built into mark-up rates for its coverage; the argument appears to be a subterfuge for keeping the mark-up spread high.

The fact that bank profits have been rising at a staggering pace for the fourth consecutive year proves that risks are being managed well. It is beyond belief how banks can call themselves improved institutional arrangements while their intermediation charge keeps rising. Credibility and dependability of operational arrangements should be reflected in a trend of lower, not higher mark-up spread.

It is no secret that since 2002, employee remuneration (especially of the top-brass) in the banking sector has risen substantially. The top brass in Pakistan’s banking sector is now among the most highly paid in South Asia.

No one would hold a grudge (although there is justifiable room for it) against the highly paid bankers if they deliver by making the sector cost-efficient for its customers. That, unfortunately, has not been happening but the bankers appear unconcerned about the rising cost of intermediation.

Even in a developing country like Pakistan, to survive reasonably well the banking system shouldn’t need to charge a spread exceeding four per cent over its deposit cost. Anything that banks earn over this level only enriches bank owners at the expense of the society at large.

Economic analysts have been spending sleepless nights trying to find the causes of poverty and ways for containing it but, apparently, they have not inquired into how banks’ intermediation cost indirectly contributes to inflation and market inefficiency, and accentuate poverty.

It seems that banks don’t appreciate as well as they should, that in a country like Pakistan (where businesses are over-leveraged), intermediation cost charged by banks forms a significant part of the industry’s cost structure. By keeping this cost high (spurred by the profit motive rather than coverage of intermediation risk), banks are steadily eroding the already weak competitive edge of Pakistan’s industry, especially the export-oriented sector.

This is evident from the many well-publicized desperate appeals by several key trade associations. This is not a good omen either for the banking sector or the industry.

We can go on blaming the industry endlessly for being inherently inefficient but the choice we face right now is whether to let the industry collapse or help it survive and at the same time make a concerted effort to mend its ways.

A scenario, in which banking sector profits escalate while the industry slowly withers away, would seriously damage the banking sector’s credibility.

Recent studies indicate that economic growth is genuine and lasting if it is supported by domestic savings, not the result of higher consumption. By offering savers returns that are well below the going inflation rate banks only encourage them to consume rather than save.

It is a dangerous route our society seems to be adopting, courtesy the profit-centred focus of our banks. A country like Pakistan cannot prosper if its people are not encouraged to save for building the vitally needed infrastructure; secure future is guaranteed only by lasting assets, not consumption.

It hasn’t taken us too long to discover that this trend is suicidal. In less than a year and a half, over-consumption (a lot of it financed by borrowed money) has pushed up the balance of payments deficit to a level never witnessed in our history.

It reflects not on the choices exercised by ordinary savers but on banks that seem to encourage consumption rather than saving. The nation simply cannot afford to fall in the habit of over-consuming and living on borrowed money.