Domestic Banks in Pakistan

Strong rupee deposit base, prudent banking and vision of management responsible for better results

By SHABBIR H. KAZMI
July 26 - August1, 1999

Financial results for the year 1998 clearly indicate the potential for domestic banks that are prudently managed and have a lucid business strategy. Most of the commercial banks emerged stronger during 1998. They displayed the ability to adopt quickly to the changed scenario after the post-nuclear situation and capital controls. This demanded shift from relying on foreign currency accounts (FCAs) to rupee deposits.

At the same time, 1998 also highlighted that there were two distinct categories of listed banks. Almost all the listed banks, with the exception of Muslim Commercial Bank, are the product of the 1991 PML government policy of allowing new private sector banks. By 1998, one category of banks has emerged as viable business entities having management quality, deposit base and franchise as well as sufficient capital and resources to move confidently into the next millennium. The other category is that of the 'also-rans' where the performance has been below expectations due to poor management, imprudent lending and lack of cost control or simply unclear business strategy. This category needs urgent restructuring through mergers and acquisitions, changes in management and board of directors. The central bank is actively using its regulatory influence to stabilize the long-term future of these latter institutions and thus fulfills its role of ensuring financial system stability and protection of depositors.

Even more successful banks have a big challenge ahead. The advent of information technology and its application to financial services mean that a bank can no longer be defined as 'confined to the four walls of its branches'. The 'brick and mortar branch' banking is rapidly giving way to electronic delivery system. These include ATMs, debit and credit cards, and increasing internet based secured time banking. Whether and when domestic banks embrace these new trends and transform them into profitable business lines is probably the single most important criteria during the next ten years.

A review of annual reports of commercial banks strengthens the belief that the banks enjoying a strong rupee deposit base will continue to out-perform the banks which may have larger capital base. For the sake of illustration, a comparison of the results of Muslim Commercial Bank (MCB) and Faysal Bank highlights the importance of deposit base viz-a-viz capitalization.

 

Muslim Commercial Bank has a paid-up capital of Rs 1.8 billion and shareholders equity of Rs 3.6 billion. Faysal Bank has a paid-up capital of Rs 1.2 billion and shareholders equity of Rs 2.1 billion. However, there is world of a difference in the deposit base of these two banks. The deposits of MCB at the end of 1998 were Rs 123.8 billion. Out of these, deposits to the tune of Rs 105.5 billion were in local currency and Rs 18.27 billion were in foreign currencies. Whereas the deposits of Faysal Bank were only Rs 18.7 billion at the end of 1998. Out of this Rs 11.8 billion were in foreign currencies and only Rs 6.9 billion were in local currency. However, MCB has a long history of operation as compared to Faysal Bank. While Faysal Bank has not been able to grow its deposits to optimally leverage its capital structure, MCB is, arguably, overstretched.

Another important observation is that freezing of foreign currency accounts (FCAs) resulted in large scale conversion which put serious pressure on the liquidity of Faysal Bank because of its extraordinarily high dependence on FCAs. This also impaired profitability of the Bank. Total income of the Bank was Rs 2.203 billion in 1998 as compared to Rs 2.029 billion in the previous year. But, return on deposits and mark-up on borrowings took a jump from Rs. 1.73 billion in 1997 to Rs 2.080 billion in 1998. The balance sheet footing of Faysal Bank also shrank due to a loss before taxation amounting to Rs 644 million. This loss was mainly due to the provision against non-performing financing amounting to Rs 661 million and provision against diminution value of investment other than NIT units. Though, there was also pressure on MCB for the withdrawals from FCAs, it managed to keep its total deposits more or less at the level of previous year — there was a decline of 0.48 per cent only. The cost of funding also increased in case of MCB, though to a much lesser extent but the Bank managed to declare 17.5 per cent cash dividend at the end of the year.

A review of operations of Indus Bank results indicates the most un-impressive track record. Despite the SBP requirement that minimum paid-up capital of a listed commercial bank should be Rs 500 million, Indus Bank failed to meet this requirement. Its paid-up capital was Rs 300 million and shareholders equity was Rs 322 million only on December 31, 1998. The balance sheet shows a subordinate loan of Rs 27 million. This represents an equivalent sum of US$ 647,000 received from the Franklin Credit and Investment Company Limited — an associate undertaking of the sponsors. This subordinate loan has to be converted into equity in accordance with the requirement of the SBP.

