With increasing levels of competition and a variety of deposit schemes, This sector seems poised for an interesting future

Jun 01 - 07, 1996

Nawee A. Mangi

After a disappointing year's performance by the foreign banking sector, the results of domestic banks seemed more encouraging, during 1995 with more banks posting better results and less disasters on the whole. Competitive pressures intensified though, with two more private banks, Platinum and Prudential commencing commercial operations. The sector also had its share of problems of course most prominent of which was the struggle of the privatization commission to sell UBL and the fiasco which ensued.

Our survey of 19 banks in this sector, including the three nationalized commercial banks, reveals that combined pre-tax profits have risen by more than 13% over 1994 to reach the Rs 78 billion mark. After-tax profits showed a more substantial rise of just over 36% to Rs 28.5 billion. This compares well with foreign banks which had a 25% drop in pre-tax and a 51% drop in after-tax profits; the Advisor to the Prime Minister on Finance and Economic Affairs, V.A. Jafarey, however, recently expressed his total dissatisfaction with the sector as a whole.

Key ratios worsened through the year though; after-tax return on total assets was 0.71%, down from 0.97% the year before as asset growth (at 17.5% to Rs 1,026,283 million) did not keep pace with growth in after-tax profits. After-tax profits as a proportion of deposits, was at 1.39%, down from 1.49% the year before as deposits rose about 19% to Rs 625771 million.

Main issues in 1995

The year 1995 brought a few changes in the sector as the State Bank tried to ease credit restrictions in a gradual move towards more market oriented policies. Early in the year, the SBP abolished the credit / deposit ratio and removed the interest rate cap of 17.5% on short-term lending. Lending was expected to rise significantly and advances did rise by more than 23% to a total figure of Rs 329,607 million, but the Advance / Deposit ratio did not change all that much increasing to almost 53% at the end of 1995 from the end 1994 ratio of almost 51%. And although the CDR was abolished, the SBP still held strong notions of "acceptable" levels of lending; and as Askari, ABN-Amro and Citibank expanded lending, they were warned and penalized by the SBP, requiring to keep an additional 2% of deposits in a non-interest bearing account with the SBP in addition to the 5% requirement. For Askari the 2% translated to Rs 196 million; about Rs 2.5 million per month if the same amount had been lent out for a year.


As most bankers complained of not having met their targets, they pointed to narrowing spreads as the main reason; interest expenditure during the year grew by just over 28% and interest income grew by less than 27%. As competition heated up especially within the private banks which absorb about 16% of total deposits, with some banks like Askari and AL-Habib giving even foreign banks a run for their money, deposit rates obviously rose sharply.

A PLS savings account can now earn you upto 10.5% a year with some minimum deposit requirements as low as Rs 25000 and term deposits are earning upto 13% for a 1 year tenure. Although depositors were still not left with all that much, after discounting for inflation and taxes on accounts (zakat and withholding tax), they were nonetheless receiving higher rates than before. And on the flip-side, lending rates were also coming down as regulation was relaxed and the borrower had more options to choose from; banks like Askari and Soneri was lending at rates within the 16% range for short-term trade financing. This negativity of falling spreads was being somewhat countered as non-interest income rose 14.6% year-on-year.

A major problem many private banks faced was one of credibility; in the developing world in general and in politically uncertain times in particular the security of ones money is normally a prime consideration. This coupled with intense competition within private banks, posed the problem for many banks of a poor reputation or a bad name to cope with. For certain banks, especially those established by groups with a variety of business and industrial interests in the country (as is the most common case), the position of the bank is, and logically too, judged by the reputation of the group it is backed by. These banks tend to offer higher rates of deposit to counter the lack of confidence in their future, and advertising and marketing campaigns as well as higher levels of customer service, personal banking as well as automation and technology were used. But as the President of one such bank put it, which we feel represents the trend in general, " we almost never have walk-in customers", and most of the deposit base is comprised of the group's personal and business associates. Of course, there is no substitute to the "tried and tested" , and indeed we believe that once these banks have performed over the more medium-to-longer term, attracting deposits will be a substantially easier task for them. Through this period, of course, the industry might go through a consolidation phase and mergersmight be a strategic choice for many of the smaller banks, providing for a larger capital base.

