The banking sector kept on enjoying the PIB bonanza in CY15 despite the fact that SBP policy rate fell by 300 basis points during the year. According to the SBP’s quarterly compendium statistics of banking system released last week, profit before tax of thirty-five banks increased by 33 percent. Government has taken back relatively high chunk of easy money made by banks, primarily on government papers, by imposing one-time super tax of 4 percent in FY16 (applicable for 2HCY15) in addition to income tax of 35 percent to limit the profit after tax growth to 22 percent as PAT stood at Rs199 billion in CY15.
The total assets size of commercial banks increased by 17 percent or Rs2,037 billion in CY15 with the growth predominantly emanating from investment portfolio (read government papers) which jumped by Rs1571 (30%). In case of advances, the toll marginally increased by Rs89 billion on a net basis in 9MCY15. The flurry was in the last quarter with an increase of 6 percent (Rs280bn) to take the yearly growth to 8 percent.
Pick up in advances in the last quarter is a good omen. Though, the pickup in advances in Oct-Dec period is seasonal due to high working capital needs of textile and other industries; but tamed fiscal deficit in 2QFY16 and improved economic sentiments partially explain the growth in advances.
Banks’ confidence to lend to the private sector is slowly building as financial soundness indicators of the banking sector are encouraging. For instance, net NPLs to net loans ratio which averaged 4.5 percent in CY09-14 is down to 1.9 percent in CY15 (2.7 in CY14). With falling NPLs and increasing concentration of assets in risk-free government securities, banks’ risk-weighted capital adequacy ratio (CAR) inched up to 17.1 percent from 16.8 percent in the previous year.
Deposit base could not keep pace with the growth in assets – up by 13 percent in CY15 and rest was filled by borrowings. The pickup in deposits was good in the first half which grew by 8 percent or Rs740 billion in Jan-June. However, there was a lull in the third quarter as the newly imposed transaction tax on non-filers, and seasonal withdrawals related to Eid and Hajj reduced the base by Rs255 billion or 2.5 percent in Jul-Sep. The money taken out the system had to come back one way or the other and it happened in the fourth quarter as deposits jumped by Rs674 billion (7%) to reach Rs10,389 billion by Dec end.
Banks have worked hard on improving cost to income ratio by bringing down cost through increasing CASA ratio in the deposit mix – the cost to income ratio declined from 55.1 percent in CY14 to 47.1 percent in CY15. Banks have also worked on diversifying the income portfolio with its trading to gross income ratio increased from 5.5 percent in CY14 to 9.7 percent in CY15
The profitability ratios are all encouraging too. Return on average equity is 15.6 percent in CY15 as compared to an average of 13.5 percent in CY09-14 and similarly return on average assets at 1.5 percent is better than previous five years average of 1.3 percent.
All the indicators are shaping well – bad loans are shrinking, capital adequacy is at unprecedented levels and profitability is peaking. But what are missing are the banks’ loans to the private sector – Advances to deposits ratio kept on its southward journey as it decreased from 67.7 percent in CY09 to 46.4 percent in CY15.
It’s about time for banks to start looking at the private sector lending as its core business. Otherwise, low-interest rates are going to bite profitability. PIB easy money era will soon be over. In 2014 alone, finance ministry in an effort to improve its debt maturity profile has issued over Rs2.2 trillion PIBs as against Rs1.4 trillion in previous thirteen years (2001-13). The idea was to shift from T-Bills to PIBs while the return on PIBs on an average was 250 basis points higher than on T-Bills.
More than half of newly issued PIBs were of 3 years with maturity in July 2016. Banks were able to lock in those PIBs of effective maturity of 1.5-2.5 years in 2014 at the time when interest rates were high. SBP’s policy rate is effectively down by 400 bps since Nov 14, but banks’ profitability largely remained insulated to the fall in interest rates because they had locked into PIBs at higher rates.
Be it government’s lack of foresight on interest rate outlook or banks’ sheer luck; the party time is soon to be over. Now those banks who have realized it and are working on building private sector portfolio will be the beneficiaries and for rest, the profitability will erode fast in 2016 and 2017. Thus, the banks with better balance sheet footage and having board’s approval on assuming high risk but high return private sector lending will take the lead.
There are numerous projects in power sector where banks can assume positions, good quality SME assets are there for banks and consumer portfolio in auto and mortgage are there in offing. Geopolitical landscape is changing and banks need to find financing partners in China, Russia, and Iran. Lately, a team from Lahore based bank owned by the UAE group was in Iran to see the business opportunities. Such commercial decisions have to be taken by banks to leverage their high CAR and accumulated equity.
First published in the BR Research on February 29, 2016.
