Aug 8 - 14, 2011

There cannot be two opinions that average spreads in Pakistan are higher as compared to the region as well international standards. However, it is also a fact that 'big five' banks rake up money mainly because a significantly high percentage of their deposits are either cost free or very low returns are paid to the depositors. They enjoy this edge because of long history and greater outreach.

During the regime of one of the past governors of the central bank, Dr. Shamshad Akhtar it was made mandatory for the commercial banks to pay minimum five per cent return on deposits. However, many of the banks made the best efforts to keep the payout least on different basis i.e. minimum balance and average balance. They were not willing to pay any return to small depositors, enjoying the largest share in the total banking deposits.

According to the details available with the central bank total banking sector deposits were Rs5.6 trillion on June 30, 2011, up 17.35 per cent year on year. Strong deposit growth has not accompanied with a compromise on margin where CASA has gradually inched up and weighted average spreads have expanded.

This clearly shows that the banks have the capacity to pay higher return but keep the rates low only to discourage the depositors.

The latest increase in deposits has come mainly because of very substantial increase in deposits maintained with the Islamic banks. Till recently Islamic banks were not keen in accepting more deposits only because a few options were available for investment, as the private sector appetite for credit was low and these institutions could not invest in treasury bills and Pakistan Investment Bonds. Flotation of sovereign Ijarah Sukuk over Rs220 billion offered an opportunity for investment offering substantial risk-free return, which encouraged Islamic banks to solicit more funds at very competitive rate.

Weighted average banking sector spreads have been registered at an exceptional 7.86 per cent in June 2011, up 26bps YoY and 21bps MoM. As a result average 1HCY11 spreads have clocked in at 7.62 per cent., up 25bps vs. average 1HCY10 spreads of 7.37 per cent.

Recent sequential increase in spreads has been because of higher lending rates and lower return on deposits. While the former is likely due to lagged pricing and risk-averse lending stance, AKD analyst believes that the latter is an indication of strong transactional deposit mobilization. Accordingly, strong spread led growth in net interest income (NII) should adequately compensate for credit costs expected to be the key feature of upcoming 1HCY11 results.

In turn, NII may tweak the bottom-line where earnings growth momentum should continue (aggregate profits for listed banks rose by 17 per cent YoY in 1QCY11). However, despite the growth momentum banks have underperformed the KSE-100 index by more than 10 per cent.

It is on record that while some of the commercial banks were earning very high spreads, others were earning marginal of negative spreads. The key reason for this precarious situation has been non-performing loans and resulting huge provisions. The situation has improved lately but still remains far from satisfactory.

According to the data available with the SBP, total banking sector provisions have increased by Rs8 billion in 2QCY11 as compared to an increase of Rs18 billion in 1QCY11 and Rs12 billion in 4QCY10, while actual provisions in 2QCY11 may be tad higher due to last minute write downs. Analysts believe the overall situation bodes well for upcoming 1HCY11 results.

In the past, banks were often alleged for reckless lending and some of the loans are still disbursed imprudently, mostly under the political pressure. Most of such borrowers have clear intentions of not paying the loans or the projects against which borrowing is done are economically unviable. Therefore, very soon the borrowers become delinquent. Since the central bank has a very clearly laid down procedure for making provisions, the banks do not have many options except comply with the rules.

However, banks have found a quick remedy 'writing off such loans after declaring them unrecoverable'. A closer look indicates that most of the beneficiaries have been the 'turncoats'.

One of the harsh realities of recent times is that extensive load shedding of electricity and gas is turning many of the profit making business entities delinquent. If manufacturing facilities do get electricity up to 12 hours a day and gas for nearly half of the week, no business entity can survive. Initially, efforts were made to run standby generators but running these for 12 hours is not viable. There is also no substitute of gas for fertilizer plants. Though they have been able to pass on the additional cost to the farmers, soon fertilizer will become unaffordable for the farmers and will affect the output of major as well as minor crops.

It is encouraging that this time the central bank announced half a percent reduction in discount rate. The policy decision has been termed 'paradigm shift' and trade and industry expects further reduction in interest rates over the months to come. However, it is necessary to reiterate that unless other irritants i.e. load shedding of electricity and gas and law and order situation in the country is improved, the outlook for trade and industry would remain grim.

Any substantial reduction in interest rate can improve profitability of those business entities that carry huge load of borrowing. Many of the spinning units, cement manufacturing plants, and even the government are the victims of high interest rates. Therefore, efforts should be made to bring down the interest rate to single digit. The sooner this happens the better it will be for the trade and industry in general and restoring competitiveness of the local manufacturers in the global markets in particular.