The profitability of the banking sector has increased tremendously in the aftermath of 9/11.

Dec 04 - Dec 10, 2006

The banking sector is claimed to have become robust during the last few years. The major indicators for judging the buoyancy/ robustness of the banks could be: (a) profitability- both in absolute terms as well as the ratio of the pre-tax profits to the assets/equity, (b) fulfillment of capital adequacy requirement as per the Basle II agreement, (c) asset quality, etc.

The profitability of the banking sector has increased tremendously in the aftermath of 9/11. The details of pre-tax profit (+)/ loss (-) since calendar year (CY) 1997 are: 1997 (-) Rs 10.8 billion, 1998 (-) Rs 4.2 billion, 1999 (+) Rs 7 billion, 2000 Rs (+) 4.5 billion, 2001 (+) Rs 1.1 billion, 2002 Rs (+) 19 billion, 2003 Rs (+) 43.7 billion, 2004 Rs 52.00 and 2005 (+) 93.8 billion [source: SBP Banking System Review for the year 2005].

The (pre-tax) profitability of the banks as percentage of the 'assets' rose from (loss) 0.8 per cent in 1997 to 2.8 per cent in 2005. The after tax profitability as a percentage of 'assets' rose from (Loss) 1.2 per cent in 1997 to 1.9 per cent in 2005.

The (pre-tax) profitability as a percentage of equity rose from (Loss) 20.2 per cent in 1997 to 38.2 per cent in 2005. The after tax profitability as percentage of equity rose from (Loss) 30.7 per cent in 1997 to 25.8 per cent in 2005. Thus after tax profit exceeding 25 per cent of the equity is unprecedented in our banking history.

The profits of the banking sector are also rising enormously in 2006 as well.

The basic cause of the losses in the banking sector were Habib Bank Ltd [HBL] and United Bank Ltd [UBL]. The losses caused by these banks during 1997, 1998 and 2001 aggregate Rs 46.212 billion. The details are: HBL Rs 13.687 billion in 1997, UBL Rs 21.015 billion in 1997, Rs 5.769 billion in 1998, Rs 5.741 billion in 2001 [In 1996 too HBL's pre-tax loss was Rs 3.468 billion]. The losses had eroded the capital base of these two banks and consequently the government had to provide funding to them to the extent of Rs 46.6 billion by borrowing from the international financial institutions (IFIs). The details are: 1997-UBL Rs 21 billion, 1998-HBL Rs 9.7 billion, 2001-HBL Rs 8 billion, and 2002-UBL 7.9 billion.

Judged from the capital adequacy ratio requirement, the banking sector has met the Basle II agreement requirement [of 8 per cent of the lendings and investment] as the ratio has improved from 4.5 per cent in 1997 to 11.3 per cent in 2005. The public sector Pakistani banks including HBL/UBL were mainly responsible for the deficiency in this respect in the earlier years.

As for the quality of assets, as per the international standards, the non-performing loans (NPLs) should be within 5 per cent of the lending portfolio. The banking sector is still to go a long way to go in this respect as the NPLs as at the end of CY 2005 comprise 8.3 per cent despite the fact that the major four banks viz National Bank of Pakistan (NBP), HBL, UBL and MCB Bank wrote off loans exceeding Rs 79 billion during 1997-2005. The infected portfolio of NBP [@11.3 per cent] and HBL [@ 10.6 per cent] is still much higher than the international standard.

Have the banking sector attained buoyancy through the reform process? Let us first briefly examine what were the reforms; they comprise (A) recapitalization of HBL/UBL, (B) exodus of staff at a massive scale, (C) closure of branches at a large scale, (D) pushing the small account-holders from the banks' premises, etc.

The government provided funding to HBL/UBL on account of (a) recapitalization as discussed above, (b) NBP/HBL/UBL for exodus of staff [total Rs 11.337 billion] and (c) UBL Rs 7.2 billion for writing off of loans in the Middle East.

