BANKING SECTOR PERFORMANCE IN PAKISTAN

BRANCHES INCREASED TO 8,233

MULAZIM ALI KHOKHAR
Research Analyst
Sep 15 - 21, 2008

Pakistan's economy enjoying a robust growth of 7% on average for the last 5 years has now bowed to slowing global economies, financial markets and inflating oil and commodity prices. Inflation is standing at three-decade high position (monthly CPI inflation rate at 25%), foreign exchange reserves are lingering on their lowest since 2002 at US $ 9.13 billion and the rupee is down 20% against dollar worst since 1998 at around Rs. 77.

Dr. Shamshad Akhtar was quoted saying, "the timing of these global developments could not have been worse. Not only was our economy's business cycle maturing after a strong and resilient performance but the socio-political set-up was also undergoing a transitional phase".

To address the pertaining issues with economy and economic factors, the policy makers in Pakistan resolved to fiscal and monetary tightening since start of the FY08. As a result, we witnessed slowing demand & supply in the market due to augmenting costs of business, higher borrowing rates, hiking power generation and raw material costs. All this has hampered the manufacturing and ultimately the banking sector growth, which is the credit source for all the economic development in the country.

MONETARY POLICY IMPACTS

To address the inflationary pressures, the State Bank of Pakistan (SBP) increased discount rate to 12% by a cumulative increase of 350 bps since start of FY-08 and Cash Reserve Ratio (CRR) and Statutory Liquidity Requirement (SLR) for banks were increased to 9% and 19% (previously 7% and 18%) respectively. The minimum return for depositors on PLS accounts was revised to 5% per annum and NSS rates upwards by 200 bps. These steps have squeezed the banking spread, profitability, liquidity and business in the country, hampering all economic activities. Higher borrowing costs have reduced consumer and business loans, while higher inflation has reduced saving power of individuals thus disturbed banking sector performance.

FISCAL POLICY IMPACTS

Fiscal policy measures were further intended to reduce the increasing consumer credit spending trend and the Government of Pakistan resolved to:

* Increase FED on Banking services from 5% to 10%,

* Withholding tax on withdrawals increased to 0.3% from 0.2%,

* Scrap the deductions on non-performing loans which were earlier allowed by SBP.

Thus the measures have increased the current tax liabilities of banks and its users which have adversely affected banking sector performance.

BANKING SECTOR PERFORMANCE

Until December 2007 total number of branches increased to 8,233 as against 7,852 last year and the total banking sector assets jumped from Rs. 4.35 trillion to Rs. 5.16 trillion.

The banking sector profits for the 1H CY-08 have increased by increment of 1% while it decreased by 7% approximately for the accounting year 2007, as net profits stood at Rs74.1bn (US$1.2bn) as against Rs79.5bn (US$1.3bn) in 2006.

The banking spread for outstanding deposits which stood at 7.35% during June-07 declined to 7.14% during December-07 and further declined to 6.78 during June-08.

BANKING SECTOR SPREAD

1H 2007

LENDING

DEPOSIT

SPREAD

1H 2008

LENDING

DEPOSIT

SPREAD

7-Jan

11.18

3.72

7.46

8-Jan

11.26

4.19

7.07

7-Feb

11.29

3.82

7.47

8-Feb

11.23

4.17

7.06

7-Mar

11.29

3.92

7.37

8-Mar

11.26

4.17

7.09

7-Apr

11.3

3.92

7.38

8-Apr

11.33

4.18

7.15

7-May

11.32

4.02

7.3

8-May

11.55

4.21

7.34

7-Jun

11.33

3.98

7.35

8-Jun

11.96

5.18

6.78

Average

11.29

3.9

7.39

Average

11.43

4.35

7.08

As on 30th June 2008, the Non-performing loans of all banks stood at Rs. 241.33 billion and Net NPL at Rs. 33.34 billion. This amounts to Net NPL to Net Loans ratio of 1.14 as against 1.18 on 31st March 2008. During 2Q-CY08 the banks provided provisioning of Rs. 6.3 billion while it stood at Rs. 24.7 billion for the 1Q-CY08. Analysts predict lower provisioning during the coming quarters but the risks will still prevail in the rising interest rate scenario.

Weekly statement of position of all scheduled banks (for 8Months-CY08) by SBP demonstrates an increase in deposits by only 6.3% at versus 13.4% for the same period last year. The gross advances increased by 9.4% to mark Rs. 2.9 trillion. This has dragged the Advance to deposit ratio during August-08 to 76.5% as against 74.4% during July-08. Investments have declined by 14.9% to mark Rs. 1.03 trillion and in wake of further economic slow down it is now expected to increase. The new surge in credit demand has flown from industrial and power sectors owing to hiking oil and raw material prices and the inflation is still.

MERGERS AND ACQUISITIONS

The State Bank Governor was further quoted saying, '...this improvement was also backed by regulatory drive of SBP whereby the provisioning requirements were further strengthened in line with best international practices".

SBP by a circular on 6th September has further announced to increase banks' minimum capital requirements (MCR) to Rs 23 billion by 2013, and Capital Adequacy Ratio (CAR) to 10 percent to further strengthen the banking system in the country. Consequently, the banks will have to maintain the MCR at Rs. 5 billion by the end of this year, to Rs 6 billion by December 31, 2009, to Rs 10 billion by December 31, 2010, to Rs 15 billion by December 31, 2011, to Rs 19 billion by December 31, 2012, and finally to Rs 23 billion by December 31, 2013.

This will provide new avenues for merger and acquisition by big players and will improve the competitive environment and solvency of the bank and will reduce related risks.

FUTURE OUTLOOK

Going forward, in a general global and domestic economic slowdown, the (real) credit offtake will remain tight and therefore, spreads are likely to remain under further pressure. There is still room for further penetration of financial services, which are low yet and this will provide many opportunities for the banking industry to grow.

Further monetary tightening is expected during 2H-CY08, where discount rate may be raised by 50-100 bps. It will slow down the economic growth pace and will affect the banking sector performance during coming year or so. This will contract spread, squeeze liquidity and, hamper advances and loans; if the global oil and raw material prices stabilize.

The banking regulations in Pakistan are being improved to match global standards and this implication will attract foreign capital inflows in the country in the form of FDI and successful mergers and acquisitions.