CPEC projects create credit expansion opportunities for banks

Tawfiq Husain, chief executive officer of Pakistan Banks Association (PBA) talked about banking issues in an interview. 

Q: Are banks willing to participate in financing of China-Pakistan Economic Corridor (CPEC) projects?  

A: The CPEC opens up opportunities for the banks to expand their credit activities in Pakistan. Banks can participate in the CPEC projects across energy, infrastructure and related sectors by providing a meaningful share of the required local currency funding. Loan syndicates can be formed to meet local currency project costs and for working capital requirements of the projects.

Foreign funding is normally used for meeting foreign currency payments for machinery and other equipment’s imports.

Our banks can participate in cross-border transactions with Chinese creditors and other international financial institutions to arrange foreign currency component of credit facilities. 

I think CPEC can provide attractive opportunities for the capital market participants as well, as they can introduce structured equity and fixed income instruments and provide the investors with new investment products.

Q: Banks are often criticised for parking funds into the government securities. What’s your take? 

A: The government remains the largest borrower of the banks and has crowded out the private sector.

Instead of heavily relying on bank financing to meet its funding requirements, the government needs to improve its fiscal position by increasing tax and non-tax revenues and managing its expenditure.   

It’s not fair to be critical of banks investing in government papers and for the banks generating healthy profits, as investing in government securities (short and long term) is a perfectly normal and common business activity of banks worldwide. It grows during increased borrowings by governments from banks.

Furthermore, the equity return is healthy, but not exceptional, if viewed against the total equity deployed and the total assets of the banking sector.

The State Bank of Pakistan’s figures showed that as of December 31, 2015, banks’ total equity stood at Rs1.3 trillion with Rs14.2 trillion in total assets and return on equity after taxes of 15.6 percent last year, which, I repeat, is healthy, but not exceptional.

Banks earned after tax profit of Rs199 billion, but, at the same time, provided Rs39 billion against bad debts. The heavy provisioning cost is unique to banking business and figures prominently in the business economics of banks.

 Moreover, banks pay 35 percent corporate tax, which is the highest rate, despite the reduction in income tax rates for businesses announced by the government in the previous budget. The government cut income tax rates for the corporate sector from 35 percent to 34 percent for the tax year 2014, to 33 percent for 2015 and to 32 percent for 2016. However, a similar reduction has not been provided to the banking sector.

Banks are eager to lend more to private businesses and less to the government but, for this the government and regulators also need to improve the relevant laws.

The legislation for amendment to the Financial Institutions Recovery Ordinance and a good and effective Corporate Rehabilitation Law will definitely support banks’ increased credit to the private sector.

Banks and development finance institutions (DFIs, members of PBA) paid corporate and income tax of Rs111 billion in year ended December 31, 2015, which, we understand, is the highest from any business sector in Pakistan. On top of that, banks and DFIs also paid Rs10 billion in federal excise duty and sales tax.

Therefore, total taxes paid by banks and DFIs were over Rs121 billion. Furthermore, banks and DFIs collected Rs105 billion as withholding tax and paid it to the Federal Board of Revenue (FBR) in 2015.

Therefore, total taxes paid by banks and DFIs and withholding taxes collected and paid by them to FBR were Rs226 billion.

That, you will agree, is a staggering figure and demonstrates that banking sector is a very important stakeholder for the government, in general, and for the FBR, in particular.

Q: Is there any regulatory development on the systematically important financial institutions (SIFs) by the central bank? 

A:  The SBP has worked on a study for supervising SFIs. It’s a global practice where the regulator assesses the sectoral risk and does stress testing of the banking system, with special focus on the SFIs.

Such studies are deep and analytical in nature and take time before regulations are developed and introduced.

Comfort can be drawn from the fact that there has been no bank failure in Pakistan. Most of the banks are compliant with the regulatory requirements fixed by the SBP.

Minimum paid-up capital and capital adequacy ratio (CAR) are the requirements based on risk assets on balance sheets and show how much capital the banks have to hold under Basel 111 Capital Accord.

Banks in Pakistan are required to maintain 10.25 percent capital adequacy ratio as of Dec 31, 2015, which is higher than the CAR requirement of 8.625 percent for the banks in other international markets.

Actual CAR of Pakistan banking industry was just over 17 percent as of Dec 31, 2015, indicating it has the capacity to absorb a lot more risk assets on the balance sheets of the banks.

Q: Do you think that withholding tax on non-filers is impeding deposit growth?

A: This has become the law of the land and banks have to comply with it, even if it decelerates the growth in bank deposits. This tax is likely to adversely affect financial inclusion, which is a big strategic objective of the government, SBP and the banks.

The PBA recommended, for the next fiscal year, that Section 236 P of the Income Tax Ordinance concerning advance tax on banking transactions, other than through cash, should be removed or exemption be provided to vulnerable groups. It also recommended to the FBR that the threshold of transactions should be increased to Rs100,000.

The unnecessary disclosures of customer information under Income Tax Ordinance 2001, sections 165 and 165 A and, more importantly, the online access to customer accounts, should be avoided and requirements under these two sections should be dispensed with and the law amended. This will strengthen the confidence of bank customers in the banking system and help increase the financial inclusion in Pakistan.

Q: How will Islamic banks handle their excess liquidity? 

A: The Islamic banks generally have surplus liquidity. Unencumbered/available assets have to be identified against which additional sukuks can be issued by the government. This is a major matter, which needs to be resolved on an urgent basis.

Also, the SBP is reviewing the lender of last resort facility for the special requirements of the Islamic banks and trying to set up a Shariah-compliant arrangement.