Banks usually wax and wane along with the economies they serve. Pakistan, for better or worse, is slave to no one else’s model, and its banks have been faring rather better than the country at large. But they lend more to the government than the real economy, which heightens both their credit and their strategic risk.
Given how poorly Pakistan's economy performed after the global financial crisis of 2008, it may seem surprising how stable the country's banking industry has been. That reflects how firmly banks have been regulated by the State Bank of Pakistan (SBP), which does not allow leveraging up and insists all loans of any size are secured. It also reflects the reforms that took place as the big banks began to be re-privatised in the 1990s. That sometimes-controversial process began under current prime minister Nawaz Sharif during an earlier term of office and he now hopes to complete it.
Investment growth
The SBP lists 38 banks licensed in Pakistan, including seven foreign entities. Foreign banks are no longer a major presence, however, since the security situation and stiff local competition caused most of them to pack their bags. But the banking system has scarcely noticed. Between the end of 2008 and June 2014, its total assets doubled to Rs11,115bn ($107bn). Deposits doubled over the same period to Rs8774bn.
Net investments have grown in this time by 350% to Rs4500bn (mainly government securities), while net advances grew by only 156% to Rs4200bn, which tells its own story. Non-performing loan ratios have declined over the past five years to stand at 12.8% of the total or a net 2.9% after provisions. While profits took a dive in 2008, the Pakistani banking sector has remained profitable throughout this period. At June 2014, according to the SBP, the industry's return on assets was 2.1% pre-tax, with a 23.5% pre-tax return on equity and a risk-weighted capital adequacy ratio of 15.1%. Not a bad picture.
The top five banks account for about half the industry’s total assets. They emerged after the 1974 nationalisation and subsequent rationalisation of 14 banks by Zulfikar Ali Bhutto’s government, and most have now been returned to majority private ownership in one form or another. The exception is National Bank of Pakistan (NBP), which has a 23% free float on the Karachi Stock Exchange, while the rest remains in state hands.
Capital adequacy requirements were tightened last year to 10% of risk-weighted assets and the SBP has been gradually raising minimum capital requirements. By the end of this year, all banks will need at least Rs10bn in paid-up capital. At least a dozen smaller banks are said to be unable or unwilling to meet the new standards, so there may be some consolidation as the deadline approaches.
Heaven-sent opportunity
The big five have no such problems, being well capitalised and, for the most part, very profitable. This has required no great ingenuity on their part, but merely the ability to spot a heaven-sent arbitrage opportunity when one presents itself. As long as the government keeps running up large budget deficits, these will need to be financed. And because willing lenders are not exactly in abundance, it must pay up. So the banks are able to offer up to 7% for deposits and lend the money on to the government for 10% to 12%, depending on the tenor.
Last year, only NBP lent more to the real economy than it invested in this way, and then only just, with a loan-to-asset ratio of 52%. While United Bank was not too far behind with a 47% ratio, the other three were all running below 40%. As the last remaining state bank, NBP is often called upon to lend where others will not. The SBP has described NBP’s financial condition as deteriorating due to weaknesses in corporate governance and controls. Its profits fell dramatically last year after a Rs9.7bn provision against losses in Bangladesh.
If NBP has the lowest return on assets of the big five, MCB Bank has the highest. It ranks fourth by size of assets, but makes almost as much money as the biggest, Habib Bank, on less than half of its assets. MCB and Allied Bank, the smallest of the big five, are both headquartered in Lahore, the prime minister’s stamping ground, and are regarded as close to him. Both are controlled by Lahori entrepreneurs rather than financial professionals. Although Malaysia’s Maybank owns a 20% stake, MCB’s controlling shareholder is textile magnate Mian Muhammad Mansha, Pakistan’s richest man.
Allied Bank concentrates on the corporate market, the safest sector in Pakistan but also the most competitive, and augments its yields with what some say is the industry’s best capital markets portfolio. It has the lowest non-performing loan ratio, followed by MCB. MCB sees itself as a blue-chip bank, more focused on customer quality than on size for its own sake. Its weakness, if it has one, is a lack of international reach, which it is now exploring.
Habib Bank, on the other hand, has a presence in 25 countries and describes itself as Pakistan’s largest multinational. It is 51% owned by the Aga Khan Fund for Economic Development, with a 7.5% free float. The state still owns the balance, which it hopes to sell in two tranches this year and next.
Overseas remittances
With more domestic customers than anyone else, Habib Bank has been adding branches and ATMs with vigour. But it has also used its international presence to build a strong position in remittances from overseas Pakistanis. While it has 15% of the banking system’s assets, its share of remittance transmission is approaching 23%, according to chief executive Nauman Dar.
“For us it’s a very lucrative and important business, which brings in the flows,” says Mr Dar. “We view ourselves as a national institution and this is providing a national service.” Traditionally, sums have been remitted via the Hundi system, outside the foreign reserves net, using middlemen who charge handsomely. By contrast, the bank uses as much straight-through processing as it can. “The remitter can track the money, which gets there really fast. It used to take a month,” says Mr Dar.
United Bank is also controlled by an entrepreneur, albeit one who lives in the UK. Sir Anwar Pervez’s Bestway Group now owns 51% of the bank, and the government’s remaining 20% stake was sold largely to international portfolio investors, many in the US, in a highly successful secondary market sale in June.
