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Banks’ profitability face choppy waters

November 13, 2017

Banks’ profits have declined in the first quarter of this fiscal year as their investment in long-term Pakistan Investment Bonds (PIBs) fetched lower returns and as lending to the government sector remained low.

The State Bank of Pakistan (SBP) quarterly report on banking statistics is still awaited but according to a brokerage house report, profit of all banks combined, minus Habib Bank Ltd., fell 2pc in July-September this year from the same period of the last year.

The Topline Securities report has excluded Habib Bank while calculating profitability of banks because HBL had to dish out $225 million as settlement payment to the New York Department of Financial Services in relation to the latter’s finding of weaknesses in HBL’s New York branch. This one-time huge outflow, made in Q1FY18, resulted in a quarterly after-tax loss of Rs14.224 billion to the bank that normally makes sizable profits.

“The long-stretched lax monetary policy keeps our spreads low, and interest income on growing loan stocks does not translate into quicker and fatter addition in after-tax profits, more so because the super tax remains in place,” says a senior local banker

Banks lending to the government and private sector credit are two main sources of their interest income and a big increase in their private sector lending (Rs748bn in FY17 against Rs446bn in FY16) should ideally have boosted their after-tax profit in the last fiscal year.

But that did not happen, rather after-tax profit of all banks slipped from Rs94bn at end-June 2016 to Rs90bn at end-June 2017

chiefly because net government borrowing from banks fell dramatically from Rs1.28 trillion in FY16 to Rs179bn in FY17.

Official consolidated statement of profit and loss of all banks for the first quarter of this fiscal year would be out after some time. But government borrowing from banks (in Q1FY18) remained lower than expected and that, too, more through low-rate treasury bills that offer a return slightly higher than the SBP key policy rate.

Besides, as usual on net basis the private sector kept retiring funds during the quarter instead of making fresh borrowings. Together these two factors had a depressing effect on banks’ profitability bankers say.

Private sector credit normally remains negative in the first quarter due to seasonal retirements and banks have to rely on returns on the stock of private sector loans. As the stock of private sector loans are growing, so is net return on them.

“But the long-stretched lax monetary policy is keeping our spreads low and even interest income on growing stocks of loans does not translate into quicker and fatter addition in after-tax profits, more so because the super tax remains in place,” says a senior local banker.

In FY18 budget the government did not heed bankers’ demand to bring the super tax on banks at par with that on non-bank companies and announced to maintain the tax at 4pc for banks and at 3pc for non-bank companies (in case bank or a non-bank company makes more than Rs500m annual profit).

Banks’ interest rate spread, if calculated as the gap between fresh average lending and deposit rates (excluding zero-rated and inter-bank dealings) inched up 10 basis points to 258bps in September this year from 248bps in September last year. This is a welcome improvement but it has come in the wake of a dramatic rise in consumer finance which is costlier than corporate finance.

“As we are in now in the second quarter (of FY18) and as I see prospects of both net private sector credit and government borrowing increasing, I hope banks’ profits would not be as bad as in the first quarter,” says a senior executive of another large local bank.

Bankers are optimistic, however, that the situation would change for the better during this quarter. And, they cite several reasons for this including an expected increase in fresh government borrowing (due to lingering fiscal woes) and accelerated net flows of private sector credit.

For many years, banks in Pakistan have remained excessively focused on zero-risk government debt securities for earning profits, ignoring private sector credit demand. And, credit flows to the private sector have thickened only during the last two fiscal years.

During this year, too, the target for private sector lending is an ambitious Rs1tr and going by growing demand and banks’ readiness to accept the challenge of lending more to private businesses, chances are that they would come close to meeting the target. “This is sure to bring some structural shifts in our sources of profit earning,” says an official of Pakistan Banks Association.

Already, the advances to credit ratio of banks that had plunged to an all time low of 46.4pc in December 2015 has now risen past 52pc reflecting the recent years’ gains in higher lending to the private sector.

Meanwhile, the entry of a second Chinese bank in the local banking arena will also have an impact on banking culture as we move along, bankers say.

“It depends on how prepared you’re to live happily with a newcomer,” says head of a large local bank when asked about his take on this issue. “We’re prepared. We’re excited.”

Local banks with developed expertise in trade and project financing have reasons to celebrate the arrival of Bank of China (BOC) in Pakistan after the entry of Industrial and Commercial Bank of China (ICBC), back in 2011. But banks focused more on consumer finance and involved aggressively in agricultural lending have little to gain, at least in the short-run, bankers stipulate.

Pakistani banks have long been over-investing in risk-free government debt securities. Their rekindled romance with the private sector borrowers is only two and a half year old. “Clearly, they need to go a long way before they can win financing contacts of big volumes as new CPEC projects come up and the ongoing ones move faster. In both cases, only a handful of Pakistan banks can benefit as much as the Chinese banks,” says a senior official of the state-run National Bank.

Published in Dawn, The Business and Finance Weekly, November 13th, 2017