As against a paid-up capital of Rs. 300 million the balance sheet footing is just Rs 349 million. For the year 1998 the Bank has posted a pre-tax profit of Rs. 6.5 million. This was possible only because of 'other income' of Rs 18.4 million. Otherwise, the operating expenses amounting to Rs 109 million were more than the income of Rs 102.9 million. Clearly this is a case for change of management and possibly takeover of control by the central bank to protect the depositors.

Prudential Commercial Bank has posted a disappointing after tax profit of Rs 59,000 only for the year 1998 as compared to a profit of Rs 24.7 million for the previous year. This dismal profit was due to increase in administrative expenses and provisions against non-performing advances. Administrative expenses increased from Rs 95.9 million in 1997 to Rs 135 million in 1998. Whereas the provisions against non-performing advances jumped from Rs 30.5 million to Rs 78.6 million at the end of the year.

While the Bank managed to comply with the SBP requirement by raising the paid-up capital to Rs 500 million, this was possible only through induction of two new members on the Board of Directors. Mrs. Sanobar Akhtar Yacoob and Mohammad Salman Rashid retired and Tahir Hassan and Mohammad Asif Dar are the new incumbents. It is incredible how any business entity can continue operating as a going concern with results like this.

Bolan Bank has the largest network of 50 branches among the listed commercial banks — after Muslim Commercial Bank. The Bank was able to fulfil the central bank requirement for raising the paid-up capital to Rs 500 million. This was made possible through issue of Rs 46.7 million Bonus Shares and Rs 161.25 million Right Shares. Due to an after tax loss of Rs 13.6 million the total reserves were reduced from Rs 119.7 million in 1997 to Rs 81.6 million at the end of 1998.

A factor responsible for the disappointing performance of Bolan Bank was substantial increase in cost of funding. While the deposits of the Bank reduced by approximately one billion rupees or 10 per cent of total deposits held in 1997, the Bank was forced to pay higher cost of fund, which went up from Rs 296 million in 1997 to Rs 408 million in 1998. This eroded the advantage of increased mark-up/interest and/or return earned which increased from Rs 539 million in 1997 to Rs 623 million in 1998 as the overall spread narrowed. While the Bank was able to increase its investments from Rs 1.44 billion to Rs 1.63 billion the advances declined from Rs 3.14 billion to Rs 2 billion. At the same time borrowings from other banks and other liabilities also registered significant increase.

According to its annual report, paid-up capital of Metropolitan Bank was also below the specified limit of Rs 500 million as on December 31, 1998. However, Rs 125 million from earnings of 1998 has been appropriated for the issue of Bonus Shares. The prudent but conservative approach of the management has been the main reason behind improving pre-tax income of the Bank. While the efforts to increase deposits helped the Bank to earn better returns, the Bank was also able to contain its cost of intimidation of funds. The cost/return on deposits and borrowings remained more or less at the level of 1997.

Union Bank, sponsored by the Saigol Group, has also witnessed a change at the Board of Directors. Mrs. Sehyar Saigol and Mrs Amber Saigol have been replaced by Qazi Mazharul Haque and Syed Salman Ali Shah. The change confirmed the fears expressed in the past that the Group was losing control in the management of the Bank. PAGE reported the possible change in its Issue No.6 of 1999 while forecasting the possible results of listed commercial banks. The change took place shortly after the publication of the report.

Askari Commercial Bank offers glimpse of steady growth since commencement of operations. The gloomy economic and financial climate affected the performance of all financial institutions. However, the Bank was able to minimize the impact by increasing deposits and business volume while absorbing the adverse impact of increase in cost of deposits and fall in yields on government securities. In view of the prevailing market conditions, the Bank further strengthened its credit appraisal, sanctioning and monitoring systems. Most of the advances are trade related, short-term and are secured by cash or readily cash-convertible securities and collaterals.