Only 11% of Pakistan’s population has a bank account so, as in other developing markets, the authorities are encouraging branchless banking and microfinance (see story pXX). Of all the top banks, United Bank has made the most headway in branchless banking, having launched its Omni card in 2010. The card was used as a distribution medium by donor agencies after the floods that ravaged the country that year. The bank also has a strong position in remittances, building on its strong links with the Middle East. The Abu Dhabi Group, a major investor in Pakistan, was a joint post-privatisation shareholder in United, although it has since sold down its holding.
Thinning margins
United Bank has the highest return on capital among the big five, even though margins generally have been the thinnest for five years, as interest rates move down. It also has the lowest capital adequacy ratio and the highest ratio of risk-weighted assets to assets.
Wajahat Husain, chief executive of United, believes that Pakistani banking has been doing well, but it could do much better. “Banks are flush with liquidity. There should be worthy borrowers, with the right collateral and the right profile,” he says.
After a small dip in 2013, private sector credit has resumed moderate growth in 2014, mostly for working capital, according to the SBP. Mr Husain predicts that it will pick up further once the fiscal situation improves. “There are two triggers for take-off – law and order, and the tax collection regime," he says. "Even a little improvement in private sector credit will translate into increased book growth [in small and medium-sized enterprises, or SMEs] for us.”
Some more seasoned Pakistani bankers would welcome that, critical as they are of 'lazy banking'. Corporate lending is fiercely competitive and some multinationals can now borrow at a discount to the Karachi Interbank Offered Rate, Kibor. Consumer finance and lending to SMEs offers returns that rival government bonds, but with somewhat more risk. Commercial banks have therefore neglected both segments and will revisit them only when government demand for funds is lower and rates fall accordingly.
Until July, credit rating agency Moody’s had a 'negative' outlook for the Pakistani banking system, partly because of its reliance on government stock. “The banks’ high and increasing exposures to Pakistani government securities... pose a significant credit risk, tying the system’s solvency to sovereign default risk”, it said at the time. The outlook has since been changed to 'stable', although the agency says "challenges persist".
Debt capital market
A functioning long-term debt capital market would provide an alternative source in Pakistan and allow debt to find its natural price level, but there seems little likelihood of one developing soon. Salim Raza, a former governor of the SBP, points out that banks in the country hold 66% of long-term government bonds and own some of the biggest mutuals that invest in some of the rest.
“They are not about to begin trading with each other,” says Mr Raza, adding that they are also reluctant to do anything to shrink their “outsize” spreads. “So unless you break the stranglehold of the banks, you won’t have a trading market.”
Nothing lasts forever, so what are the strategies of the big five for when government paper is less plentiful and less profitable? The problem, according to Zubyr Soomro, an elder statesman of the Karachi banking community, is that most of them do not have one. “The big banks try to do everything – consumer, corporate and investment banking – and most of the smaller banks follow their example,” says Mr Soomro, who has been Citibank country head for Pakistan, a transformative chairman and president of United Bank, and is now a member of the finance minister’s Economic Advisory Council. “In good times you can get away with that. But in bad times, to build a sustainable business, you must look at where you can be competitive and how you can differentiate.”
Some mid-sized banks such as Bank Al Habib and Habib Metropolitan Bank have focused successfully on trade finance. The state-owned First Women Bank supports female entrepreneurs. Pakistan would be well served by more financial institutions with niche specialisms such as housing or consumer finance. Yet one particular specialism is making substantial progress and that is Islamic banking.
Islamic banking
Islamic banking has been growing rapidly in Pakistan and now accounts for more than 10% of total banking deposits and just under 10% of assets. There are more than 1300 dedicated branches, concentrated in the most populated provinces of Punjab and Sindh. After the failure of an earlier attempt to Islamise the entire Pakistani banking system, the first Islamic banking licence was granted in 2002 to Meezan Bank, which acquired the operations of the departing Société Générale. The new official thinking was that customers should be allowed to choose the type of banking they wanted and there are currently three models.
First are the independent Islamic banks, of which there are currently five: Meezan, Dubai Islamic Bank, BankIslami, Al Baraka Bank and Burj Bank. Most include Gulf investors. Meezan, which recently agreed to take over HSBC’s Pakistani operations, became profitable in its first six months and has remained so ever since, perhaps because it had enough time to establish itself before the global financial crisis. Other standalone Islamic banks, founded shortly before the crisis, have had a harder time of things.
Next are commercial banks with Islamic banking windows. Although most of the bigger banks started down this route, some are now going for option number three, a fully owned Islamic banking subsidiary.
MCB considered buying Burj, but has since decided to launch its own Islamic subsidiary. NBP says it will now conduct due diligence over Burj. Two smaller banks that had Islamic windows have said they will convert wholly to Islamic banking – Summit Bank and Faysal Bank.
Islamic deposits are easier to come by than Islamic assets, so some Islamic banks are very competitive when bidding for corporate loans. “I understand they need to undercut me, but do they need to undercut me by 50 to 100 basis points?” grumbles one conventional banker.
The SBP ran an awareness campaign for Islamic banking last year and bankers seem confident that growth will continue. “Islamic banking is one of the fastest growing segments,” says NBP chairman Muneer Kamal, adding that in a conventional bank, an Islamic subsidiary was less confusing for the customer than a window. “It now accounts for 29% of Malaysian banking. In Pakistan we started later, but the government is now focusing on it and we believe that in the next 10 years we can get to 20% plus.”
