Commercials banks should be allowed to invest more in the equities market


Dec 27, 2004 - Jan 02, 2005









Lately, banking sector in Pakistan has remained in limelight due to two factors: efforts to enhance paid up capital and adjust investments in equities. Incidentally both the requirements are part of central bank's efforts to consolidate the banking sector in the country. Arif Habib, Chairman, Karachi Stock Exchange asked the Prime Minister to consider enhancing banks' existing limited of investment in equities. However, the limit automatically increases, in term of number of rupees, with the enhancement in paid-up capital of commercial banks.

During more than one decade the banking sector in Pakistan has been undergoing a profound transformation, and if the existing scenario is any indication, the next ten years are likely to be just as exciting. The future of the industry is likely to be earmarked by increasing competition, further consolidation and continued growth in consumer financing. Additionally, the management of potential portfolio losses is also likely to be a key factor affecting the performance of the banking sector in the short to medium term.

The State Bank of Pakistan has instructed the commercial banks to raise their paid up capital. According to the notification, commercial banks are required to increase their paid up capital to 1.5 billion by 31-Dec-2004 and further increase it to 2,000mn by 31-Dec-2005. The step has been taken in an effort to increase the financial stability of the banks, but more so to consolidate the banking sector. It seems that the State Bank would like to see the smaller banks to be acquired by their larger counterparts.

Among the four major banks that are listed at the local stock exchanges, only National Bank of Pakistan and Muslim Commercial Bank comfortably meet the criteria. The other two banks are likely to issue stock dividend to meet the paid up capital requirement. It is believed that some of the banks have sought some relaxation from the State Bank and are likely to issue stock dividends along with their annual results to be announced in early 2005. However, some of the sector analysts believe that the announcement may come even before the year 2004 ends.

The combination of growing competition, falling margins, permission from the State Bank to enter previously restricted markets (such as the leasing sector) and the offering of various incentives by the government for amalgamation made it very lucrative for banks to carry out mergers and acquisitions during recent years. This consolidation drive is expected to continue in the foreseeable future, both within the industry and across the non-banking financial institutions. This assertion is based on three reasons: (1) a number of small banks have emerged during the past couple of years. Given the tough operating environment in the industry, they are likely to be acquired by their larger counterparts. (2) Banks are likely to continue exploring different avenues, including takeovers, to counter the continued ill effects of low spreads and (3) extension in the incentives for amalgamation of banks with NBFIs and insurance companies till June 2006.

Since the beginning of the year, stock market investments of the banking sector have declined significantly. This is a reflection of the imposition of a regulation whereby banks' had to trim equity investments to a maximum of 20% of their equity. The combined effects of an increase in advances and a decline in investments have resulted in a shift in asset mix. Advances to Earning Assets ratio has increased from 60% as of the beginning of the year to 69%. Investments as a percentage of total earning assets have declined to 31% from 41% as of the beginning of the year.

Banking sector deposits have increased by 17.3% since the beginning of calendar year 2004 till the last week of November. This has led to a 30.6% growth in advances over the same period that has helped push the Advances to Deposits Ratio (ADR) to 65% as compared to 59% at the beginning of the year. Current advances that stand at 1,414 billion rupees are at their all time high, reflecting the impact of increased money supply and banks' emphasis on aggressively increasing their loan portfolios.



Incidentally some of the critics are not in favor of banks investing in equities, as they consider it riskier than the government securities. However, others believe that managing the risk prudently is the responsibility of the banks. The low return to depositors is often associated to low return on T-Bills. Therefore, unless the banks start investing in high yielding securities, including equities, the return to depositors cannot be improved.

It may be true that in the past the number of quality scrips and market float was low, which did not allow the bank to take large exposure in equities market. However, over the last five years, the situation has changed and it is expected to improve further with some more large-cap companies on the board. Therefore, the State Bank must consider the suggestion of Arif Habib.