Pre-tax profit of Bank AL-Habib in 1998 was more or less at the level of previous year. However, after tax profit improved from Rs 198.6 million in 1997 to Rs 203.1 million in 1998. This enabled the Bank to announce 10 per cent cash dividend and 32 per cent Bonus Shares from the income of the year. Shareholders equity also increased from Rs 851 million to Rs. 1.016 billion. While investments of the Bank decreased, advances increased. While there was an increase in mark-up/interest income the increased cost of funding reduced the spread. The administrative expenses went up from Rs 264 million in 1997 to Rs 308 million in 1998 However, the reversal of provisions against non-perforing advances amounting to Rs 18.4 million improved the after tax profit.

The capital and reserves of The Bank of Punjab increased from Rs 1.677 billion in 1997 to Rs 1.795 billion in 1998. Similarly deposits, investments, advances and total assets showed improvement culminating in a pre-tax profit of Rs 135.6 million. The Bank's capital adequacy ratio at slightly more than 18 per cent seems also comfortable. While the overall performance was satisfactory, the loss of potential revenue on account of dividend income from NIT adversely impaired the target. In line with its commitment to provide financial assistance to the priority sectors, Kissan Dost Agriculture Scheme and Green Tractors Scheme, the Bank made increased lending of Rs 547 million during 1998.

Spread of Platinum Commercial Bank reduced but fee-based income increased from Rs 81.5 million in 1997 to Rs 128 million in 1998. However, this advantage was eroded due to increase in administrative expenses and provisions against non-performing advances. The reduction in pre-tax profit from Rs 106.7 million in 1997 to Rs 79 million in 1998 also reduced the after tax profit and the Bank did not declare any cash dividend to the shareholders.

Prime Bank could not remain immune to the economic downturn. Not only the spread shrank, the fee and commission income also dropped. The Bank's management increased its specific and general provisions for its advances by making maximum possible provisions out of current year's profit and augmenting this by a further sum of Rs 400 million through transfer of an equivalent amount, less deferred tax, from the general reserves. As a result, the Bank's profit before tax came down from Rs 302 million in 1997 to Rs. 170 million in 1998.

The freezing of FCAs and later on directives to liquidate advances against these deposits disturbed liabilities and assets volume of most of the commercial banks. Despite the changed scenario Soneri Bank not only managed to increase deposits but also changed its composition. Rupee deposits increased from Rs 3.631 billion in 1997 to Rs 7.275 billion in 1998 and FCAs reduced from Rs 6.214 billion to Rs 3.8 billion during the corresponding period. The Bank issued 10 per cent Bonus Shares out of profit earned in 1998 to comply with SBP regulation and also announced 10 per cent cash dividend.

The management of Habib Bank termed that 1998 was the year of a complete turnaround. In the backdrop of a difficult economic scenario and increasingly intense competition the Bank posted a pre-tax profit of Rs 1.2 billion in 1998 as against a pre-tax loss of Rs 3.4 billion in 1997. Deposits increased by 13 per cent, advances grew by 14.5 per cent resulting in 15.7 per cent increase in total assets of the Bank as compared to previous year. Bank's revenue increased by 52 per cent due to excellent performance of Retail Banking Group, enhanced business in the Corporate Group and greater stress on fee-based income. Side by side, stringent cost controls helped in curtailing administrative expenses which came down from 4 per cent in 1997 to 3.5 per cent in 1998. In a nutshell, all the efforts helped in improving capital adequacy ratio from 5.5 per cent in 1997 to about 11 per cent at the end of 1998.

Despite the economic slow down in the domestic and world economy, United Bank was able to post an operating profit before provision of Rs 133 million for 1998 as against a loss of Rs 3.7 billion for the previous year. Even after making various provisions, the Bank was able to post an after tax profit of Rs 3 billion because it was able to recognize deferred tax credit of Rs 9.1 billion relating to a portion of tax losses. To strengthen the Bank, the central bank injected Rs 21 billion equity in May 1998. This, combined with surplus on revaluation of fixed assets and recognition of tax credits on prior year losses, enhanced the shareholders equity from negative Rs 18.5 billion to positive Rs 8.1 billion. Consequently, the capital adequacy ratio improved to over 10 per cent. This ratio for the Bank, exceeded the Bank for International Settlements standard which United Bank was expected to meet by year 2000.

