IT was generally believed that the declining policy rate might affect the profitability of the banking sector.
However, the State Bank of Pakistan’s banking performance review for the first half of the year (1HCY15) belies all such fears, as the sector’s pre-tax profits surged 113pc to Rs171bn from Rs80bn in the first quarter (1QCY15). On a yearly basis, the half-yearly earnings are higher by 52pc (from Rs113bn in 1HCY14).
The performance of the banking sector is reviewed from a number of angles. First, the overall health of banks — measured through their capital base, asset quality, profitability etc — is taken into account.
Second, the quality/cost of service provided to different stakeholders, the rates of return paid to depositors, and the flow of credit to important sectors of the economy are examined. It is surprising that the SBP’s performance review did not go beyond explaining some quantitative aspects viz a viz capital adequacy, return on investment and liquidity/solvency etc.
However, statistics provided in the review’s annexure betrays a number of factors that warrant serious attention of the central bank.
The ‘sunny optimism’ portrayed in the SBP’s performance reviews does not tell the whole truth about the soundness of the banking sector
The interest earned by banks during 1HCY15 almost doubled to Rs495bn from Rs255bn in the first quarter. This amount represents the fund-based income of banks mainly earned from advances, investment and bills purchased/discounted etc. Against this, banks’ interest expenses totalled Rs249bn, leaving behind net income (after provisions) of Rs221bn by end-June (against Rs106bn in 1QCY15).
During a regime of falling lending rates, a two-fold increase in banks’ net income leaves a big question mark. It could easily be inferred that the decline in lending rates was more than off-set by a much larger corresponding decrease in deposit rate. In banking business, deposits work like blood in the human body.
By end-June, out of total deposits of Rs10tr, Rs7tr were in current and savings accounts. Of these Rs7tr, Rs3tr were in current accounts on which banks do not pay any return to the accountholders.
Banks are aggressively mobilising current accounts, which rose sharply from Rs1.9tr in CY12 to Rs3.3tr by June. The banking business is thriving on the strength of these low-cost deposits and the banks are not prepared to pay a better return to their accountholders.
During 1HCY15, banks’ non-funded income — including fees, commissions, forex income etc — went to Rs118bn from the first quarter’s Rs55bn. Furthermore, banks’ administrative expenses also doubled during the period, from Rs81bn to Rs168bn.
The banks’ non-interest earnings and expenses not only indicate the higher fees and commissions they charge on money transfers, but also betray the extravagance embedded in their working. Such a sharp increase in administrative expenses is not understandable in a fully automated banking environment. Generally, the use of modern technology decreases costs, as seen in the case of local and foreign telephone charges.
However, the banks tell a different story. Most banking operations have now been converted from manual systems to software programmes. But the cost of service has gone up substantially. This is more pronounced in case of branchless banking, where bank charges are much higher when compared with the almost negligible cost of interbank transactions.
And while the promotion of financial outreach is one of the important policy objectives of the SBP’s Strategic Plan, the performance review is totally silent about it. In fact, the landscape of the country’s banking system has changed in a big way, where banks now find little appetite for financing small and medium enterprises (SMEs) and other weak segments of the economy.
The government is the biggest customer of banks, at the cost of the corporate sector. By end-June, banks’ net investment in government papers amounted to Rs6.2tr, against their net advances of Rs4.5tr — a scenario never seen in the country’s banking history.
Meanwhile, the fat fees and commissions that banks charge, coupled with their activities in the forex market and the selling of third-party products (Bancassurance), are all wholesale money-making outlets. For example, banks’ income from dealing in foreign currencies jumped from Rs7bn in 1QCY15 to Rs12bn in 1HCY15. In calendar year 2014, this income was as high as Rs28bn.
There are huge incentives for bankers, including foreign trips, for selling insurance policies to their customers. Some bank branches are said to be profitable only due to this activity.
Under such circumstances, how can urban-oriented banks go to shabby SME clusters and far-off rural areas in search of viable but unbanked customers, as desired by the SBP’s financial outreach plans?
This analysis suggests that the ‘sunny optimism’ portrayed in the SBP’s performance reviews does not tell the whole truth about the soundness of the banking sector. Amidst such songs of financial soundness, the KASB Bank crisis had erupted last year.
In order to make the performance review a useful document for bankers, academics and researchers, the scope and coverage of the analysis needs to be enhanced by including qualitative aspects. Furthermore, a category-wise analysis of banks’ performance (including that of microfinance and Islamic banks) will be more meaningful.
The writer is President, Institute of Banking and Business Learning.