Banks need to move more aggressively into the areas ignored in the past

May 10 - 16, 2004

The paradigm shift in the commercial banking seems to have started positive results. Growing deposits and ever increasing appetite for credit by the private sector have provided the added impetus. Low interest rates are encouraging the existing players to expand their installed capacities as well as to undertake greater value addition. The vibrant equities market also allows the bank to make large capital gains as well as draw substantial dividend income from their investment portfolios. The only concern is, how will the interest rates move in the near as well as long term?

A closer look at the financial accounts released by commercial banks for the year ended December 31, 2003 shows that despite low interest rates and persistently growing operating expenses, all the players have been able to posted results better than previous years. One of the factors contributing to improved profits was the reduction in tax rate applicable on banking companies.

The increase in operating expenses can be attributed to the ongoing branch expansion programme. Another factor responsible for higher operating expenses is the massive investment being made in upgrading the existing branch network and substantial investment being made in technology. The private banks have been fully cognizant of their limited branch work. To overcome this limitation they are relying heavily on technology. The concept of 'bricks and mortar' branch is being replaced by e-banking.

Another emerging phenomenon is 'dying commercial banks and emerging financial super market'. Historically, commercial banks in Pakistan have been maintaining checking accounts, providing working capital loans and offering international trade related services and financing. However, over the last decade they also ventured into leasing, housing and consumer finance. Though the quantum of income generated through these activities is still low, the growth in business volume has been very significant. Since the pie size is very large only the policies of an institution limits its share.

Lately, Pakistan witnessed the establishment of a commercial bank offering commercial banking based on Sharia. The response has been overwhelming to the extent that most of the banks have either established separate windows for Islamic Banking or are in the process of opening dedicated branches. Most of the banks were not able to identify the size of Islamic banking market and the potential response from the clients, despite pressure for eliminating Riba from banking. They chose to offer Islamic Banking in parallel with conventional banking and allowed the clients to make their own choice. The response from the clients has been beyond expectations.

Another emerging phenomenon is constantly growing investment in equities and term finance certificates. Historically, banks have been investing mostly in government securities. Two factors were responsible for this prachee, virtually no risk and higher yield. However, lately government has become no longer the biggest borrower from commercial banks and yields have also gone down exceptionally very low, from as high as 12.5% to as low as 1.5%. This forced the banks to explore other high yielding opportunities. A vibrant equities market and attractive dividend yield attracted the banks to take greater exposure in relatively high-risk options.

However, there was severe criticism on banks' exposure to equities market. The growing fear was that most probably a bubble was emerging, which might burst any time. Therefore, the central bank, as a precautionary step told all the banks to follow the Prudential Regulations, pertaining to the investment in equities. However, to avoid any run down, banks have been given sufficient time to bring their investment within the stipulated limits.

According to a banking sector expert, "It was a very difficult decision to make. Had the bank opted to sell a large part of their portfolio, the share prices would have eroded, which would have been bad for the banks as well as the equities market. Therefore, they had to look for some other option, whereby the losses could be minimized without creating bearish spell in the equities market. This option has become evident if one looks at the number and size of mutual funds being floated. Some of the large funds have been floated most recently and the collective size of funds in the pipeline is estimated around Rs 15 billion".

According to another analysts, "It is the most appropriate time to enhance minimum paid-up capital requirement for commercial banks. The minimum capital should be raised to Rs 1.5 billion by end 2004 and to Rs 2 billion by end 2005. The shareholders' equity of most of the banks already exceeds the suggested limit. However, the additional capital should only be raised through issue of Right Shares at a price close to quoted prices".