It will help in increasing the free float as well as price volatility

Feb 28 - Mar 06, 2005

Reportedly a proposal is under consideration to raise the minimum paid-up capital for commercial banks to Rs6 billion. The State Bank of Pakistan has already raised the minimum limit and all the banks are required to raise their paid-up capital to Rs2 billion by 31st December 2005. Raising this limit by three-fold over the next three years seems an ambitious target.

However, some of the banking sector analysts are of the view that the enhanced limit is aimed at reducing the number of commercial banks. For some time it has been felt that 'Pakistan is an over-banked country and the number should be reduced to around a dozen only'. And the objective can only be achieved through mergers and acquisitions. The increase in paid-up has led to exit of a number of foreign banks from Pakistan. However, this also increased the number of local banks. And the only way to reduce the number is forced mergers.

Whereas, some analysts are also of the view that if one compares the paid-up capital of five 'big banks' with rest of the lot, the difference is colossal. This gives some of the big players an edge over the others. There are also too many branches, which only add to the operating expenses. In the shrinking spreads environment, the return to depositors has become negative. And if the return has to be improved operating/administrative expenses have to be curtailed.

The deployment of technology, rising number of ATMs, credit and debit cards and offering of variety of Interest-based services no longer require such a large number of conventional branches. Therefore, the number of branches, particularly in the urban areas, has to be reduced drastically. However, some analysts do not subscribe to this theory. They say, "There may be too many branches of a bank in some of the urban cities, but the number of branches is 'too small' in rural areas. Therefore, banks should increase the number of branches in rural areas rather than reducing the number."

However, bankers have their own point of view. They say, "Opening up of branches is not an easy task as it involves a lot of investment. Banks open branches in the areas offering potential, both in terms of existing business and also future growth. We are not a charitable organization or a social service entity. The rule of tub is that the branch should be self supporting, at least. We are accountable to our shareholders as well as accountholders. If the return on deposit is low, the client would not like to keep their money with us. And if the dividend payout is low, no investor would like to buy the shares of our bank. However, this simple logic is either not understood by the critics or they criticize the policy only to achieve political mileage".

The rational behind raising paid-up capital is aimed at strengthening the commercial banks. The demand for fund is on a constant rise. The borrowers need larger amounts because now capital intensive industries are being established. The existing paid-up capital often becomes a constraint. The banks have to comply with prudential regulations and to also maintain required capital adequacy ratio. This clearly demands that minimum paid-up capital requirement should be raised. Therefore, one should only talk about the timeframe and the minimum limit.

Lately a number of banks have announced Right and Bonus issues to meet the minimum paid-up capital requirement. The banks are also expected to follow the same practice to meet Rs2  billion requirement by 31 December 2005. Investors have responded to such announcements in a very positive manner. However, they suggest that to meet the future demand, the central bank should insist on Right Issue rather than allowing the banks to meet the requirement through issue of Bonus Shares. Right Issues will not only help in raising the additional capital but would also help in expanding shareholders base.

Some of the critics are of the view that persistent increase in capital will dilute the earnings of shareholders. However, some analysts say, "The shareholders are much better off compared to the depositors. While the depositors are being paid pathetically low return, the shareholders get much higher dividend. The policy being followed by the banks is discriminatory. As such, both the depositors and the shareholders contribute cash, which is extended to borrowers. The return on deposit should also be close to the return on equity."

There is no doubt that the minimum paid-up capital requirement of commercial banks should be increased. It will help them in raising their credit extension limit to meet the growing demand for fund by the private sector. It will also increase the free float of banks and help in containing skyrocketing of their share prices. On top of every thing, the market appetite is high and Right Issues, if properly priced, it will get a good response from the investors. However, the time frame must be decided after consultation with the commercial banks.