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Lower interest rates strike bank profits

Deposits are becoming unattractive for the customers

The profitability of the banking industry is under substantial pressure. The last two years have been very challenging for the banks. The reduction in interest rates and downward re-pricing of government papers (domestic public debt) have flattened the spreads to 2-3 percent from 5-6 percent and affected the yields of banks.

The State Bank of Pakistan has slashed its policy rate since it started monetary easing in 2014-15 to boost weak private investment.

The reduced spreads are impacting the bottom line of the (small to medium-sized) banks. Many analysts believe that the small- to medium-sized banks could face tougher times in 2017 if the existing low interest rate environment remains unchanged.

Analyst are of the opinion that there is need to focus on increasing their non-interest, fee incomes to maintain profitability. Some argue that the increase in private credit off-take could also help the sector.

A number of 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.

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 China-Pakistan Economic Corridor (CPEC) are completed.

FAYSAL BANK

Lower spreads have left down Faysal Bank’s own interest income by a fifth to Rs13.28 billion from Rs16.53 billion during the first half of the present year to June. Non-interest earnings of the bank remain almost flat at Rs9.93 billion. Faysal Bank’s operating profit was down by 10 percent to Rs4.80 billion from Rs5.34 billion.

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

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. The number of depositors in the country was growing as reflected by the growth in deposits.

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 12 percent of its total assets of Rs456 billion, consumer financing 7.4 percent and SME financing 8.6 percent of its gross advances or risk assets of Rs220.32 billion.

HOW BANKS CHARGING?

Banks in Pakistan are charging up to 29 percent interest rate to their borrowers despite the lowest 5.45 percent policy rate of the SBP (State Bank of Pakistan).

Policy rate is the interest rate on which SBP gives financial loans to commercial banks. Consequently, banks can charge an interest rate slightly higher than this to cover their expenses and potential business risks.

This slightly higher percentage has reached more than 23 percent which is very shocking. Such interest rate parity between SBP and commercial banks was revealed in National Assembly.

The interest rates of the banks in the report were explained as WAORI that counts for the loan on agriculture, business, loan, housing, and salary.

Both public sector and private sector are offering loans on higher interest rates, starting from 7.72 percent by Habib Metropolitan Bank to the 28.8 percent, the interest rate charged by Standard Chartered Bank.

The Islamic banks have the profit rate charge at 13.11 percent in which Bank Islamic and Dubai Islamic Bank charge at 11. 65 percent. Bank of Punjab, Sindh Bank and Bank of Khyber were charging at 9.66 percent, 9.73 percent, and 10.23 percent respectively.

First Women Bank offered loans at the rate of 18.44 percent which is highest among the State-Owned Banks.

At such lower level of policy rates it is difficult for an ordinary man to reap the benefits if the commercial banks are bent on depriving people of their monetary resources in the name of interest.

The banking sector’s spread fell 31 basis points to 4.97 percent year-on-year in November 2016 on soft lending and deposit rates and in line with the State Bank’s monetary stance.

The latest data released by the State Bank of Pakistan (SBP) showed that easy monetary conditions reduced weighted average lending rate to 8.12 percent. This was the lowest since June 2005 in November.

The weighted average deposit rate dropped to 3.11 percent, the level last seen in July 2006. The average spreads clocked in at 5.12 percent, down 47 basis points year-on-year in January-November period of 2016.

Low interest rates have compressed a spread between lending and deposit rates. This coupled with falling yield on treasury investments are already taking a toll on the sector’s profitability.

Banks have been hit by lower interest rates, which make deposits unattractive for the customers. It is believed that discount rate has bottomed out due to build up of inflationary pressure.

For an anticipated 50bps increase in discount rate in March and September 2017 monetary policy respectively; there is optimisms on spreads going forward.

The SBP’s data also revealed that total outstanding bank credit rose 13.4 percent to Rs13.5 trillion year-on-years in November 2016.

The major increase in bank credit expansion came from government sector, which unlike the recent past, reverted to the State Bank of Pakistan. The central bank’s credit to government sector increased 53.7 percent to Rs873 billion in November 2016.

Government borrowing from commercial banks remained almost stagnant at Rs104 billion in November.

Amid low interest rates and higher credits, banking sector posted flat earnings. State Bank of Pakistan has released its Quarterly Performance Review of the banking sector for the quarter ended 31st December, 2016.

Profitability of the banking sector narrowed due to low interest rate environment and reduced quantum of investment.

Deposit growth has remained on steady path while 4th quarter’s profit improved as compared to last years’, though entire year’s profit slightly narrowed owing to low interest rate environment.

The report highlights that the asset base of the banking sector has expanded by 4.6 percent in the quarterly calendar 2016.

The key contribution has come from demand for credit from private sector; due to better economic conditions, and improved liquidity.

A bounce back in the advances flow has been observed in the textile sector; the largest borrower of the banking sector. Besides, sugar, energy, agribusiness, and cement are some other sectors which have availed major financing from the banking sector in fourth quarterly 2016.

Banks’ investments, however, has fallen by 1.5 percent during fourth quarterly 2016 mainly on account of decline in investments in government securities.

Deposits the key funding source of the banking sector has observed growth of 6.4 percent. The addition in the overall deposits has been contributed by non-remunerative current deposits followed by fixed deposits and saving deposits.

The report highlights that the high deposit growth in the 4th quarter as well in the entire year is a good sign considering decline in deposit growth observed in the last couple of years.

The asset quality of the banking sector has improved with decline in non-performing loans (NPLs) and corresponding ratios. Particularly, NPLs to loans ratio declined to 10.1 percent, the lowest level in eight years.

Besides pick up in advances, recoveries in NPLs have played a strategic role in bringing the ratio down. The drop in interest margins and reduced quantum of investment has narrowed the year-to-date profitability of the banking sector.

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