Banks face tax pressure as ADR falls

Banks in Pakistan are contemplating reducing client deposits to sidestep a looming additional tax of up to 16%, prompted by a significant drop in their advance-to-deposit ratio (ADR), which is currently well below the required 50%.

In the second quarter (April-June) of 2024, the banking sector experienced a 26% increase in profit, reaching Rs137 billion. This figure excludes the National Bank of Pakistan (NBP), which reported a substantial loss due to pension settlements for retired employees.

According to JS Global Research's commentary titled "Tax Threat Looms, Banks Race to Boost ADR," the sector's ADR had declined to 39% by July 2024, falling short of the 50% threshold necessary to avoid higher taxes on investment income. To address this, banks may need to boost their ADR by the end of the year. Assuming deposits remain unchanged, the sector would need to increase its loan portfolio by Rs3.4 trillion (a 29% growth) from August 1 to December 31, compared to a historical average growth rate of 8%.

The research noted that achieving such rapid loan expansion might be unlikely, and banks could also limit deposit growth, as observed in 2022. A 10% reduction in deposits from August to December 2024 would necessitate a 16% increase in loans to reach a 50% ADR.

Topline Research reported a 26% rise in banking sector profits despite recent interest rate cuts. This profit growth was primarily driven by increases in net interest income (NII) and non-interest income.

The report highlighted that NBP recorded a one-time loss of Rs49 billion in the second quarter of 2024 due to pension settlements following a Supreme Court verdict.

Despite the interest rate decline, the sector's NII reached Rs488 billion, up 7% year-on-year and 4% quarter-on-quarter for the second quarter of 2024, due to volumetric growth and favourable repricing impacts.

Interest income increased by 35% year-on-year and 6% quarter-on-quarter to Rs1.8 trillion, while interest expenses rose by 47% year-on-year and 6% quarter-on-quarter to Rs1.4 trillion.

Non-interest income surged 49% year-on-year and 2% quarter-on-quarter to Rs127 billion, driven by gains on securities and higher foreign exchange income. Conversely, non-interest expenses grew by 20% year-on-year and 7% quarter-on-quarter to Rs260 billion, reflecting higher administrative costs in line with inflation trends.

The sector's cost-to-income ratio was 45% for the quarter, compared to 43% in the same quarter of 2023 and 44% in the first quarter of 2024.

Interestingly, despite high interest rates, the sector recorded a provisioning reversal of Rs1 billion in the second quarter of 2024, in contrast to a provision charge of Rs12.9 billion in the same quarter of 2023 and Rs8.5 billion in the first quarter of 2024, due to strong asset quality.

The effective tax rate for the second quarter of 2024 was 49%, down from 52% in the same quarter of 2023 and 50% in the first quarter of 2024.

In the first half of 2024, bank profitability increased by 12% year-on-year to Rs289 billion, driven primarily by a 13% growth in net interest income to Rs881 billion and a 56% rise in non-interest income.