Banks must avoid reckless lending and offer investment portfolio for small depositors too




Sep 29 - Oct 05, 2003





In the declining interest rates scenario people with small savings are very upset. Retired people and widows who have been investing in various products offered by National Savings Scheme (NSS) are feeling the brunt. The government has promised to offer specific products for these disadvantaged groups. However, the investment by nouveau riche in NSS has forced the government to review its earlier decision. Till the government come up with a plausible solution, the disadvantaged are expected to continue to suffer.

Until recently the average lending rates were high because the GoP was the biggest borrower. Due to huge budget deficit, heavy load of internal and external debt and ever-increasing debt-servicing requirement, the GoP was forced to borrow at very high interest rates. The level of uneasiness could be gauged from the fact that at one time the cutoff yield on treasury bills went up to as high as 12.75% per annum. It looks colossal when compared with the yields being offered at present.

The exceptionally high return offered on government securities, also offering the least risk, inculcated the negative psyche in management of commercial banks. Instead of lending the funds to industrial and commercial entities, the banks chose to invest in government securities. To the extent that even at present, bulk of their investment is still in these securities.


As the situation changed in the post 9/11 era and government became lesser dependent on borrowing from commercial banks, the interest rates started declining. With the improvement in foreign exchange reserves, reprofiling of external debt and reduction in debt servicing charges, the GoP also started retiring its expensive debts. With the reduction in the GoP's appetite for borrowing, the central bank also expressed its determination to bring down average lending rates in the country.

While there was pressure on commercial banks to bring down lending rates, they decided to curtail return on deposits much sharply as compared to the reduction in average lending rates. At present, the average return on deposits range from 1.5% to less than 5%, depending on the tenure, but average lending rates are still as high as 8-10 per cent per annum. Depositors, particularly the smaller ones, often complain about the disparity between borrowing and lending rates of the banks. There seems to be no justification for keeping spread (the difference between borrowing and lending rate) so high.

According to banking sector experts there are two reasons for the higher spread. First, the nationalized commercial banks are still carrying a heavy load of non-performing loans, they need a thicker cushion to ensure appropriate provisioning. Second, listed banks are busy in expansion and consolidation and need extra funds. Therefore, it may not be wrong to say that while commercial banks are cleaning their slate, expanding and upgrading their infrastructure, depositors are being deprived of modest return. The employees and shareholders are also benefiting from the growth of banking sector.

Dividend factor

The brunt becomes more pinching when commercial banks distribute fabulous dividend among the shareholders and pay only a meager return to depositors. According to a disgruntled depositor, "The real money comes from small depositors running into billions. The so-called large depositors are also the biggest borrowers. While the banks are never tired of lending money to the big fishes, the prudential regulations and collateral-based lending does not allow small depositors to borrow even a penny from the banks."

Another depositor says, "Looking at the pathetic rate of return on deposits, I do not wish to keep my money with any of the banks. However, I am forced to keep my money in a bank due to precarious law and order situation. Therefore, I do not hesitate for a second in saying that commercial banks take the fullest advantage of the disadvantageous position of smaller depositors. The bank employees get handsome salaries and maximum fringe benefits, which often eats up bulk of the income of most of the banks. I would not name the bank, but I was surprised when I found out from its Annual Accounts that operating expenses ate up almost the entire income. I believe, this is not fair either with the depositors or the shareholders."




However, management of banks have their own rationalization for paying return that doesn't commensurate with the inflation rate in the country. The copy book reply is, "The banking system in the country is going through a transitory period. We are moving away from stand-alone branches to online banking and have started offering a host of other banking related facilities. This could not be achieved without making substantial investment in technology and improving branch infrastructure. Therefore, operating expenses seem to be on higher side. However, we are making the best efforts to bring the mediation cost. The cost cannot be brought down overnight because banks are still carrying the load of expensive deposits."

A large number of the depositors doesn't accept this rationalization. They say, "It may be true that some of the banks have invested heavily in technology and also succeeded in improving the quality of services they offer, but the excuse of higher mediation cost is totally unacceptable. The banks, particularly nationalized commercial banks have billions of rupee in deposits, which are cost free. The sole reason for their inability to pay a modest return to depositors is heavy load of non-performing loans (NPLs). The load of NPLs is the result of reckless lending in the past, either due to political pressure or corruption. While only a few have benefited, masses are still paying the cost through their noses."