Under the reform process, NBP/HBL/UBL and MCB Bank retrenched staff and closed branches at a massive scale; the details are: during 1997-2005, these banks collectively reduced the strength of employees by 42,369 [actual retrenchment would be much higher-as a portion of the vacancies caused by retrenchment was filled up by fresh recruitments] and closed out 1858 branches throughout the country. But the closure of branches and the exodus of staff at such a massive scale did not bring any financial relief to the banks. Contrarily, the salary/allowance expenditure of these four major banks increased from Rs 16.947 billion in 1997 to Rs 23.668 billion in 2005- a hefty increase of Rs 6.721 billion or 39.65 per cent. This was because new employees were hired at fabulous emoluments after retrenching low paid ones. It is believed that recruitments are now made from posh areas.

For pushing the small account-holders from the banks' premises, minimum balance requirements were prescribed and in the event of the balance falling below the limit, the account-holders have to pay penalties. The quantum of the minimum balance/penalty differs from bank to bank. This was done with the concurrence of the State Bank of Pakistan (SBP). The result is that the number of accounts having balances upto Rs 20,000 fell from 22.8 million in 1999 to 12.242 million in 2005.

Another tactic to get rid of the small depositors was to reduce the interest rates on deposits to almost zero. As at the end of CY 2005, the deposits of the banking sector aggregated Rs 2661.697 billion out of which deposits held with the four major banks [NBP/HBL/UBL/MCB] amounted to Rs 1414.543 billion i.e. 53.14 per cent. These banks are not paying any interest on deposits upto Rs 20,000. The maximum interest on PLS savings accounts currently paid by these banks is: NBP 1.2 per cent p.a/ HBL 2 per cent p.a./ MCB 1 per cent p.a. which are extremely negative in the context of the on-going inflation rate exceeding 8 per cent.

SBP's Banking System Review admits that the main reason for small depositors' exit from the banking sector is almost zero interest rate. The lowering of the return on National Savings Scheme instruments by the government also provided impetus to the banking sector to squeeze the depositors.

The above four banks also share the profits of the banking sector to the extent of over 59 per cent. The banking sector earned pre-tax profit of Rs 93.8 billion in CY 2005 out of which Rs 55.39 billion went to these four banks.

The unprecedented increase in the banking sector's profits in the aftermath of 9/11 owes its origin to: (a) exploitation of the depositors of the highest order for the benefit of the large-sized borrowers, (b) consumer financing where quite a high interest rate is charged, (c) earnings from the risky business of stock trading [so much so that SBP had to put restriction-effective January, 2004 on the banks to limit their investment in the stocks to 20 per cent of their equity; but the powerful bourses' lobby has been successful in getting the limit raised to 30 per cent], (d) unprecedented increase in service charges including penalties on the depositors where the balance falls below the minimum limit etc.

The banking sector, as a whole, and the four major banks comprising over half of the banking sector are not prepared to share their huge profits with the depositors. At the two-day Asia Finance Conference (May 13-14, 2006) arranged by Dawn, the SBP Governor, in her address, had asked the banks to share their profits with the depositors. The SBP in its second quarterly report for FY-06 [October-December 2005] had also emphasized that the savers should be given positive return on their deposits. All this has fallen on the deaf years of the banking lobby. Rather, the Banking sector appears to have succeeded in prevailing over the SBP to recently announce that "SBP cannot compel the banks to increase the deposit rates as it is the market forces which determine the deposit/lending rates" [Chief Spokesman, SBP's statement published in the business pages of Dawn dated 23rd August, 2006].

The question, therefore, is if the SBP is not prepared to protect the interest of the depositors, whom should they fall back upon to get justice?

Despite the buoyancy achieved, some individual banks are still not out of wood. The worst position is that if the Industrial Development Bank of Pakistan whose 96 per cent loan portfolio is infected followed by Zarai Taraqqiati Bank and the Bank of Khyber whose infected loan portfolios stand at 36.2 per cent and 23.6 per cent, respectively.