Banking sector consolidates amidst tight monetary policy and tough market competition
The past few years have been quite fruitful for the sector because of more or less complete privatisation of the public banks with the financial and technical assistance of the WB
By M. Sharif

In the one and a half decade the banking sector had ample time to have undergone the healthy experience of privatisation gradually. The past few years have been quite fruitful for the sector because of more or less complete privatisation of the public banks with the financial and technical assistance of the WB. The growth and development of private banks under the regulatory umbrella of the SBP and generation of market competition has worked to the mutual benefit of the banks, economy and consumers. Finally, the banking sector has entered into the consolidation phase that is not without a number of market and consumer-based challenges.

The consolidation

A careful analysis of the sector during 2006 establishes the fact that the sector has entered into consolidation phase. Three factors contributed towards it. One, regulatory measures taken by the SBP that generated competitive environment for the banks and enabled them to establish themselves on sound basis. They felt the necessity of introducing consumer-friendly products that added to their profitability substantially. Two, implementation of rules like raising paid up capital to Rs6.0 billion by 2006 has made operation of small and less efficient banks unlikely in the competitive market. Three, inflow of capital through remittances and reduction of interest rates between 2001and 2004 and financial liquidity available with the banks enabled them to become effective role players in the national economy.

During the past seven months, a number of acquisitions and mergers have taken place through investment by the locally well-established banks, by big European banks and on the back of inflow of capital from the Middle East petro-dollars. Consequently, Rupali Bank merged with Arif Habib Bank, Atlas Investment Bank merged with Habib A. G. Zurich and Allied Bank merged with Metropolitan Bank First Allied Modaraba, and Standard Chartered Bank acquired Union Bank. Other acquisitions are in pipeline and are likely to be completed by the end of current fiscal year. The biggest acquisition is likely to be of PICIC by NIB Bank. Acquisition of Crescent Commercial Bank by Samba Financial Group of Saudi Arabia is also on the cards. These acquisitions are certainly a good news for consolidation of the banking sector and for its competitiveness but as we shall see later that they are not without conflict of interest between the SBP, the consumers and the depositors and would need transparent implementation of robust regulatory rules in letter and spirit.

How sound is financial health of the banking sector? A few statistics in this regard are quite revealing. During outgoing calendar year the banks profits increased by around 30.0 per cent over the profits of 2005, to Rs90.0 billion. This to a larger extent explains lateral entry by foreign capital and big banks in the banking sector. During past three years the banks have lent around Rs1.0 trillion to the industry and other creditors and have thus played their role effectively in strengthening selected sectors of the national economy. Moody’s Investors Service in its latest Banking System Outlook for Pakistan has stated that “the efficiency of Pakistan’s financial system has improved as a result of privatisation, consolidation and restructuring ... extensive restructuring at these banks has meant a much more efficient use of capital and an added focus on enhancing customer service which in turn has stimulated competition, especially among the larger banks. This trend has also been facilitated by an increasing credit penetration and client base in Pakistan”. This gives somewhat a realistic picture of the banking sector in the country at present.

As stated earlier, intensive competition and high increase in the paid up capital have made survival of smaller banks somewhat difficult. Their merger and acquisition have encouraged and made possible for emergence of larger banks. According to the latest figures, Pakistan’s banking sector is highly concentrated, as top six banks possess 63.0 per cent of the total bank’s deposits. Their share in the total profit of the sector is 64.0 per cent. Analysts are of the view that the existing trend of earning greater share of profits by the larger banks will continue during the current calendar year also because they have developed capability of attracting business. This is likely to leave smaller banks in a lurch. As a result of it, smaller banks are likely to opt to sell their operations and assets for better returns.

Profitability and tight monetary policy

Privatisation, competitiveness and financial liquidity created environment for greater profitability for the banking sector particularly during past three years. Expansionary monetary policy pursued by the SBP till 2004 and tilt towards consumer financing gave a great impetus towards market competition and the banks came up with innovative products for consumer and auto- financing to lure their clients. House building financing remained on lower side and much below the expectations. Speculative business also thrived during hey days of expansionary monetary policy and cheap credit.

The banks are in intense competition to win over clients by selling credit cards and providing consumer and auto financing. This mode of business fetches them high profit within a range of 22.0 per cent to 25.0 per cent. Earning such a high rate of profit is likely to be envied by lenders of any sort any where in the world. The profitability of the banks and bank spread of 7.0 per cent should have shown a downward trend soon after the SBP had started pursuing a tight monetary policy two years earlier to keep a lid on inflation that has persisted at a high rate of around 8.0 per cent since then. It is likely to stay slightly less than 8.0 per cent during current fiscal year despite the tight monetary policy pursued by the SBP. This could be considered a positive step for keeping growth momentum of economy on track and satisfying the public.

The SBP’s objective that banks should increase interest rates on deposits is yet to be realised despite the fact that some of the banks keeping pace with tight monetary policy have started marketing long and medium term products with comparatively higher interest rates that at least take care of ongoing high rate of inflation. Nevertheless, interest rates on short-term deposits are inadequate. The SBP in its latest monetary policy has been emphatic on increasing interest rates on all sorts of term deposits to attract deposits.

Governor SBP had stated last month that necessary action against larger banks in case they failed to increase returns on the deposits. Press reports indicate that bankers want to exploit the best performance of the sector during 2006 that increased market capitalisation by 34.0 per cent over last year to their advantage by taking the stance that it was not possible to increase the interest rates in view of tough market competition, high risk in lending money particularly for consumer and auto-financing.

An important question needs consideration: what action can the central bank stipulate in case market forces of the banking sector decide not to oblige the central bank for the reasons stated above? This question is important with reference to two pertinent points. One, the government and the central bank are committed to free market economic regime. The only option, at least for the time being for the government is to increase interest rates of the NSS. But there, too, the government cannot go beyond certain limit because increased interest rates will make deposits costly for the government.  Two, despite assertion by the central bank, hardly any legal framework exists that can really force the large banks to go along with the dictates of the central bank. The large banks have become quite powerful in very short span. The battle of conflict of interests between the central bank and the large banks will be closely watched during 2007.

Bank’s broader objectives

There are three specific areas. One, the banks should move swiftly to introduce products that are approachable by comparatively less well-off segments of the society. They need to extend their areas of operation in the same context. A big landmass of the country where millions are deprived of the banking facilities, remains out of sight of the banks particularly, the large banks.

Two, notwithstanding the assertion of the SBP to increase rate of interests on deposits, the fact remains that banks earn profit mostly because of the money of the depositors. It is therefore, quite natural for the depositors to look forward to higher returns particularly when higher returns are being offered by the SBP on T-bills and the bank’s profits are sky-high. Three, there are visible areas where the banks should have interfaced more rigorously by now. They can pay attention to agri-sector and poverty alleviation programmes introduced by the government. They have potential to address some of these problems.

Conclusion

Pakistan is committed to free market regime. Some of the policies pursued within the framework of this policy have yielded good results. Emergence of a dynamic and vibrant banking sector with an ever increase in capitalisation, rate of profits for the banks; credit extended to private sector and micro and auto-financing. It reflects a stable outlook for the banks. They would have played their role well in building the economy and the nation, in case they made a whole hearted effort to share a reasonable percentage of their profits by reaching out to deprived segments of the society through micro-financing, may be voluntarily and hidden corners of economy without bothering who was asking for it.