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Time to redefine the strategies

June 28 - July 04,1999

Foreign banks, operating in the country, have posted destitute results for the period ending December 31, 1998 after a long time. Slow pace of economic activities, declining lending rates, shrinking spread and increasing competition for resource mobilization are expected to continue to keep their profit margins under pressure. Foreign exchange deposits, a strong base for these banks in the past, is no longer available. Declining yield on T-Bills is another reason for reduction in the profit. The year 1999 will be even more difficult. None of these banks is expected to take an exit from Pakistan but further expansion in branch network may not take place in near future. However, the edge attained by these banks in the past through heavy investment in technology and improvised standard of service will compensate for smaller branch network.

A closer look at the annual report of these banks for 1998 indicates divergent trend. While some of the banks have succeeded in increasing deposits many have registered considerable decline. Profit margin has reduced and some of the banks have posted loss for the year. However, one can say with confidence that these losses were not the result of any sluggishness on the part of management. Working conditions changed due to shift in government policies. Recessionary trend of the economy and freezing of foreign currency accounts abated their deposit base. Declining repayment ability of borrowers disrupted their cash flow. Heavy provisioning against non-performing loans was a factor responsible for the reduction in the profitability of these banks. Dearth of quality borrowers, reduction in the quantum of foreign trade business and hardly any investment activity in the country had an adverse impact on their fee-based income.

Foreign banks which were prompt in redefining their strategy for operation in Pakistan, after the nuclear test, succeeded in maintaining their share in total deposits and retaining their profit margin levels. However, listed private domestic banks have successfully intruded into the market segment previously considered to be an exclusive domain of foreign banks. This dent was made by the local banks by making huge investment in technology and offering superior quality service.


Before making any analysis of the performance of foreign banks during 1998, it is necessary to recap the economic situation of the country. The improved economic performance witnessed during the first half of 1998 was marred by the imposition of economic sanctions. The GDP growth rate declined, external trade volume shrank, balance of payment situation remained precarious, debts accumulated and foreign exchange reserves position remained extremely critical.

The subdued economic activity, reduced trade volume, meager foreign exchange reserves and reduced spending on developmental work had a negative impact on the business of banking sector. The freezing of foreign currency accounts (FCAs) and consequent erosion of deposit base added further to the problems of the sector. This resulted into intense competition for resource mobilization thereby raising rate of return on deposits and shrinking spread .

While the fallout of FCAs freezing was not significant in case of local banks, foreign banks suffered the most. At an average, over 50 per cent of their deposits were in foreign currency. In certain cases the share of forex deposits was as high as 90 per cent. With the run for encashment of dollars they faced serious liquidity problem. The strength of the banks, in the past, was mainly due to swap dollar deposits. When the central bank asked the borrowers to settle borrowing against dollar deposits these banks also lost a handsome percentage of forex deposits.


Although there are nearly two dozen foreign banks operating in Pakistan, our review is based on 13 banks only, which control the largest market share.


The key factor of profitability of commercial banks is dependent on the spread — the difference between the borrowing and the lending rates. According to banking sector analysts, only four banks have spread above the Peer Average of 1998. These were ANZ Grindlays, Citibank, Emirates Bank International and Bank of America. Whereas the spread of other nine banks was below Peer average of 1998.


Provisioning against non-performing loans affect the profitability of banks directly. Citibank made the highest provision amounting to Rs 512 million followed by Standard Chartered Bank, Rs 225 million and ANZ Grindlays Bank, Rs 174 million. However, the sector analysts say, "It is the strength of a financial institutions to do the maximum hedging and no analysts should get up set with the absolute number of rupees." These provisions are written back in case of recovery. Annual accounts for 1998 substantiate their point of view. Mashreq Bank and Emirates Bank have written back the provisions in 1997 and 1998. Similarly Hong Kong Shanghai and ABN Amro have also written back the provisions in 1998.


Citibank, despite 12.6 per cent decline in deposits as compared to 1997, has once again emerged to be controlling the largest share. With total deposits of Rs 49,304 million it controls 27 per cent of the total deposits. The other banks holding above 10 per cent of total deposits are ANZ Grindlays (15%), ABN Amro (10%) and Standard Chartered Bank (10%). Looking at the composition of deposits, Citibank controls the highest percentage of foreign currency deposits of 24 per cent followed by ANZ Grindlays (14%), Standard Chartered (13%) and ABN Amro (11%).

While Standard Chartered registered the highest growth in deposit of 24.6 per cent, the banks experiencing major decline in deposits were American Express (36.5%) and Deutsche Bank (35.3%).


Five banks out of 13 have registered decline in advances. The banks, registering the highest growth in advances, are The Hong Kong and Shanghai Banking Corporation and ANZ Grindlays. Despite 16 per cent decline in advances as compared to previous year, Citibank has the highest amount of Rs 21, 855 million.


However, when one looks at the profit before tax figures of these banks, ANZ Grindlays has earned the highest operating profit amounting to Rs 1,358 million. Whereas the second highest profit was posted by Bank of America amounting to Rs 688 million. It is interesting that while ANZ Grindlays profit declined by 5.6 per cent the profit earned by Bank of America improved by 6.2 per cent. The banks registering significant reduction in profit are Deutsche Bank (163.9%) American Express (91%), Citibank (66.5%) and Standard Chartered Bank ((47.5%).

