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Banks’ quest for profitability

September 02, 2013

Banks’ quest for profitability is taking a new turn, and this time quite in the right direction in view of the emerging business scenario for them.

Now in the first half of 2013, banks have also tried to boost profits by increasing their non-interest income, and some of them have succeeded remarkably.

In the past few years, banks usually made profits through investment in government papers, to compensate for lesser lending to the private sector, and a squeeze in banking spreads due to monetary easing.

Bank deposits grew by 9.5 per cent during the first half of this year — more than double from the 4.1 per cent growth seen in the year-ago period.

But as monetary easing continued, and the minimum return of six per cent on savings deposits remained unchanged, banks utilised most of their surplus funds in government papers. And as the yields on government papers remained flat or fell at times, their profitability was hurt.

Witnessing a decline in their core interest incomes, most banks increased their non-interest incomes through investment advisory, brokerage and custodian services.

UBL and Bank Alfalah reported that their non-interest income in the first half of 2013 shot up 31 per cent and 26 per cent respectively, to Rs9.4 billion and about Rs3.9 billion. Some other banks, including state-run NBP, also reported a rise in non-interest income.

“In a low interest rate environment, banks should ideally strive to boost non-interest incomes because that’s where a huge untapped demand exists, and exploiting it doesn’t carry the kind of risk associated with private lending,” says the head of a large local bank.

Combined pre-tax profits of the five major local banks — ABL, HBL, MCB Bank, NBP and UBL — at Rs41.1 billion in the first half of 2013, was down 12 per cent from the year-ago period, according to a research report from Topline Securities.

In overall 2012, profits of these banks had risen by six per cent to Rs88.3 billion.

For the last few years, banks have relied too heavily on investment in government papers, and this continued in the first half of 2013 as well, when their overall investment rose 6.2 per cent over the first half of 2012. Against that, their overall lending remained almost static at just 0.03 per cent.

Banks’ investment in government securities could have been lower, had the government not opted for clearing part of the Rs500 billion circular debt in May-June by borrowing from banks through T-bills and Pakistan Investment Bonds (PIBs).

“This, on one hand, helped us employ surplus funds instead of allowing them to remain idle. But on the other, it made lending to the private sector a secondary priority,” says the treasurer of a local bank.

“Additionally, as the stock market continued its upward journey, banks’ net lending to non-bank financial institutions also fell. So there wasn’t much choice for banks but to continue to invest in T-bills and PIBs.”

A falling trend in overall net lending by banks was also reflected in banks’ advances to deposits ratio (ADR). The ADR of HBL and UBL, for example, declined to 38 per cent and 47 per cent respectively in January-June 2013, from 45 per cent and 52 per cent in the same period of 2012.

The ratio for state-run NBP, which generally remains higher than that of its peer banks, also fell to 57 per cent from 61 per cent, as it resorted to heavier provisioning against bad loans.

The ABL, on the other hand, saw its ADR fall from about 53 per cent to 46 per cent for a different reason — a big growth in its deposit base and a small decline in advances.

It’s deposits rose from Rs514 billion in December 2012 to Rs570 billion in June 2013, whereas its total advances shrank from Rs271 billion to Rs262 billion.

Some smaller banks, however, recorded a rising trend in their advances to deposits ratios, chiefly because they either had to spend little on provisioning of bad loans, or they lent more to selected growing segments of private sector businesses like textiles and food and beverages. NIB Bank, for example, improved its January-June 2013 ADR to 81 per cent from 71 per cent in January-June 2012.

Citibank’s ADR also inched up from 28 per cent in the first half of 2012 to 29 per cent in the first half of 2013, but that improvement is deceptive in the sense that it emerged because of a massive decline in the bank’s deposits — down from 64 billion to Rs38 billion.

The bank’s actual advances also declined from Rs18 billion in January-June 2012 to Rs11 billion in January-June 2013.

Bankers say that in the second half of the current year, challenges for the banking industry would be different than those in the same period of last year.

“First of all, the rescheduling of the monetary policy announcement indicates that the policymakers are buying time to build arguments for keeping the interest rates unchanged, instead of hiking them,” says a senior executive of a foreign bank.

“Secondly, we don’t think government borrowing from banks would be as huge now as in the past, because tax revenue has started rising fast and big foreign exchange inflows, including that from an IMF loan, are about to come in,” adds the senior executive.

But industries are growing faster than before; public-sector enterprises are being revamped and injected with fresh liquidity, and big-ticket development projects are likely to be initiated.

All of this indicates that private sector credit demand would be strong. Now it depends on banks on how they can exploit it to their benefit.

Bankers admit that the core issue in profitability of banks is not limited to finding ways for increasing net interest income, which is earning on advances (excluding the cost involved) minus spending on paying returns on deposits (including the cost of their mobilisation).

They admit that even in the current low interest rate environment, the banking spread is not too bad — 538 basis points in July 2013, based on fresh lending and deposit rates, including zero mark-up but excluding interbank transactions.

“Regardless of which way the monetary policy moves, if banks need to maintain their profitability or increase it further, they need to bear in mind that sustainable profitability originates from both interest and non-interest incomes, and also from a diversified class of clients from both public and private sectors,” says a senior central banker.