The profitability of the banking industry is under significant pressure as their spreads — the difference between borrowing and lending rates — compress to a multi-year low on the back of monetary easing during the last couple of years.

The emerging environment is especially tough for small to medium-sized banks, which were not ready for thinning spreads and are now finding their profits getting a big hit as their core income flattens out.

“The last one and a half years have been very challenging (for the banks). The reduction in interest rates and (downward) re-pricing of government papers (domestic public debt) have compressed the spreads to 2-3pc from 5-6pc and affected the yields of banks. The profitability (of the banking sector) is going to be flat during 2016,” Nauman Ansari, president and chief executive officer of Faysal Bank, said in a telephonic interview with Dawn last weekend.

The central bank has slashed its policy rate by 375bps since it started monetary easing in 2014/2015 to boost flagging private investment, forcing spreads to drop to just above 5pc in July from 7.2pc in 2012. “The reduced spreads are impacting the bottom line of the (small to medium-sized) banks,” Amreen Soorani, financial analyst at JS Global, told this writer.

Many analysts argue that the small- to medium-sized banks could face tougher times in 2017 than in the present year if the existing low interest rate environment remains unchanged

Lower spreads have knocked down Faysal Bank’s own interest income by a fifth to Rs13.28bn from Rs16.53bn during the first half of the present year to June, according to its unaudited accounts for the period. Non-interest earnings of the bank remain almost flat at Rs9.93bn.

Faysal Bank’s operating profit was down by 10pc to Rs4.80bn from Rs5.34bn. Overall, the bank was able to maintain its pre-tax profit for the first half of the year at the previous year’s level of Rs4.36bn; on the back of a 37pc reduction in provisioning against nonperforming advances to Rs454m and for diminution in value of investments to just Rs9m from Rs259m.

Its after-tax profit rose slightly to Rs2.81bn from Rs2.56bn in spite of the ‘super tax’ payment amounting to Rs347m or 4pc of the bank’s earnings.

“It will be a big achievement if banks are able to maintain the profitability they showed last year during 2016,” Nauman, who has over 22 years of credit, corporate and investment banking experience, said. In response to a question, he said the smaller banks could survive (in the tough low spread environment). “But they will need to work in a very niche market or go for consolidation if they want to operate universally.”

Many analysts argue that the small to medium-sized banks could face tougher times in 2017 than in the present year if the existing low interest rate environment remains unchanged. “They need to focus on increasing their non-interest, fee incomes to maintain profitability,” said Amreen. Others argue that the increase in private credit off-take could also help the sector.

Nauman, who has held a number of senior positions at several global banks, said banks have recently witnessed a big credit off-take in the infrastructure, consumer goods and power sectors, which had been absent for a long time, as road and power projects under the $46bn China Pakistan Economic Corridor project get underway.

“The corporate sector too is exploring opportunities. People are coming to us. But I don’t see a paradigm shift in investment,” he said. “I think the demand for credit in the corporate sector will pick up in the next one year, or a year and a half, once the power projects under CPEC are completed,” he argued.

In order to cope with the changing environment, Faysal Bank is focusing on improving customer services, developing new products to attract more customers, mobilising low cost deposits and expanding its Islamic banking operations.

It plans to increase its present network of 294 branches, including 82 dedicated Islamic banking branches, in 91 cities to 350 branches by the end of 2016 in order to reach out to more people and increase its profitability.

The number of Islamic banking branches will go up to 100 as the bank sees a lot of potential to expand this segment by expanding its distribution coverage. The bank is also using alternate distribution channels — internet and mobile banking etc — in order to improve customer satisfaction and grow the number of depositors.

Nauman insisted that the number of depositors in the country was growing as reflected by the growth in deposits. His own bank’s deposits have crossed the Rs315bn mark as it expands its coverage through new branches.

The bank plans to expand more aggressively into Islamic banking, as well as invest more in consumer and SME financing going forward to maintain its growth momentum and profitability. The bank’s Islamic assets stand at just over 12pc of its total assets of Rs456bn, consumer financing 7.4pc and SME financing 8.6pc of its gross advances or risk assets of Rs220.32bn.

The gross advances include non-performing loans of Rs30.45bn or 13.8pc of gross advances — above industry average of little over 11pc. The Bulk of the bank’s NPL portfolio was inherited at the time of its acquisition of the Royal Bank of Scotland. “The important thing is that the bulk of our NPL portfolio — ore more than 80pc — had adequately been provisioned for,” the president/CEO said.

Nauman is very excited about the future of his bank. “We are well positioned in the market and present across all business. Now we’re focusing on broad-based growth, customer services and products that meet their needs.”

Published in Dawn, Business & Finance weekly, September 5th, 2016