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Crests and troughs in the banking sector during 2017

Review of banking industry

In order to propel economic growth, the State Bank of Pakistan has recently identified three priority areas for extending loans — agriculture, SMEs and low-cost housing finance with focus on financial inclusion and Islamic banking. Right mix of agriculture sector policies can give an immediate push to growth. Although, the banks disbursed Rs700 billion in agriculture sector loans, the data shows that the production loans are even lower than the previous year’s level. Banks also have not done well in the SME sector, as in a span of just 10 years, the SME lending as percentage of total credit went down from 17% to mere 7%. Further, the banks need to pump in credit to the housing sector as there is a shortage of about 7 million homes in the country.

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 (Rs748 billion in FY17 against Rs446 billion 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 Rs94 billion at end-June 2016 to Rs90 billion at end-June 2017 chiefly because:

  1. Net government borrowing from banks fell dramatically from Rs1.28 trillion in FY16 to Rs179 billion in FY17.
  2. The private sector kept retiring funds instead of making fresh borrowings.
  3. HBL was fined $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.

With expected increase in fresh government borrowing (due to lingering fiscal deficit) and accelerated net flows of private sector credit in the second quarter of FY18, prospects of both net private sector credit and government borrowing are increasing. During this year, too, the target for private sector lending is an ambitious Rs. 1trillion 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.

Pakistani banks have long been over-investing in risk-free government debt securities. Credit flows to the private sector have thickened only during the last two fiscal years. The advances to credit ratio of banks that had plunged to an all-time low of 46.4% in December 2015 has now risen past 52% reflecting the recent years’ gains in higher lending to the private sector. Banks’ interest rate spread 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.


Devaluation of rupee

The recent rupee depreciation could indirectly impact the banking sector in two ways: any further and more significant depreciation could slow down the economy and increase non-performing loans of banks going forward. Secondly, any further and more significant rupee depreciation will increase inflation to double digits, causing bigger and earlier hikes in interest rates. This will subsequently result in rising spreads but the impact on profitability could be off-set by higher investment to deposit ratio. In light of this situation, banks would be left with no other option than to increase their exposure in PIBs.

CPEC and banking industry

From the CPEC perspective, as new projects are coming up, winning of high volume financing contracts depends on the local banks expertise in trade and project financing given that Bank of China has arrived after the entry of Industrial & Commercial Bank of China. With the surge of borrowings from China under the China-Pakistan Economic Corridor (CPEC), the State Bank of Pakistan (SBP) has admitted that a large chunk of power machinery from China is being imported without using Pakistani banking channel for financing.

Pakistani banks are ignored for import or export of machinery when a firm makes a business deal with a foreign company while using its same company registered in the other country. According to reliable sources, the machineries are now largely being imported by either Chinese firms, registered both in China and Pakistan, or any Pakistani company having registration in Dubai to avoid the duty and taxes. Hence, the country ultimately was losing huge revenue in terms of taxes and duties.

Digitization in banking

Pakistan’s financial sector has responded to the challenges of applying these new technologies by strengthening its human resource and developing customer interface platforms. Most banks now have Chief Innovation Officers or Digital Initiative departments. Various online Payment Systems and Mobile Apps have been developed to encourage branchless banking. E-Commerce is picking up with 571 merchants offering their products online. During FY2017, 1.2 million transactions valued at Rs9.4 billion were processed through e-commerce. At least 25 financial institutions provide internet banking and 18 have mobile apps. During FY17, 25.2million internet banking transactions were processed valuing at Rs969 billion. Mobile banking accounted for 7.4million transactions valuing Rs141 billion, representing an annual volume growth of 32 percent and 12 percent respectively.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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