Allied Bank was able to increase fund-based income but there was a considerable decline in fee-based and services related income. The Bank posted a pre-tax profit of Rs 170 million in 1998 as a profit of Rs 229 million in the previous year. However, due to taxation of Rs 150 million in 1998 as against Rs 15 million in the previous year, after tax profit reduced to a meager Rs 20 million. While the financials of the Bank may look strong, the conflict between various employee shareholder groups has been a source of concern. This was said to be reason for delay in the sale of remaining government stake in the Bank.

The suggestion for mergers and acquisitions, considering the year 1998 was not a normal year, may look a little outrageous. However, if one looks at the operations and the results of Indus Bank, Prudential Commercial Bank, Metropolitan Bank and Bolan Bank the recommended strategy is to amalgamate these banks with some strong domestic or foreign commercial banks.

The composition of Boards of quite a few listed banks has undergone drastic changes since commencement of their operations. The recent amendment in law is also to facilitate such changes. Some of the banking sector analysts say that the probability of takeover of controlling shares of above mentioned banks by some large size domestic banks and/or foreign banks should not be ignored.

The central bank not only allowed the Saigol family to transfer part of its share holding to some foreign groups but also amended the law regarding share holding by foreign investors in commercial banks subsequently. According to some banking sector analysts similar changes at the boards of other commercial banks are also expected in the near future.

The change of status of Faysal Bank is on the record. Faysal Islamic Bank of Bahrain entered Pakistan as a foreign bank. Subsequently, Faysal Bank was incorporated in Pakistan to takeover the operations of Faysal Islamic Bank in the country. Analysts say that since opening of new branches has become 'expensive' for foreign banks operating in Pakistan, acquiring controlling shares of smaller domestic banks is a more convenient route to expand the branch network.

Besides, sale of Habib Credit & Exchange, through privatization, and sale of shares of the Schon Group to an Oman based group, indicates strong interest of foreign investors in Pakistani commercial banks. Some foreign investors also made an attempt to takeover controlling shares of Islamic Investment Bank. As the Bank was in desperate need for funds, a 100 per cent Rights Issue was announced. This was fully underwritten by a group of foreign investors. Since hardly any subscription against the Rights was expected as the share of the Bank was selling around Rs 3.50 at that time, it was expected that the whole Rights Issue would be taken up by the underwriter. However, the foreign underwriter refused to fulfil its obligation after imposition of economic sanctions on Pakistan.

The question is, however, why should any foreign investor be interested in making such a deal? Analysts say that no fresh permission for establishing a commercial or investment bank is expected even in the distant future. Therefore, if a foreign investor/group is keen in entering into Pakistan acquiring controlling shares of a financial institution is the only possible way. By acquiring the controlling shares of a smaller bank, having reasonable number of branches, foreign investor can get an immediate exposure in Pakistan.

The amendment regarding mandatory disclosure, if someone acquires more than 5 per cent shares of a commercial bank, clearly indicates that with the broadening of capital base to minimum Rs 500 million the share holding of original sponsors can dilute considerably and this has indeed been the case. Licences to the original sponsors were given after evaluation of their financial strength and credibility. Since the sponsors have been gradually losing the controlling shares, it has also become the responsibility of the SBP to check and approve changes in the boards of commercial banks for the protection of depositors and shareholders..

All the listed commercial banks, except MCB, have commenced their operations around the same time. It was the management outlook, policies and the level of prudence which made the difference. While some of these banks have grown in size (paid-up capital, branch network, deposits and advances) others have failed to grow. The working environment is the same for all the players. Therefore, one can say that it is the management style which made the difference. The change of sponsors and shift in management policies at Gulf Commercial Bank (previously Schon Bank) is the single largest illustration of this belief.

The shares belonging to Schon Group were sold to present sponsors of Gulf Commercial Bank in 1997. The Bank posted a pre-tax loss of Rs 100 million for that year. It was part of 'cleansing the slate' exercise. Although, 1998 was a more difficult year when compared with 1997, the Bank was able to post Rs 126 million pre-tax profit. It should be kept in mind that while the new sponsors got control of the Bank in 1997, the change of name took place in July 1998. Therefore, it will be right to say that a shift in policies and quantitative change in risk profile was responsible for the turnaround of the Bank. A lot of credit goes to Badar-ud-Din Khan who did not succumb to the pressure of previous sponsors and continued to work as a dedicated professional. In recognition of his pursuit to protect the interest of depositors and shareholders during a difficult time and his professional integrity, the new sponsors decided to allow him to continue his endeavor as president and CEO of the Bank.

