“Real beneficiaries of the annual budget-making exercise are banks, not the people of Pakistan.” — Syed Shabbar Zaidi, former Sindh finance minister and senior partner at AF Ferguson & Company, an auditing and business advisory firm.
GDP growth in Pakistan has largely remained stunted post-2008 with the private sector complaining untiringly about unfriendly government policies.
Major sectors of the economy, such as sugar, textile, leather, rice, livestock, fertiliser, asset management and brokerage, have at one point or another tried to lobby through newspaper ads and press statements for lower taxes and subsidies.
But the banking sector is one of the few exceptions in the sense that it is rarely critical of government policies in the media. And why would it be? Despite poor economic conditions in the country, earnings of the banking sector are growing while banks choke private-sector credit by investing heavily in risk-free government securities.
It’s been a fairly smooth ride for banks following 2009. The sector’s cumulative return on equity (ROE) has increased three-quarters following the financial crisis of 2008. Known as one of the best indicators of a lending institution’s profitability, ROE shows annual earnings as a percentage of the money its shareholders have invested in the bank. The ROE of the banking sector increased from 8.9% in 2009 to 15.6% in 2015.
Similarly, the industry-wide return on assets (ROA) rose from 0.9% to 1.5% over the same six-year period, which shows that banks have substantially grown their income as a percentage of their assets, i.e. loans and investments.
If ROE and ROA sound bank-speak to you, just consider the fact that the net profit of the entire banking sector rose from Rs54 billion in 2009 to Rs199 billion in 2015, an average growth rate of 24.3% per year between 2009 and 2015. Few other sectors of the economy have managed to increase their net profits by almost one-fourth every year for the last six years.
What the PML-N has done with banks
Immediately after coming into power in June 2013, the PML-N government announced a reduction of 1% in the corporate income tax to 34%. After lowering the rate by 1% in each of the two consecutive years, the corporate income tax now stands at 32% for 2015-16.
However, much to the chagrin of the banking sector, Finance Minister Ishaq Dar did not give it the cumulative cut of 3% in the corporate income tax rate that non-banking companies have received since June 2013. It’s no wonder that the Pakistan Bankers’ Association (PBA) has demanded that the tax rate for all sectors be “rationalised with uniformity” 2016-17 onwards.
While the PML-N government refrained from upsetting banks in the first two fiscal years in large measure, the 2015-16 budget proved to be rather eventful for them given drastic changes in the tax policy.
The 2015-16 budget imposed a “one-time” levy of 4% on the income of banking companies whose annual earnings exceeded Rs500 million in 2014. Following the imposition of “super tax” to help rehabilitate internally displaced people in the aftermath of Operation Zarb-e-Azb, banks had to book a higher tax charge in April-June of 2015.
According to BMA Capital research analyst Jehanzaib Zafar, super tax wiped off 2.5%‐3% from the bottom lines of banks that earned in excess of Rs500 million in 2014.
In addition, Dar streamlined tax rates that banks pay on different avenues of banking income. Instead of paying taxes at rates ranging from 10% to 25% on different sources of income – such as dividends and income from mutual funds – banks had to pay a uniform tax rate of 35% on all sources of banking incomes July 2015 onwards.
This increased the effective tax rate for banks and dented their bottom lines last year. According to Topline Securities senior research analyst Umair Naseer, listed banks’ effective tax rate clocked up at 40% in 2015 as opposed to 33% in 2014.
Levy on transactions
The last budget delivered another blow to the banking sector in the shape of a withholding tax on transactions and cash withdrawals by non-filers of income tax returns.
Aimed at encouraging people to file tax returns, the withholding tax on cash withdrawals and banking transactions of Rs50,000 or more by a non-filer in a day was imposed initially at 0.6%. It was later reduced to 0.3% and then revised up to 0.4%.
As a result, traders took to streets, demanding that the tax be eliminated. Bankers feared massive withdrawals of deposits before the levy became effective on July 1, 2015. Moreover, expectations that people would switch to non-banking channels for making payments unnerved bankers on end.
In view of half yearly figures, the government is expected to collect roughly Rs23 billion through the withholding tax on banking transactions/cash withdrawals in 2015-16. But the latest data shows that the levy has actually hurt the banking system.
For example, banking sector deposits registered an increase of 12.5% to Rs10.3 trillion in 2015. But a look at the pace of this increase shows most of the deposits originated in the first half of 2015. Deposits grew 8% in the first six months, but the growth rate fell to only 4.2% in the latter half of last year when the levy on banking transactions was in effect.
As for the impact of the withholding tax on the volume of banking transactions, data released by the State Bank of Pakistan (SBP) points to a similar trend. The SBP’s clearing house statistics show the public actually reduced its use of cheques and pay orders post-July 1 presumably to avoid the levy on banking transactions of more than Rs50,000 in a day.
In the first six months of 2015 when there was no withholding tax on banking transactions, clearing houses processed as many as 36.3 million cheques. However, the number of cheques processed amounted to 29 million in the latter half of the year when the levy on transactions was effective. This translates into a decline of over one-fifth (20.1%) in the number of cheques processed nationwide over the six-month period.
Similarly, the amount of money passing through the SBP’s clearing houses in July-Dec 2015 was Rs11.8 trillion, down 12.6% from Rs13.5 trillion for the first six months of 2015.
So why did the government turn on the banking sector in the last budget although it has traditionally left banks alone in exchange for annual deficit financing?
Analysts believe it is becoming increasingly difficult for the government to grow the number of taxpayers. Multiple amnesty schemes to lure people into the tax net have failed to yield desired results. No wonder the government is now bent on extracting maximum amount out of its “captive taxpayers” like commercial banks.
Statistics show the changed tax policy is working well for the government. It collected as much as Rs129.8 billion in taxes from the banking sector in 2015. Thanks to higher effective tax rates for banks following the last budget, total tax collection from the sector rose 56%, or Rs46.6 billion, in one year.
Dar had declared the 4% super tax a “one-time” levy while imposing it on the banking sector in the last budget. But he upset bankers recently by announcing his intention to keep the new tax effective for the next fiscal year as well.
Things are not looking well for the banking sector in the current year. Banks had started accumulating Pakistan Investment Bonds (PIBs) after 2013. With the consistent decrease in the benchmark interest rate, their unrealised gains have gone up substantially from Rs121 billion in 2013 to Rs206 billion at the end of 2015.
Naseer says Rs1.2 trillion of PIBs are maturing in July. The massive maturity of long-term PIBs will result in a drop in the banks’ unrealised capital gains in 2016, he says.
“With the expected fall in capital gains and reinvestment risk once high-yielding PIBs mature, earnings of banks in 2016 are anticipated to remain under pressure,” Naseer added.