In their efforts to increase deposits, just this past week, private banks as a body, urged the government to place deposits of public sector organisations, which total some Rs 760 billion, and 20% of which are given to banks as a whole with private banks as that will spur their growth in deposits and profitability.

Competition and its effects

Competition showed itself most obviously in the elevation of the customer from the levels where nationalized banks have traditionally kept them to the greater , more central importance of the customer. Branch expansion, as part of a wider growth strategy, was carried out by most banks, trying to reach more customers through higher accessibility. Askari's total branches have reached 18 and expansion is planned to add a further 5 branches to the network this year. Bank AL-Habib expanded aggressively too, adding eight new branches during 1995 bringing the total to 20 and with stabilisation setting in, 3 more branches are expected in the current year. MCB, the third largest bank in the country has tried to improve efficiency in its over 1200 branch network by improving branch reporting through better, more effective technology. Allied bank also added 50 branches in 1995 to total 902 branches throughout the country. Union followed a similar strategy, adding 9 branches through 1994 and 6 more through 1995 now totalling 25 branches.

Aside from reaching customers though, banks have tried to stand out through thequality and range of their services, such as evening and Saturday banking, telephone and on-line banking, Automatic Teller Machines (ATM's), and credit cards as well as deposit products. Schemes like Union profit plus, savings account with savings rates as high as 9% on a Rs 5000 deposit, Schon Saver Classic with a 12% yield on a Rs 200000 deposit, and Soneri Savings with an annual yield of 9.5% on a Rs 100,000 deposit have become more and more commonplace. Banks like Soneri andAskari also expanded their ATM network and many banks have established training programmes for prospective employees.

Askari bank, which is well -capitalised after a 50% Rights issue in January this year, has followed a strategy of promoting the bank as a whole, and its various products and services under that umbrella, thereby cashing in on its strong backing and credibility. Askari received the Euromoney Award for Excellence in 1995, after posting a substantial 40% rise in profits and excellent 69% rise in lending. Profitability, too, was up with pretax profits rising 20% to Rs 450 million and after tax profits rising only slightly lower by 18% to Rs 183 million in 1995.

Bank AL-Habib, with more than half their deposits in foreign currency faced a rising cost of funds as the State Bank rose the forex cover fee to 4.75 % from the previous level of 3%. Providing a high return on deposits at more than 10% for rupee accounts and upto 14.5% on a five-year term deposit, they showed solid results, with deposits rising just over 22% to Rs 6353 million and loans rising about 39% to Rs 4254 million. Pre-tax profits were up almost 14% while after-tax profits rose by more than 19% touching the Rs 1276 million mark. Asset growth was also strong at 35% and after-tax return on total assets was fairly healthy at 1.13%.

Soneri was another strong performer with more than a 21% rise in pre-tax profits and almost a 10% rise in after-tax profit. This was coupled with a solid 36% rise in deposits and a robust 49% rise in advances.

Muslim Commercial Bank, a star performer of the private sector was privatized in 1992, and since then, after tax profits have risen some 150% as over $ 1 billion of fresh deposits have been generated. Not only is the bank improving its standards of service by introducing new products and a network of ATM's they have also expanded their credit card business adding to their MasterCard service with a newly-acquired Diners Club franchise as well. In addition to this, 1995 was the last year of loan provisioning that the bank has made for the infected portfolio they inherited. Since bad debts are deducted from revenues, income and profits should rise immediately from this year onwards. MCB seems to be in a strong position all round since their improved service will probably enable them to siphon off business from HBL and NBP as far as deposits are concerned and with a clean portfolio and a high per part limit, they are in a better position to increase advances as well. Being the third largest bank in the country, deposits rose by juts over 22% to Rs 99641 million, and advances grew by almost 23% to Rs 51048 million. Pre-tax profits rose by over 31% and after tax profits climbed more than 46% to Rs 371 million.