Outlook

The SBP has reportedly turned down the request of Pakistan Industrial Credit and Investment Corporation (PICIC), National Development Finance Corporation (NDFC) and Bankers Equity to set up their own commercial banks. However, PICIC has been advised that instead of setting up a new commercial bank, it may purchase one of the existing banks on which SBP would have no objection. These financial institutions had sent the said proposal to SBP as their core business is at standstill due to non-availability of foreign credit lines and liquidity crunch.

The efforts to turnaround Habib Bank and United Bank would contribute in facilitating their planned privatization in the near future. As the same efforts are also being made to sell-off remaining shares of the government in Allied Bank. All these franchise are very strong, have strong rupee deposits and foreign operations. However, these banks have partly overcome the weakness of non-performing loans. As the concerted efforts continue and economic revival takes place the probability of earlier privatization brightens as the investors are keen in acquiring the franchise despite non-performing advances. The expeditious recovery of these bad debts is possible only with the help of the government.

Listed commercial banks can be divided into three categories, working good, on the border line and not working good. It is the responsibility of SBP to monitor them carefully and minutely. A large percentage of their share holding belongs to individual investors who hardly have any say in day to day management. Above all, these institutions are custodians of billions of rupees of small depositors. It is the responsibility of management of these institutions to act in the most prudent manner. The regulators should not allow any sluggishness on the part of sponsors, board of directors and management. This country has witnessed a number of financial scams including Mehran Bank scandal. No one should be allowed to rip-off depositors and shareholders of financial institutions.

Non-performing loans, which have virtually destroyed the NCBs, have also become a serious concern for the listed banks. While part of the overdue amount is the result of circumstantial default, it is necessary to amend the existing laws for the takeover of defaulting companies, appointment of administrator and ultimately recovering the overdue amount through sale of assets of these companies. Despite award of decrees most of the time the lenders are not able to get the physical control of the assets of defaulted companies. The lengthy legal procedure and hurdles in the recovery of overdues have been responsible for the transfer of sickness of industrial sector to financial sector. This transition should be stopped immediately. The strength of financial system is a must for the economic development of the country.

Mergers and acquisitions in commercial banks sector are desired to achieve greater synergy of the system. The strength of system is more important than the number of institutions. The immediate advantage of mergers and acquisitions will be, improved use of available resources, reduction in operating cost and optimization of limited savings in the country. The reduction in lending rates, without jeopardizing the return to depositors, can only be achieved by reducing operational cost. At the same time commercial banks should invest more money in technology to improve quality of services offered by them. In the near future banking will not be confined to banking hours or four walls of branches. ATM, telebanking, credit cards, on-line banking encourage the banks with limited number of branches to clinch larger share of the market.

Operating Profit before Tax

 

Operating Profit before Tax

                                  1998       1997       1996

Rupees in millions

IB	7	7	3
MTRO	573	475	353
ACB	854	755	582
BAH	445	442	341
PRME	(230)	302	252
FB	(637)	784	697
SB	335	441	380
PLAT	79	107	104
GCB	126	(100)	172
BAF	68	7	117
UB	57	243	302
PRUD	12	61	63

 

Deposits

1998 1997 1996

Rupees in millions

PRUD	4,077	3,005	2,091
GCB	5,829	4,778	3,102
MTRO	10,715	9,608	5,834
SB	11,075	9,845	6,655
ACB	23,417	19,482	14,126
PLAT	4,555	4,065	2,841
BAH	13,251	13,445	8,573
BAF	11,878	9,019	7,980
PRME	7,904	6,866	5,311
FB	18,744	15,755	12,770
UB	10,768	11,695	8,944
IB	1,412	2,592	1,501

Assets

1998 1997 1996

Rupees in millions

PRUD	6,478	5,307	3,515
GCB	8,670	6,970	4,862
PLAT	6,632	5,588	3,793
SB	14,845	12,938	8,815
MTRO	15,256	13,496	9,104
ACB	28,562	24,025	17,906
BAH	16,897	16,515	11,248
BAF	14,321	10,527	9,606
PRME	10,123	8,999	6,939
IB	2,626	3,370	1,930
FB	23,522	21,272	17,536
UB	14,768	15,170	12,168