According to a banking sector expert, "One of the prime reasons for poor rate of return on deposits is the prevailing psyche of management of commercial banks. They continue to earn, whatever they could, from investing in government securities. They are either shy or afraid of investing in other lucrative investment options. It may be true that investment in government securities is virtually risk free, but it is not the only option. If banks start playing proactive role in exploring new options their income can improve and they can also distribute improve return on deposits. However, to do this they have to take pains for which no one seems to be ready."


A closer look at the profit and loss statement of commercial banks show that only those banks have succeeded in improving their income where management took the initiative of exploring new options. Some managed to increase their profit by improving fees-based income and others by increasing their exposure in equities market. Increase in fee-based income could only be achieved by offering prompt and superior quality services and return on investment in equities could be improved by hiring the new expertise. However, the most disappointing fact is that despite improved income these banks were not ready to offer better return to depositors.

According to a banking sector expert, "Despite improved profit the banks are not ready to improve return on deposits. The unwillingness seems to be due to 1) they don't want to receive more deposits and 2) their perception that the earning from fees-based services and investment portfolio are more like windfall." However, such thinking is not only highly unprofessional but also shows the lack of their confidence in their own capabilities and the strength of Pakistan's economy.

According to a seasoned banker, "Despite such a large influx of funds in the banking system, we are not sure how long the money will stay in the system. First, the amounts may be huge but the period for which they stay in accounts are highly unpredictable. Second, it is often not possible to find where the large withdrawals/transfers go. It is often said that the funds are going to equities market or real estate markets but no one can say about the ultimate destination with full confidence. The quick and large deposits and withdrawals do not allow the management to make long-term commitments. Therefore, despite improvement in the bottom line, banks are not willing to increase return on deposits."


There is general complaint that masses are not benefiting from huge foreign exchange reserves or current account surplus. Some of the economists have been suggesting that the elected government should come up with some 'popular policies' and initiate dispersion of funds at concessional rates to those who cannot borrow under the prevailing prudential regulations. However, they tend to forget the colossal damage caused to commercial banks by 'Yellow Cab' and 'Green Tractor' schemes.

The banking sector experts strongly believe that the successive governments in Pakistan have often misused depositors' money. The nationalized commercial banks were often used to provide employment for 'party supporters and favorites', loans were extended as political bribe and bankers were forced to create economic justification for lending to an unviable business or industrial project. These practices not only caused damage to the financial health of these institutions but also proliferated corruption among the professional bankers.



Yet another blatant misuse of depositors' money was utilization of foreign currency deposits by the successive governments. When economic sanctions were imposed on Pakistan in May 1998, the then elected government of Mian Mohammad Nawaz Sharif froze the foreign currency accounts fearing massive withdrawal. The fact was that the various governments have already utilized bulk of these deposits and the only face saving was to freeze these accounts. The freezing of foreign currency accounts has caused the worst damage to depositors' confidence in local banking system.

The lack of confidence in banking system is also exhibited from the nature of deposits maintained with the banks, bulk of these comprise of short-term deposits. The very nature of deposits does not allow the banks to make any long-term commitment. While the bankers attribute the present situation to lack of confidence of depositors in banking system, depositors have their own reasons for not depositing funds for longer tenure. The worst complaint is, "Banks thrive on small savings but offer hardly any regard to this 'pressureless' group. The latest attempt to keep the small depositors away from banks is the imposition of service charges for not maintaining the stipulated minimum balance in the accounts."


The other common complaint is that banks are penalizing the depositors under the grab of 'use of technology'. Depositors are pursued to acquire ATM/Debt Cards offering tremendous convenience. These cards can only be acquired at cost and there is a fee for each transaction. The fact is that banks want to retain money for as longer a period as possible but at the same time do not like accountholders visiting branches for withdrawal of small amounts. Accountholders are also told to use an ATM of a network, in case they cannot find a dedicated machine in close proximity. However, very few people know that they pay Rs 15 per transaction being the service charge for using the network machines.