Allied Bank also performed well with their MasterCard and unorganised sector financing scheme proving widely successful. They worked hard at image building as part of their Vision 2000 programme and added 9 new ATMs during the year taking the total to 14. They also increased the number of branches dealing with evening banking from 135 to 149 and added 50 new branches overall. Deposits rose 23% to Rs 51124 million and advances grew by 49% to Rs 29552 million. Pre-tax profits grew 54% to Rs 531 million and after-tax profits grew 53% to Rs 211 million.

Trade Finance

Trade finance seemed to have been an important revenue generator for several private banks; Providing short-term working capital finance either for foreign trade or local manufacturing concerns was a major activity for many banks. The benefit of financing foreign trade ventures, of course, is that it also brings in fee-based income in the form of letters of credit, other foreign exchange business, guarantees and so on. Askari Bank did import and export business of Rs 17921 million in 1995 up more than 53% to Rs 11 696 million last year. Bank AL-Habib, too has a high level of commitment to export financing with more than 70% of their loan portfolio allocated to the textile sector. They handled foreign trade business worth Rs 12.8 billion, up 58% from the year before and their fee income rose 73% in 1995. Allied also increased their import and export business by over 29% from the previous year to a level of Rs 38101 million. And Soneri Bank handled import and export business worth Rs 14188 million in 1995 up 44.8% from the year before, with their main market in smaller trading concerns, which represent some 32% of their loan portfolio, and export businesses constituting about 40% of total lending. Lending at a low rate of 16%, Soneri has a default rate as low as 0.5%.

Union bank attributes its success largely to foreign trade business in 1995, handling exports worth Rs 10.5 billion and imports with Rs 6.15 billion. They, of course are helped by their corresponding banking relationships worth a network of 142 banks in 67 countries around the world and their representative office in London.

Prudential Bank, too, relied on trade financing, transacting Rs 1041 million worth of import business and Rs 600 million worth of export business in 1995, while Schon did foreign trade business worth Rs 3835 million with Rs 2081 million in exports and the rest in imports. The non-interest efficiency ratio for the sector as a whole, though, which is a good indicator of the ability of the bank to generate fee income dropped from 44.6% to 42.2% in 1995.

Provincial Banks

The two provincial banks, which attained the status of scheduled banks this past year, the Bank of Punjab and the Bank of Khyber, both under-performedin comparison with the rest of the sector. The Bank of Punjab showed a 22% fall in pre tax profits to a level of Rs 194 million and after-tax profits fell by slightly more at 24% to Rs 174 million. Although after-tax return on assets was at 1.2, the higher tier among the sector, it was down from a good 2% from 1994. Deposit growth stayed strong with almost a 29% rise to Rs 12116, and advances grew 33% to Rs 12695 million. The fall in profitability seemed to stem from the rise in non-interest expenditure which rose from Rs 301 million to Rs 411 million in 1995 as against non-interest income which fell from Rs 556 million in 1994 to Rs 541 million this past year. They did, however pay out a 30% bonus dividend this month.

The Bank of Khyber, the worst performer, reported a massive 88% fall in pretax profits from Rs 102 million in 1994 to just Rs 12 million this past year. After-tax profits also fell by just over 88% to Rs 10 million only. After-tax return on assets which was a good 2.28% in 1994 fell to an abysmal 0.205 in 1995, but deposits grew by almost 17% to Rs 3677 million and advances grew by 23% to Rs 1038 million. The drop was driven by the substantial climb in expenditure and sluggish income growth; interest expenditure rose 34% and non interest expenditure rose 51% as operating expenses doubled, while interest income rose only 9% and non-interest income rose only 6%.

