May 21 - 27, 20

Over the years, commercial banks have emerged as 'financial supermarkets' in Pakistan. They have established asset management companies, insurance companies and modarabas.

At present, there are suggestions to contain the role of commercial banks but reversing the process is likely to cause more damage than yielding any significant benefit. Analysts are also of the opinion that any effort to increase tax incidence or impose new tax must be discouraged. However, the central banks should follow 'financial inclusion program' more rigorously by creating enabling environment.

Lately, the central bank raised mandatory payment of profit on deposits to six per cent from five six per cent. This decision attracted some criticism. The move was opposed on the grounds that it will reduce the earnings of commercial banks, particularly the big-5. These institutions have enjoyed access to 'cost free deposits' for considerably long time.

Experts are of the view that smaller banks are already offering higher return on deposits and are not likely to be affected by the move. The basis of the hike in rate is linked to significant increase in the earnings of banks due to huge investment in risk-free government papers offering higher return but no provisioning. In fact, NPLs and provisioning by banks have come down due to investment in government securities.

Over the years, it has also been felt that as a percentage of total lending, disbursement of loans to agriculture has remained very low. While the central bank is making concerted efforts to increase lending to farmers and a positive change is there, the overall disbursement remains minuscule.

Keeping in view the share of agriculture in total GDP and government aiming to achieve food security, it has become necessary to boost lending to farmers.

Since lending to farmers is exposed to natural calamities, it requires appropriate risk mitigation. The central bank has made it mandatory for the commercial banks to acquire insurance cover for the amounts lent to farmers. However, it has been observed that the instruction is not being followed in letter and spirit.

Based on the government's target of lending to farmers fixed around Rs300 billion, the overall premium collection should have been six billion rupees for the full year but the income statements of insurance companies don't reflect this quantum jump. It is feared that some of commercial banks are not acquiring such cover. It is also on record that farmers have not received claims originating from 2010 and 2011 floods.

For some times, experts have been contemplating increasing corporate tax on commercial banks in an attempt to mobilize more tax. In the prevailing situation where banks are investing heavily in government securities, the demand gets more credibility. If approved, the move will bring down the cost of borrowing for the government, which is paying higher interest rate. However, the logic seems contrary to the demand that interest rates should be brought down in the country to facilitate the private sector in creation of new productive facilities. Though addition of new facilities has slow impact, the move on one hand creates new job opportunities and boosts GDP growth rate on the other.

The added advantage is that in this process disposable income of people increases, which in turn increases demand for virtually everything. When consumption increases, the overall revenue collection also increases.

According to a report by InvestCap, the government plans to impose tax on return earned on treasury bills, as the category makes up a significant portion of banks' balance sheets (industry average 24 per cent but it ranges from eight to 47 per cent).

The overall investment of banks in government securities average 66 per cent, but range from 40 to 91 per cent as per detailed full-year CY11 figures. However, to calculate the impact, the brokerage house has made certain assumptions in case of an expected 15 per cent incremental tax on T-bills returns is imposed.

If it is assumed that the proposed tax is imposed, net profit of banks may see an average erosion of seven per cent, while ex-SLR investments and returns on T-bills (which makes more sense with incremental tax on ex-SLR earnings from T-bills) banks' earnings only get affected by a marginal three per cent on an average.

Banks having larger contribution from T-bills earnings to their gross interest income (GII) are expected to be affected the most. Mid-tier and lower-tier banks would see earnings decline by maximum 10 per cent.

The analyst expects any extra tax on T-bills' returns would yield a less than Rs9 billion for the government but the move will be perceived against market economy and sector efficiency. Instead, a more appropriate action with lasting impacts could be improving depositor/investor's awareness on investment avenues, policies supporting competition amongst banks to cause material improvement in deposit rates, rigorous capital requirement, narrower cap on investment in government papers, and promotion of a regular bond/TFC market, and last, but the most important one, secondary market/central bank borrowing should be one part of the source of funding fiscal deficit and not the only source for that matter.

While there is growing pressure on the central bank to contain government borrowing, it seems highly unlikely keeping in view that inflow of aid, grants, and soft-term loans have virtually dried. In such a scenario, efforts to mobilize deposits should be augmented.

Since bulk of the deposits maintained with the commercial banks are of less than one year maturity, the efforts should be to lock the funds for longer tenor.

In the past, the government has mobilized funds from local as well as international markets at very competitive rates. However, due to poor law and order conditions, volatile political situation, and economic downturn, the government is reluctant in going to international markets. However, one should not forget the successful launch of sovereign Ijara Sukuk.

The total outstanding value of the Sukuk is close to Rs300 billion. This has become possible because the government has announced plan for the auctions and investors are also aware of estimated return. Raising such a quantum amount has certainly eased pressure on the commercial banks because bulk of the amount has come from Islamic financial institutions, which were reluctant in accepting deposits in the past because they were suffering from 'surplus liquidity'.