Banks continue to shine

KARACHI: The last winter marked the beginning of the low interest rate era—but banks found life a little easier and appeared on track to mitigate the negative effects of expansionary monetary policy on their earnings during the last year. Fortunately, investments in the government securities and hefty gains realised on equity stocks kept their profitability intact.

A sharp reduction in inflation and inflationary expectations and shrinking fiscal deficit enabled the central bank to change its monetary policy stance from tight to easing. 

The State Bank of Pakistan (SBP) slashed the benchmark policy [target] rate by a cumulative 3.5 percentage points to a multi-decade low of six percent during the seven monetary policy decisions (from November 2014 to November 2015).

Generally, monetary easing dents bank earnings as it reduces the spread.

The banking spread — a difference between lending and deposit rates — has been decreasing since 2014. It was at record lows of 5.34 percent in October this year as against 5.38 percent in September.

Falling spreads reduce corporate profitability as banks need to pay higher interest on deposits and earn smaller return on advances.

However, the government’s high appetite for bank borrowing to meet its funding requirements forced the financial institutions to invest more in the government papers that offer guaranteed returns. 

Banks reported Rs148 billion profits during the January to September period of 2015 as against Rs115 billion in the same period of 2014. The after-tax profit of the banks stood at Rs112 billion in 2013.

Analysts say the nine-month financial results, posted by banks, mirrored their impressive performance despite the low interest rate environment.

“Banks have done very well over the past few years in terms of profitability on account of heavy borrowing by the government,” said Sakib Sherani, chief executive officer at Macroeconomic Insights.

“This has been a risk-free lending, but at a relatively higher interest rate than what risk-free lending should be at. To a partial extent, this has compensated for the crowding out of the private sector from the credit markets.” The robust profits of Islamic banks also helped in boosting the overall sectors’ earnings.

All in all, banking sector’s profitability will see some pressure, but overall conditions are unlikely to be too different or difficult for them in 2016, Sherani added.

The expected foreclosure laws and formation of modern deposit insurance scheme with adaptation of Basel III liquidity rules are likely to put positive impact on performance of the financial sector in the near future. The share of the government bonds in the total banking assets continued to rise. Total assets of banks rose to Rs13.518 trillion in Jan-Sept 2015 from Rs11.129 trillion a year earlier. 

A quick look at the key variables of the banking industry revealed that banks’ investment [outstanding stocks] in the government securities (Pakistan Investments Bonds, market treasury bills and Sukuk) increased 30 percent by the end of November 2015 over the same period last year. Banks invested Rs5.841 trillion in the government securities compared with Rs4.474 trillion till November in 2014.

Many analysts believed that monetary easing will show its real impact in 2016 in which the benefit of locked-in yields in long-term papers will partially vanish off.

“For the next year, one major challenge awaiting banking sector is the heavy amount of PIBs that are maturing in the second half of 2016,” Rohit Kumar, an analyst at Taurus Securities said.

“The government is likely to roll over these PIBs, but the yields would be much lower than the yields of maturing PIBs.”

Sherani said that together with the bunching of repayment of PIBs, which will necessitate a new round of PIB issuance by the government, there is likely to be a mixed interest by banks in longer tenor PIBs.

“Possibly first half till June will witness stronger interest, which will then begin to gradually wane as banks' expectations of an interest rate increase by the SBP start to become stronger.”

But, he said if the government begins to issue fresh PIBs the offered yields would be lower than the yields on maturing bonds, “so, the net interest margins of the banks can face challenges in coming year.”

“Given the potential volume of issuance the government will have to offer higher yields. Banks are unlikely to invest large amounts at lower yields,” he added.

Kumar also expected earnings of banking sector for the next year to decline by average four to five percent mainly due to absence of capital gains and contracting net interest margins.

Advances marginally increased to Rs4.536 trillion in the Jan-Sept 2015 period from Rs4.209 trillion a year ago.

Analysts, however, said the outlook for bank advances appears to be upbeat over the next few years. 

“The opportunities for the banks would be the upcoming China-Pakistan Economic Corridor and energy projects, where banks can jack up their advances portfolio and provide support to the margins,” Kumar said.

“Nonetheless, banks with healthy capital adequacy and lower advance-to-deposit ratios would be well poised to accelerate credit off-take.”

Sherani said government bank borrowing will continue to remain high in 2016 as high roll-over of domestic debt takes place in conjunction with the shifting of SBP's net domestic assets to the banking sector balance sheet.

Deposits, which are the largest source of banks’ funding, rose to Rs9.715 trillion in the nine-month period of 2015 as against Rs8.311 trillion in the same period the preceding year.

Imposition of withholding tax on bank transactions by the income tax non-filers has started to hamper deposits growth.

Analysts, however, said there is a huge potential for deposit mobilisation by banks with the growing middle income class, improving households’ earnings and the SBP's push for financial inclusion. 

The risks to the performance of banks largely emanate from their ability to generate low cost funds.

Banks need to focus more on deposit mobalisation to finance both the advances and investments this year, the analysts added.

Bad loans are a big problem for banks and they need to bring down the level of non-performing loans. 

During Jan-Sept, 2015, the level of NPLs stood at Rs630 billion as against Rs608 billion in the comparable period of 2014.

The financial sector remained resilient as rise in eligible capital augmented its capital adequacy ratio to 18.2 percent, well above the local benchmark of 10 percent and international benchmark of eight percent.

Right shares issue and equity injection are addressing the capital shortfall issues facing some banks.

Last May, BankIslami took over KASB Bank, which was struggling to meet its minimum capital requirement (MCR).

Last year, the merger and acquisition activities remained sluggish. The central bank allowed the merger of Barclays Bank with HBL.

In April, the government raised $1.02 billion through selling its remaining 609 million shares in Habib Bank.