 

Investments

1998 1997 1996

Rupees in millions

MTRO	5,957	5,324	1,985
BAH	6,999	7,440	2,489
SB	6,142	4,918	2,211
ACB	13,886	11,773	6,180
PRME	3,655	3,601	1,979
UB	4,617	5,278	2,506
PLAT	1,512	1,785	915
GCB	1,338	1,088	920
PRUD	995	1,109	930
FB	3,615	5,356	3,658
BAF	3,406	3,349	3,641
IB	387	690	700

 

Provisions Operating Income

1998 1997 1998 1997

Rupees in millions

BAH	(5)	43	748	750
SB	12	23	610	675
ACB	101	193	1,524	1,409
MTRO	65	38	877	722
GCB	58	213	440	310
BAF	95	74	500	314
PLAT	56	18	260	236
PRUD	79	31	230	192
UB	293	40	791	713
IB	53	—	116	93
PRME	481	43	554	660
FB	999	144	848	1,352

Note: Operating income includes spread and non-funded revenue

 

Non-Funded Revenue to Operating Income

Non-Funded Revenue Operating Income

1998 1997 1998 1997

Rupees in millions

PRUD	120	82	230	192
PLAT	130	83	260	236
UB	387	347	791	713
MTRO	389	364	877	722
GCB	177	138	440	310
FB	336 390	848	1,352
IB	45	55	116	93
PRME	215	280	554	660
BAF	188 192	500	314
SB	227 303	610	675
ACB	554 384	1,524	1,409
BAH	226 178	748	750

Note: Operating income includes spread and non-funded revenue

Operating Cost Operating Income

1998 1997 1998 1997

Rupees in millions

MTRO	239	209	877	722
ACB	569 461	1,524	1,409
BAH	308	264	748	750
SB	262 211	610	675
PLAT	126 111	260	236
IB	57	86	116	93
PRME	303	315	554	660
UB	441	431	791	713
FB	486 425	848	1,352
GCB	255 196	440	310
PRUD	140 100	230	192
BAF	337 233	500	314

Note: Operating income includes spread and non-funded revenue

 

Return on Average Equity

Profit After Tax Equity

1998 1997 1998 1997 1996

Rupees in minions

BAH 203	199	1,016	851	718
MTRO 201	179	1,030	829	650
ACB 359	311	1,937	1,775	1,581
BAF 145	—	859	713	713
SB	145	172	970	875
GCB 52	(80)	595	580	661
PLAT 37	40	639	602	562
IB 1	—	322	321	350
PRUD —	25	564	364	339
PRME (96)	128	912	1,075	644
UB (106)	95	879	985	889
FB (333)	449	1,712	2,045	1,875

 

Average Earning Assets

Earning Assets

1998 1997 1996

Rupees in millions

MTRO	16,962	14,947	7,987
FB	20,985	18,691	15,342
BAF	12,839	9,203	8,056
BAH	17,354	15,117	10,303
PRUD	6,737	5,120	4,106
PRME	8,507	8,663	6,172
UB	13,431	14,072	10,792
ACB	25,150	21,925	16,065
PLAT	5,648	4,903	3,249
SB	12,808	11,161	7,316
GCB	8,406	6,206	3,995
IB	3,245	2,776	1,298

Note: Total assets exclude operating and other assets

Earning assets and total assets include repo transactions

 

Foreign Currency Deposits

1998 1997

Rupees in millions

IB	193	1,804
PLAT	1,319	2,476
PRUD	1,198	1,681
GCB	1,827	3,058
SB	3,800	6,214
PRME	2,733	4,163
UB	3,923	7,024
ACB	9,764	12,074
BAH	5,773	9,855
MTRO	5,497	7,034
FB	11,836	11,436
BAF	7,884	7,809

 

LEGENDS

ACB Askari Commercial Bank Limited

BAF         Bank Alfalah Limited

BAH Bank AL Habib Limited

FB        Faysal bank Limited

GCB Gulf Commercial Bank Limited

IB        Indus Bank Limited

MTRO Metropolitan Bank Limited

PLAT Platinum Commercial Bank Limited

PRME Prime Commercial bank Limited

PRUD Prudential Commercial bank Limited

SB        Soneri Bank Limited

UB        Union Bank Limited