Many disgruntled depositors have started looking for new options to earn a modest return on their life savings. During the last couple of years lots of funds have found their destination in equities market. Some investors have made a killing (unbelievable profit) but many have lost their entire amount. Lately a lot has been propagated about the benefits of investing in equities. However, it is regrettable that all those who have lost the money read the first line of the story and never bothered to know about the potential pitfalls.

Depositing the amount in a bank for a specified time period is very simple but picking up the right scrip is an uphill task. While it is said that return on equities, at present, is far higher than the return on deposits it may prove totally incorrect if a wrong investment decision is made. Most of the time investment decisions go wrong because these are based on partial information or inadequate homework. For example, a credible dividend payment record does not provide a guarantee that the company would not incur loss in future. The dividend pay out percentage without looking at quoted price is totally meaningless.

Investing in equities demand reasonably good knowledge about the company, the sector or industry, the company belongs to, management and above all dividend payment ability of the company. Since it is almost difficult for an individual investor to acquire so much information, investors normally look towards a brokerage house enjoying integrity and credibility. The common saying is that the investor must consult more than one broker but should always make his/her own decisions.

Some investment advisors are of the view that small investors should not invest directly in shares of companies. Since the amount is small, an individual can buy shares of one or a couple of companies. In case the said company faces any problem the entire investment can be at stake. They suggest that small investors should preferably invest in shares of mutual funds. The mutual funds are managed by professionals and have a diversified portfolio. Therefore, these are better hedged against market volatility, poor performance of one of few companies can continue to pay dividend even in difficult times.

For people enjoying larger amounts at their disposal, they suggest maintaining a diversified portfolio comprising of equities and fixed income securities (term finance certificates). The underlined caution is that investors should not fall pray to traders' modus operandi. Traders normally buy/sell shares on speculation. The investor should chose scrip only on the basis of economic fundamentals and earnings potential. Another advice is that investors should only buy shares that are registered at Central Depository Company (CDC) and should also maintain their Investor Account with the depository.




Equities may offer attractive yield but till such time investors develop the required expertise, depositing money with banks would continue to be a preferred choice. Therefore, banks should follow what they have been preaching to depositors, "one should not discontinue banking during good days".

It may be true that banks are sitting on tonnes of deposits but should not follow the policy of discouraging the small savers to keep their money in banks. It is heartening to note that central bank has now made it mandatory for the banks to lend certain percentage of their total advances to agriculture sector, small and medium enterprises and also being pursued to actively participate in consumer finance and housing finance.

Auto leasing, consumer finance and loans for purchase/construction of housing units are normally provided at interest rates ranging from 8-12 per cent per annum. Whereas, depositors are being paid around 1.5 to 5 per cent return annually. This shows that the spread is very high. Therefore, if the banks reduce their investment in low yielding government securities and more actively pursue consumer and housing finance they can improve their earnings and also afford to pay higher return to depositors.

The successful experience of some of the banks making investment in equities and term finance certificates suggest that other banks should also develop their investment portfolio and expand, if they already have. However, it is a rather tricky business and may lead to loses if the person heading investment portfolio management also starts trading in his/her account. Though, monitoring is difficult but one thing can always be ensured that he/she does not 'park' the bad investment in bank's portfolio.

Last but not the least, the management must not discourage people from keeping their money with the banks. They should rather try to expand their advances, develop and expand investment portfolio to earn higher return on the deposits available with them. Once upon a time the job of development officers, working for a bank, was to solicit new deposits. Their new role should be to increase lending by the banks. However, no bank should indulge in reckless lending.


The ongoing phenomenon of mergers and acquisitions in banking sector is best explained by Aquib Memboob Elahi, Head of Research, ADK Securities. He said' "We expect the death of commercial banks as we know them and bid welcome to 'financial supermarkets'. The concept of financial super markets is not the brainchild of Aquib. Mohammad Ali Khoja, Chairman, PICIC is the pioneer of this concept. Following this strategy PICIC took over Gulf Commercial Bank, established Leasing Division within PICIC and acquired management control of some of the ICP mutual funds. Others following the strategy are Pak Kuwait Investment Company, Khadim Ali Shah Bukhari & Company and Faysal Bank. The concept has already been accepted and yielding positive results. It is expected to further proliferate to achieve greater synergy. More mergers and acquisitions are expected in the days to come.