Nationalized Commercial Banks

More than 20 years after the traumatic nationalization of the banking system, the country has an accumulation of bad loans worth Rs 89.5 billion. Despite complete ignorance of customer service, the three nationalized banks absorb more than 60% of total deposits dominating the industry. MCB and ABL were privatized in 1992 and 1991 and the privatization of both UBL and HBL is on the cards.

The present credit squeeze is attributed to both default by private borrowers and government borrowings. According to some estimates there are about 50000 default cases with potential recovery rates well below 5%. The government's own borrowing is also a source of concern having far exceeded their Rs 28 billion target, now touching Rs 71 billion.

The State Bank has in recent days warned these banks to prepare specific action plans not only to recover loans but to curtail high administrative costs (which are 24% of average income as compared to 7% for private and 4% for foreign banks), and total administrative expenditure( average 36% of income as compared to 19% for private banks). Habib Bank received a warning from the State Bank just this past week to improve deposits, control expenditure, and recover bad loans which are worth some Rs 23 billion. They did make loan provisions though and recovered Rs 6 billion in 1995, up from Rs 3.5 billion in 1994. The mandatory loan provisioning by the SBP has led to better asset-liability management practices, as the MCB case has shown. Loan provisioning has to be done at a rate of 100% of loans outstanding for more than two years and in many cases high profitability in the past has been a reluctance to provide against bad loans

The performance of these banks has traditionally been characterized by the supply of credit to a large number of high risk clients, high overheads and subsidized lending. In comparison foreign banks generally lend either to multinational clients or local blue chips at competitive rates, thus having a smaller proportion of bad loans and deriving a lot of their business from fee-based income.

United Bank Limited posed a huge confidence and credibility problem for both the banking sector and the privatization commission; at the end of April the bank was taken over by the SBP and the management replaced, averting at the last moment a potentially disastrous sale to the Basharahill group. The bank is plagued with problems of a strong union, acute overstaffing, an unstable deposit base and a high proportion of bad loans in its portfolio. Although they have not declared results since 1994, it is estimated that their profits fell from Rs 270 million to just Rs 7 million in 1995. The sale of the Bank is now likely to be postponed for some time but needless to say, its successful privatisation will add enormously to the credibility of PC.

National Bank of Pakistan, with the highest deposit base at Rs 208283 million registered a growth of 22% and lending rose 30% to Rs 81528 million. Pretax profits were up 10% and after tax profits registered a massive 128% rise. Return on assets after tax was up from 0.111 to 0.2%. Habib Bank Limited also registered a 9.5% rise in deposits, a 13% rise in advances, a 6% increase in pre-tax profits and a 102% increase in after tax profits. After-tax return on assets fell from 0.6 to 0.11. Both banks also actively marketed monthly income schemes at annual yields of 16.5% for a five year term and a minimum deposit of Rs 10000.

Outlook for 1996

Growth in the past year seems to have been largely driven by foreign trade and industrial development. In 1996, growth in the loan portfolio might remain slow as these two main determinants of profitability stabilise; imports are likely to continue on the increase rise but it is likely that mostLC business will go to foreign banks for reasons of efficiency and industrial production is not likely to exceed 5% in the current year.

Competition will continue to intensify and spreads are likely to continue dropping as deposit rates rise. We can therefore expect an overall improvement in service and efficiency of operation as well as technology.

If nationalized banks continue to provide for bad loans and actively seek to recover loans as well as curtail lending to high risk clients the scenario will begin to improve.

One banker at a local private bank was of the opinion that the outlook for the year depends on the government's ability to reduce borrowings and ensure strong GDP growth. The SBP has maintained somewhat of a restrictive stance on monetary policy since October last year and the prospects for the banking sector will depend strongly on their position in the future.

The State Bank of Pakistan

  • 5% of total deposits to be held in an obligatory cash reserve

  • 25% to be invested in T-bills and FIB's

  • 3.5% of rupee-based deposits to be held in a special reserve at 12.5% annual yield

  • Corporate tax appies at 59%; to be reduced to 55% by 1998

  • Loan provisioning to be made at a rate of 100% of loans outstanding for more than two years