Banks’ ROE drops in 10 years

KARACHI: Large banks’ saw a fall in return on equity (ROE) -- a key measure of profitability -- during the last decade as a rise in the minimum deposit rate, implementation of BASEL-III and a sharp decrease in advance to deposit ratio hit the industry, a brokerage report said on Thursday.

The ROE of the top five banks declined by 600 basis points to 13 percent in 2020 from 19 percent in 2011. This decline has not been sudden or due to one odd factor, but it has been a continuous downward trajectory from 2011.

“This fall is slightly less steep if we take ROEs (excluding revaluation surplus) which has gone down to 17 percent in 2020 from 22 percent in 2011,” said an analyst at Topline Securities in a report.

“Equity base of the large banks has grown significantly during the last 10 years and revaluation gains on fixed assets and available for sales investments (AFS) is a major driving factor,” it added.

“Even in 2021, ROEs are anticipated to remain flat in spite of growth in profits as low single-digit Policy Rate is likely to contain any major uptick in Net Interest Margins (NIMs) of the sector.”

The drop in the ROE can not only be attributed to some banks’ specific issues as other factors played their part too, according to the report.

The factors like increase in the minimum deposit rate (MDR), implementation of BASEL-III, declining Advance to Deposit ratio (ADR), lower payout, below average current and saving accounts (CASA) growth have also led to the reduction in the ROE of the banking sector.

In contrast to large banks, mid-tier banks witnessed major improvement in ROEs during the last 10 years as their ROEs rose to 18 percent in 2020 from 12 percent in 2011, the report said. The increase in ROE is attributed to banks’ above average CASA growth, higher concentration in high yielding advances, and domestic assets.

Mid-tier banks CASA have grown at a 10-year compound annual growth rate of 17 percent better than the industry average of 15 percent. This has led to their margins remain flat at around four percent during the last decade, compared with the large banks which saw a dip in NIMs.

The report expects an increase in the concentration of high yielding assets, increased current account mix, and higher dividend payouts can improve ROEs for banks going forward.

“IFRS-9 implementation will also start from 2022 which may negatively impact banks. Hence, banks with strong capital adequacy (CAR) and coverage ratio are better placed to increase exposure in high yielding assets and improve their payouts and maintain/increase their ROEs.”