The bottom line: Is the banking sector’s record streak about to snap?

After a blowout year in 2011, banks may see marginal declines in profits going forward.

KARACHI:

Is the party in the banking sector over or is it just getting started? While the State Bank of Pakistan recently took some actions that most analysts view as having a negative impact for the banks, for the most part, the record-breaking profits look set to continue for the foreseeable future.

The year 2011 has been an outstanding one for the banks. While the results are still being compiled for some, by most accounts, the commercial banks in Pakistan closed out the most profitable year in their history on December 31, 2011. The 22 listed commercial banks had a combined profitability of Rs117.5 billion, up an astonishing 84% compared to 2010. Even when one excludes the banks that had losses in the previous year, the banking sector’s profitability is still up a very respectable 27%.

Part of the reason for the blow-out increase in the sector’s bottom line is simply the fact that the bank that were haemorrhaging losses last year are now turning profits. Yet this is not the entirety of the picture. Many banks have simply grown at a dramatic pace, and sometimes seeing their profits double or triple.

Bank Alfalah, for instance, saw its profits rise by a massive 262%, while Meezan Bank saw its profits rise by over 105%. Even Standard Chartered Bank saw its net income increase by 54%. So how did these banks do it?

It does not appear to be an extraordinary increase in the sector’s deposits, which grew by about 14.6% last year, which is about on par with the growth rate during the past decade. Nor does it appear to be an inordinate increase in the banking spread – the difference between the interest rate that banks charge their borrowers and the rate they pay out to their depositors. For much of the year, the spread hovered between 7.4% and 7.7%, which is high but nowhere near record-breaking levels.

The real difference appears to have been the provisioning for loan losses, for which the banks appear to have taken most of their lumps in the preceding three years. Nearly every bank CEO who spoke to The Express Tribune spoke of how “clean” their balance sheet was, a euphemism for having gotten rid of all of their bad loans.

There are still many experts who believe that the banks still have a lot to hide. The State Bank’s relaxation of some provisioning rules, particularly for some banks, appear to be artificially inflating the bottom lines of many banks. Some have forthcoming about the weaknesses of their balance sheet. The Bank of Punjab, for instance, admits that it did not recognise losses of about Rs28 billion after it was granted an exemption from the central bank.

The real reason for the banking sector’s lower losses on bad loans may simply be that they have stopped making them to the private sector. Nearly every bank reported a massive increase in its investments in treasury bonds – effectively lending money to the federal government, risk-free – and weak growth, or even declines, in their lending to the private sector. The State Bank appears to be unhappy with this laziness on the part of the banks, going so far as to say that “the banks have ceased to function as financial intermediaries in the economy,” in one of its most recent quarterly reports on the state of the national economy.

And in the most recent monetary policy announcement on Friday, the central bank announced that it wants the banks to pay a higher minimum rate of return on the nearly 15 million savings accounts in the country.

So will this actually reduce the banking sector profitability? Most analysts believe that the effect will be marginal, and more than offset by the fact that the bank will continue to have lower losses from bad loans. The party in the banking sector may not be sustainable, but it looks set to last for a while longer.

Published in The Express Tribune, April 16^th, 2012.