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Provisions against non-performing loans also to affect profit

May 20 -June 02, 2002

The Supreme Court of Pakistan had granted the GoP one-year extension, until June 30, 2002, to implement Riba free banking system in the country. The deadline was extended to give time to the GoP to overcome technical, legal and constitutional problems. The banking sector also got a sigh of relief at being saved from the spectre of finding themselves at odds. This was a temporary relief but not enough seems to have been done till now.

According to some sector experts, "It seems that all of us have been failing in implementing Riba free banking system in the country. Whether or not there was a court order, our aim should have been to eliminate the element of Riba from the economy. However, now we are trying to evolve a dual system, continuation of conventional banking system as well as Riba free system. It seems that we are not serious in introducing the system based on Sharia."

A review of the performance and problems faced by commercial banks indicates a few major issues, shrinking spread, ballooning non-performing loans, increasing provisions and deteriorating profit margins. Most of these issues are the outcome of slow pace of economic activities, partly due to synchronized global recession. The lower private sector credit demand is partly due to low economic activities and partly due to external shocks, the situation in Afghanistan and tension on borders with India.

According to some sector experts, "Lower demand for funds from the private sector or commercial banks suffering with 'surplus liquidity crisis' is a problem, but of lower magnitude. The real issue is shrinking spread, mainly due to declining yield on T-Bills." Commercial banks have always invested heavily in government securities and paid less attention to private sector needs. However, with the shift in GoP policy and its lower borrowing and efforts by the central bank to curtail average lending rates, commercial banks are in a fix. While the average lending rates, at present, range from 8 to 10 per cent, the banks are still carrying the load of expensive deposits.

The other factor which is responsible for reduction in spread is substantial investment in technology and branch infrastructure in the recent past. The effort to solicit more deposits, provide better services and above all retain customers, most of the commercial banks were forced to invest heavily in technology. However, it is taking time to yield the desired results, mainly due to low literacy level in the country. People still prefer to visit bank branches and do not use ATMs or phone banking. The same also goes true about credit cards. Commercial banks have invested heavily in creating enabling environment but people still wish to execute cash transactions.

The general perception among the account holders is, "The banks may have invested in technology to provide better services, the reality is contradictory. On-line banking is limited to a few branches and even fewer cities. Some of the banks even charge a fee for an ATM card. Credit card bills include retail transaction fee and what not. These institutions are simply ripping off the customers."

According to a report by IP Securities, non-performing loans as at March end this year were around Rs 278 billion. While the principal amount constituted 72 per cent, interest amounted to balance 28 per cent. The lion's share pertains to NCBs and shows an increase of 10 per cent during July-March period. The share of foreign banks and private banks has always been low. However, the infected portfolio of private banks has went up by 63 per cent during first nine months of current fiscal year. Whereas the share of foreign banks has gone down by 44 per cent.

According to another report by KASB, "A welcome revision in the reporting requirements of commercial banks has been the mandatory disclosure of the breakdown of non-performing advances in terms of their classification. Based on a sample of nine listed banks, 70 per cent of their non-performing advances has classified as 'loss', which requires 100 per cent provisioning less collateral. This amounted to Rs 15.64 billion against which the banks have provided Rs 8.77 billion."

In the last budget the GoP decided to cut down tax rate on commercial banks. Another cut, of the same magnitude, is expected in 2002-2003 budget. While the reduction in effective tax rate is expected to increase amount available for distribution among the shareholders, the above mentioned issues would erode the advantage. Therefore, an overall reduction in dividend payout by commercial banks for the year 2002 cannot be ruled out.