‘No threat to Pakistan’s financial system from global banking crisis’

KARACHI: The failure of three American banks has no relevance or impact on the lenders doing business in Pakistan as they are well-capitalised, but the banks' sizable holdings of government debt securities are raising red flags in the financial system of the country, a financial services company stated in a report.

Within a week, the Silicon Valley Bank, Signature Bank, and Silvergate Bank all collapsed, shattering public confidence and raising significant questions about the stability of the US financial system. Analysts and banking executives, meanwhile, don't detect any symptoms of stress in Pakistan's banking industry as it has adequate capital buffers. The capital adequacy ratio (CAR) of the nation's banks is higher than 16 percent. The ratio is what determines how well a bank can handle time liabilities and other risks.

Also, individual banks must make sure that their deposit base is detailed and that neither their assets nor liabilities are designated for a particular industry or clientele. According to the Deposit Protection Corporation, deposits in Pakistani banks are guaranteed up to Rs250,000 per depositor. In order to prepare for potential unfavourable eventualities, banks may run several stress test scenarios. They may also create a liquidity contingency plan.

The State Bank of Pakistan (SBP) is a proactive regulator working in close synergy with the banking industry to deal with any adverse situation. However, uncertain times call for preemptive measures, said Chase Securities in a note.

“Although, majority of Pakistan Banks have a diverse deposit base and investment portfolio duration has reduced but there are concerns on Pakistan Banks having high exposure to Government securities and intention of Government to borrow directly from Banks,” it said.

There is also stressing on the need for local debt restructuring/reprofiling along with foreign debt restructuring, a matter which should have strong policy response by the government or the regulators, it noted

“The sector balance sheets are leveraged and Government debt is at elevated levels whereas significant borrowings are to be made in the ongoing year to fund the fiscal deficit. The channel to borrow from the SBP is closed under the International Monetary Fund programme,” it added.

The risk associated with lending to the government is rising for the banks. Five Pakistani banks' long-term deposit ratings were downgraded earlier this month by Moody's Investors Service from Caa1 to Caa3. One of the reasons given by it for the rating downgrading was the banks' significant holdings of sovereign debt securities.

The banks’ high sovereign exposure, mainly in the form of government debt securities that range between 36 percent-61 percent of their total assets, also links their credit profile to that of the government, according to Moody’s.

As of June 30th, 2022, banks have invested over Rs17 trillion in treasury bills, conventional bonds, and Shariah-compliant bonds, according to SBP data.

Banks' investment-to-deposit ratio as of February 28, 2023, was 82.9 percent, while their advance-to-deposit ratio was 51 percent.

The SBP’s former governor Dr Muhammad Yaqub said in Pakistan, banks are minting money without performing the normal function of mobilizing saving from the private sector and lending to consumers and investors in the private sector and thereby taking risks involved in the process of financial intermediation between the “surplus individuals and entities (savers) and “deficit individuals and entities (consumers and investors”.

“For the last two decades banks in Pakistan are engaged in financial intermediation between the SBP and the federal government,” Yaqub said.

“The federal government recklessly borrows from commercial banks at whatever rate possible and commercial banks dump government debt documents in the discount window of the SBP, add to discount rates a profit margin of their own, and lends to the government under the cover of the so-called ‘sovereign debt guarantee’ of lending to the government,” he added.

Government papers that are piling up in commercial banks' asset portfolios are not good for Pakistani banks. It is this risk to the banking system that needs to be highlighted, according to Yaqub.

Unlike in the USA, an increase in interest rates enables banks to reap more profit for shareholders who happen to be some of the richest families in Pakistan.

“Their increase in lending rate which is mostly to the rich does not bring about a commensurate rise in the rate of return to depositors who are lulled to believe that fixed interest rates are prohibited by Islam. Thus their margin of profit increases sharply with a rise in interest rates.”

According to him, the increase in the policy rate by the SBP to 20 percent will not be accompanied by a commensurate increase in return on deposits. It will be picked by banks in the form of higher dividends and retained profits helping them strengthen the capital base that will be reflected in a higher price of shares that are held by the rich.

At the same time, banks will have a higher profit margin in absolute terms from their lending to the government financed by borrowing from the SBP.