Sunday, 07 September, 2008

Credit default has gone up, and profitability down, the latest analysis of banking operations shows.Commercial banks' results for the half year to June 30 of the calendar year 2008 indicate that the net profit declined by 20 per cent to Rs. 34.4b.

It was Rs. 43.0b in the like period of 2007. The key reason for the decline is that the banks, during this period, had to make larger provisions totaling Rs. 26.4b to cover the credit repayment default of the Non-Performing Loans (NPLs). It was 5.0 per cent higher than the like period of last year. Larger provisioning was followed by absence of capital gains because of the ongoing bearish performance of the bourses in April-June, 2008.

If the provisioning for NPLs is excluded, the banks? profitability, in fact, rose 27 per cent in the first half of calendar 2008, compared to the like period of 2007.

This is the analysis of a report prepared by Karachi-based First Capital Equities Limited (FCEL). It analysis the results of 23 banks which represent 96 per cent market capitalization. These banks have 90 per cent of the banking sector deposits.

The loan default in most banks is increasingly showing up after years of what was called Go-Go banking in mid-1960s in Britain. The British banks, then a flush with liquidity, were itching to lend to anyone who wished, and even those who had to be persuaded to borrow.

After a couple of years of such lending, UK was impacted by inflation and rising prices, that forced the government and the Bank of England to apply what was then called a credit squeeze. Pakistan is going through a similar situation now.

But, the State Bank of Pakistan (SBP), the central bank, is trying to reverse the tide by gradually raising the benchmark Discount Rate or Policy Rate to a record 13 as of now, and otherwise discouraging banks to lend freely. However, the genuine business borrowers are not starved of funds, except the fact that they have to pay a rising interest rate. Easy lending especially to as consumer finance and auto leasing is a major cause of increasing default.

The overall NPLs for all banks rose 4.6 per cent to Rs. 250.594b on June 30, compared to March 31 this year. The reason was default in consumer and farm loans advanced by all the Big-5 banks.

Despite lower profitability, the revenue growth was quite impressive as Net Interest Income (NII) witnessed a 14 per cent growth, totaling Rs. 99b. The growth was contributed by an 11 per cent increase in credit.

This was despite the fact that SBP mandated the banks to offer a minimum 5.0 per cent profit to depositors in order to encourage savings. It was also meant to provide relief to consumers whose deposits were being eroded by the present 21 per cent inflation.

Previously the profit to depositors had, generally, ranged from 2.0. to 3.0 per cent. But the newly enforced 5.0 per cent minimum profit rate had impacted the profitability only for one month included in the present analysis.

But the bad news for banks was a 36 per cent decline in their non-interest income. This was because their income from capital gains was down as the bourses and equity markets performed badly, particularly during April-June, 2008. However, the banks recorded a good growth in their non-funded income. Fee income, for instance rose 21 per cent to tot al Rs. 18b. Income from foreign currency deals rose sharply by 67 per cent. The income from other heads rose an impressive 39 percent.

On the negative side, banks administrative expenses rose 25 per cent to Rs.57.9b. The banks now have to offer more attractive pay and perks to its personnel in a competitive environment where the availability of high grade and efficient personnel is in short supply. The banks also have to spend more on upgrading their facilities, equipment and premises.

The FCEL and other financial analysts are projecting a rising growth in revenues and profitability during the second half of calendar 2008 to December 31, at the same rate. But, it may even surpass it with larger credit growth for the private sector.

The analysts expects that as soon as the present low in business and industrial activity is replaced by a buoyant environment, the private sector demand for credit will rise, ensuring higher income and profitability for banks.

"Despite higher provisions, banking sector profitability is likely to portray a growth of nine per cent," based on the FCEL universe in 2008, mainly due to lower base in fourth quarter of 2007, the report says.

Lending rates are rising as a result of SBP's tight monetary policy (TMP) aimed at checking inflationary pressures. Yields on various instruments are also rising. Karachi Inter Bank Offered Rate (KIBOR), for instance, is up at 13.20/13.70 per cent bid and offer for six months, and 13.57/14.07 for one year.

SBP, on August 29 borrowed Rs. 29.59b by auctioning the government's Pakistan Investment Bonds (PIBs). It raised cut-off yield on nearly all government security papers of long tenors. The raise ranged from 35.62 to 140.09 basis points.

The cut-off yield for 3-year PIBs rose to 13.6973 per cent a year up from 12.2964 per cent at the last auction on June 28 this year.

It was followed by 112.92 basis points increase in the 10-year government bonds which increased to 14.472 per cent from 13.4112 per cent. The cut-off yield on 15-year PIBs was raised from 13.6104 per cent to 14.7500 per cent. Yield on 30-year long-term bonds went up from 14.2496 per cent to 14.934 percent.

The central bank had raised the cut off yield on short term market treasury bills on August 27. In view of the rise in interest rate of Treasury Bills (TBs), the investors were expecting an increase in interest rates of long-term government security papers. But several of them including the insurance companies which normally invest in 20-30 year PIBs, stayed on the sidelines.

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