Feb 18 - 24, 2008

Banking sector in Pakistan has enjoyed robust group over the last five years. It was feared that the sector in general may not be able to replicate the performance but the results announced lately show that the sector still enjoys strong fundamentals.

The banking sector constitutes 35% of the KSE-100 index market capitalization, and is an important driver of the market. The sector now consists of much bigger universe but 'Big Five' continue to play a very dominant role. Most of the bigger banks are becoming part of 'foreign investment' i.e. Habib Bank, United Bank, CredBank, Standard Chartered Bank, AMB Amro Bank and NIB Bank to name a few entities. Majority stake of Saudi Pak Bank would also be transferred to yet another foreign bank and Barclays is getting ready to commence its operation in Pakistan.

Two of the factors mostly looked at to review the performance of the banks are deposits and advances. According to a report by InvestCap deposits and advances of the banking sector grew by 19% and 4% YoY. Majority of the deposits have gone towards investments, rather than conventional advances, which have witnessed a phenomenal increase of 56% YoY.

Due to the end of capital gains tax exemption 2007 results would be very different from historic performance. This was an unusual year as this was the final year of capital gains tax exemption to the banking sector. Therefore, banks are expected to book maximum capital gains during this year.

The Warid-Singtel deal has given a one-timer boost of Rs 1.3 billion to Bank Alfalah. Similarly, booking of capital gains on 10% of NIT units has improved the profitability for National Bank, Faysal Bank and Bank of Punjab. Finally, Askari Bank has also booked capital gains of Rs 1.7 billion on the sale of shares of Allied Bank in their portfolio.

In addition, State Bank of Pakistan in its notification dated 12th October 2007 withdrew the benefit of Forced Sale Value (FSV) from banks. As a result, banks will be compelled to make significant provisions in the profit and loss accounts for the year 2007. It is believed that such provisioning would reduce the sector's profitability by almost 10-15%. According to some analysts Habib Bank, Askari Bank and National Bank are expected to be most affected by this notification.

While banks may witness rising trend of delinquent loans in consumer finance the mix of advances and investment is also expected to register radical changes. With the hike in T-Bill yield the banks may revert back to investing in government securities rather than extending credit to the private sector. It is already on record that advance to deposit ratio is on the decline, despite increase in advances in absolute terms.

This is mainly because deposits are growing at a much faster rate compared to growth in advances. One of the key reasons for growth in deposits is record level of remittances. As against this the credit appetite of private sector is on the decline. The demand is expected to remain subdued due to wait and see policy of the investors.

However, some of the critics say that decline in investment due to hike in interest rate is a hoax call. Those who have definite investment plans are going head despite rising interest. They say that financial cost constitutes small percentage of total cost of doing business. It is another thing that some of the borrowers have busted their borrowing limits. It is evident from the balance sheet of listed companies that the borrowed amount is being passed on to an associate company. Previously, the amount was being transferred as loan but now the borrowers invest the amount in the shares of associate companies.

This practice is most blatant in textile industry. Most of the business houses having substantial stake in textile sector have diverted the funds to cement industry. Ironically, cement industry has its own dynamics and it is still going through expansion phase. Therefore, while the assets of a public limited company continue to grow it hardly receive any dividend income from this investment.

Analysts forecast the banking sector earnings to grow at an average of 15% over the next three years. High-base effect of previous years and increasing competition would prevent banks to repeat immaculate performance of the previous years.

Pakistan is becoming a very interesting case study. The country is suffering from surplus liquidity crises, exceptionally high M2 growth. However, neither the banks nor the investors have been able to exploit the situation. It is often said that investors should invest in equities market but volatility of the market does allow the small investors to enter this arena.

Now it is the responsibility of the commercial as well as the investment banks to mop up the overflowing liquidity and ensure its use in productive activities rather than let it being used for speculative activities.

There is an old saying that robust banking sector is a must for accelerating GDP growth rate. It is interesting that banks are getting stronger but the sectors considered to be their main customers are shrinking. This trend has to be revered by encouraging borrowing. The central banks of all the countries lower interest rate to encourage new investment. However, Pakistan's central bank is following an opposite policy. In an attempt to contain inflation interest rate is being jacked up without realizing that it is proving counter productive. The inflation rate has not come down but hike in interest rate is adding to cost of doing business.