Another important feature is that Citibank posted highest non-fund based revenue of Rs 1,211 million, followed by ANZ Grindlays (Rs 774 million), Bank of America (Rs 622 million) and ABN Amro (Rs 584 million).


The growth of assets in case of Standard Chartered Bank was the highest with 21.1 per cent. Societe Generale registered 17.2 per cent growth whereas it had registered 36.6 per cent decline in 1997 as compared to 1996. While Citibank posted 12 per cent decline in assets, the other banks registering above 30 per cent decline were Deutsche Bank (36%) and American Express (32.6%)


The investment figures reveal a very interesting story. Citibank continued to hold the largest investment portfolio. Despite reduction in assets by 12 per cent the investment portfolio registered 6 per cent growth. Citibank had posted over 54 per cent increase in investment in 1997 over 1996. The investment by Societe Generale which took a nose dive from Rs 2,974 million in 1996 to Rs 352 million 1997, once again jumped to Rs 1,556 million in 1998 — an increase of 342.5 per cent. Credit Agricole had also registered nearly 80 per cent in 1997 as compared to 1996 but posted about 9 per cent increase in 1998. The banks registering above 50 per cent reduction in investments are Deutsche Bank (67.1%), American Express (65.3%) and Bank of America (58.8%).


One of the criteria for evaluating the performance of commercial banks is return on average earning assets. On the basis of this, ANZ Grindlays emerged to be the best for the year 1998. It improved from 5th position in 1997 to 1st in 1998. Bank of America moved from 9th position in 1997 to 2nd in 1998. Citibank, however, went down from 4th position in 1997 to 9th in 1998. American Express also came down from 7th position to 12th during this period.


Return on average equity is important for the head offices of these banks. Citibank has the largest equity of Rs 3,370 million followed by ANZ Grindlays Bank, Rs 3,055 million and Standard Chartered Bank, Rs 2,196 million. Among the three banks, while Citibank registered reduction in equity, the other two witnessed increase in 1998 as compared to previous year. Deutsche Bank registered the highest erosion as the equity came down from Rs 853 million in 1997 to Rs 485 million. The return of average equity for six banks was above the Peer average of 1998 fixed at 8.2 per cent.


While evaluating the performance and effectiveness, the sector analysts review the operating cost as a percentage of operating income. During 1998 operating cost of all the banks has increased as compared to last year. Habib Bank AG Zurich appears to be the most efficient, followed by ANZ Grindlays, Bank of America and Standard Chartered Bank.


It is clear that reduction in profit margin of foreign banks for the year 1998 was not due to any sluggishness on the part but result of the shift in GoP policies. However, economic slowdown and downturn in Pakistan's external trade made an impact on their operation. Trade finance was a key area of strength for these banks. It is expected that once the economic activities become normal their profitability will also improve.

In some cases there was shrinkage in balance sheet footing. The sector experts say that a sharp shrinkage in this footing is expected over the next couple of years. This shrinkage is not due to economic conditions but mainly due to shift in the strategy of these banks. It should be a matter of concern for the GoP and its policy planners. The sale of loan assets by foreign banks to NCBs and listed banks may allow them to maintain capital adequacy ratio above minimum required level. However, the natural fallout of this move would be the down-grading of Pakistani banks. This would further dampen the prospects of privatization of NCBs.

The GoP should also take a cue from this strategy of foreign banks. Their strategy highlights the apprehension that Pakistan will not be able to meet its external debt servicing obligations in the post 2000 period and the country will be, once again, forced to demand rescheduling. The central bank has been, so far, able to control exchange rate volatility in the recent months. However, it may not be able to continue its endeavor for a long period in the absence of significant increase in the inflow of foreign exchange. Forex demand for trade-related activities and repayment of commercial debts cannot be capped for a long time. If the GoP wishes to accelerate the GDP growth rate, the central banks needs more and more forex reserves to maintain exchange rate at a realistic level.

At the same time one should not take any cue of future prospects for these banks from the results posted by Citibank. The case is termed by the banking sector analysts as 'big bath'. It was one time effort to clean the slate. Profitability of the Bank is expected to become 'normal' in the following years. This conviction is arrived at while looking at the results of Emirate Bank. There was a clear message that the banks are able to redefine their strategy to changed environment and ready to play proactive role have better prospects for turnaround.

To sum up, there are tremendous opportunities for these banks for turnaround if they use their technological advantage. On line and tele-banking and ATM facilities have helped them in overcoming the inherent disadvantage of limited number of branches. Using their existing base and by upgrading their present facilities, these banks can introduce e-commerce by creating a global database on Pakistan's external trade and initiating trade transactions and credit rating of foreign trade partners. All these activities will help in increasing their international trade financing activities in Pakistan.

The most interesting aspect while preparing this report was that no foreign bank head was available for interview unlike previous years. Be that as it may be, it is understandable due to the sensitive nature of negotiations between the GoP and these banks for the rescheduling of commercial debts

According to suggestions, made by Bank for International Settlement in Switzerland (BIS), commercial banks will have to risk-weight each loan in order to assess their risk-weighted capital requirement. Obviously, loans to GoP controlled entities will be weighed according to sovereign risk rating. Therefore, in Pakistan's case, if banks rating is like near default, it means foreign banks will need to have additional capital put aside against loans to Pakistan's public sector companies.