FOLLOWING rumours about the health of smaller banks after a troubled bank was placed under a six-month moratorium, the State Bank of Pakistan came out with a statement last week, saying the “banking sector is stable and strong”.

It supported this view by citing the ‘historic’ profits that the banks cumulatively posted for the first nine months of the year, and the industry’s 15.5pc average capital adequacy ratio (CAR), against the required 10pc. “The continuous improvement in the capital base of banks clearly contradicts the rumours currently circulating in the media,” the SBP statement read.

Interestingly enough, according to SBP data, the average CAR of the eight smallest banks in the country — at 17.5pc — exceeds that of the top five banks (16.7pc), the next five (13.1pc) and the next 10 banks in terms of asset size (12.7pc).

However, that might have more to do with one small bank’s CAR in excess of 40pc by the end of June.

That being said, the banking sector as well as the broader financial services industry has seen its fair share of merger and acquisition (M&A) activity this year, hinting that the environment might be suitable for consolidation in the industry.

Over the past month, Habib Bank Ltd showed interest in acquiring Barclays Pakistan, and the SBP has allowed it to proceed with due diligence. In October, Meezan Bank completed its acquisition of HSBC’s Pakistan operations. And earlier in February, MCB Bank had expressed an interest in acquiring Burj Bank, but no deal ultimately materialised.

Notable merger and acquisition activity has been witnessed in banking, insurance and modaraba sectors this year

The latest case is that of KASB Bank, which some market watchers expect will be acquired by another financial institution.

And the activity has not been limited to banks. At least three potential deals got underway in the insurance, modaraba and leasing sectors over the past two months.

While admitting that the financial services sector has seen relatively more deal-making activity than in the recent past, bankers and sector analysts were not sure if it proved that the industry is in full consolidation mode.

“It’s important to look at these deals and activities on a case-by-case basis. For instance, the HSBC Pakistan deal was more a result of the international bank’s strategic decision to get out of a number of markets, including Pakistan, than anything else,” one banking source explained while talking to Dawn over phone.

“Besides, the acquiring banks are now looking for inorganic growth. So that might explain some of the M&A activity,” he said.

“There has been some activity [in the banking sector], but I don’t see the environment worsening to such an extent that there will be widespread consolidation. The bank placed under the moratorium was by far the worst case, as its equity had turned negative. While the situation at none of the banks is as bad, some of them do have capital issues. But it is also much harder for smaller banks to raise Rs10bn [the minimum capital requirement prescribed by the SBP] than it is for the larger banks,” noted senior banking analyst Zeeshan Afzal.

Yet, while the industry may not be on the path to consolidation, it remains very much concentrated. By the end of September, the top 10 banks controlled 73.6pc of the industry’s assets, 77.6pc of investments, 86pc of public advances and 75.6pc of deposits.

“The market clearly favours the big boys. Still, small banks with solid capital bases and sound managements can try and ultimately make it,” said the bank source. He cited the example of a number of banks that were incorporated in the 1990s, some of whom have now been able to carve out a name for themselves in niche markets.

“While some of them struggled, others that had proactive managements and adopted prudent business strategies have now reached a stable stage.”

He added that the vast majority of the country still remains unbanked, which means that there is a lot of space for the industry, including small banks, to grow.

“Small banks also have the most room for growth; the bigger banks have virtually reached their saturation points. And calls for consolidation only started after the KASB issue,” agreed Afzal.

When asked about the long-term prospects of small banks, he noted that if they really start lending to blue chip companies, their profitability would improve, given the big difference in rates offered by government paper and private sector loans.

One banking sector watcher, however, refused to totally discount the prospect of consolidation in the industry over the long-run. “If provided with a reasonable exit, maybe some small banks would consider it. But until such deals take place, there is no sure way to know.”

Published in Dawn, Economic & Business, December 1st , 2014