Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Asia-PacificJuly 1 2016

Channelling growth in Pakistan's banking sector

Pakistan's big five banks have largely enjoyed a prosperous past 12 months. However, as Edward Russell-Walling discovers, lower interest rates, a lack of credit being extended to the private sector and the rise of Islamic finance are causing the banks to reassess their strategies. 
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
HBL embedded

Pakistan’s big banks enjoyed another good year in 2015, improving their metrics across the board. Yet as the government borrows less from them and activity in the China Pakistan Economic Corridor (CPEC) increases, they will be both pushed and pulled towards lending more to the real economy. 

For now, in an improving economy, the sector remains in robust health. In calendar year 2015 deposits grew 12.6% to Rs10,390bn ($99.35bn), and assets 16.8% to Rs14,140bn, according to the State Bank of Pakistan (SBP), the country's central bank. Asset quality improved, as the ratio of non-performing loans (NPL) to loans fell from 12.3% to 11.4% and the provision coverage ratio improved from 79.8% to 84.9%. 

Given banks’ extensive investment in government stocks, the liquidity ratio in December 2015 was 52.3%, well above the required level of 24%. An improvement in private sector lending reduced the industry’s capital adequacy ratio slightly to 17.3%, well above the local benchmark of 10.25% 

Banking was even more profitable in calendar year 2015 than the year before, with its return on assets rising from 2.2% to 2.5% and return on equity from 24.3% to 25.8%. The number of loss-making banks fell to three from six in 2014. All of the big five nationwide institutions managed to increase their pre-tax profits, some by wide margins. National Bank of Pakistan (NBP), where the state retains a 76.8% stake, raised pre-tax profits by a heroic 41.5%. 

Bank growth 

NBP, The Banker’s Bank of the Year in Pakistan for 2015, has been recovering from a poor 2013, when it had to make a large provision against losses in Bangladesh. Its 2015 results were boosted by a surprise surge in net interest income, with notable contributions from capital gains on government securities and foreign exchange, and significant write-backs in provisions. 

NBP is Pakistan's second largest bank by assets ($16.32bn) and the fourth by Tier 1 capital, which actually shrank by 4% in 2015. Among the big five, however, it again posted the lowest returns on assets and capital. 

The government sold the last of its shares in Habib Bank Limited (HBL) in 2015. HBL remains the largest bank in Pakistan by assets ($21.2bn), and leads the market by a number of other measures, including deposits, net profit and numbers of branches, customers and ATMs. In 2015 it enjoyed a 19% rise in pre-tax profits. 

“We have enjoyed very solid growth,” says Nauman Dar, HBL’s CEO. “We have generated a lot of efficiencies, brought in new customers and seen volumes increase in payment services. All those elements have helped us to make more money.” Mr Dar adds that consistently falling interest rates, amounting to 400 basis points in the previous financial year, have made life harder, and that more loosening is a possibility. 

HBL currently sponsors the hugely popular Pakistan Super League cricket tournament, and believes it has the strongest banking brand in the country. This was borne out when it won a 2015-16 World Branding Award for Pakistan. 

United Bank Limited (UBL) is Pakistan's number three bank in assets ($14.2bn). However, it has the highest return on capital, at 42.02%, and grew its 2015 pre-tax profits by 16.9%. Describing retail banking as the 'cornerstone' of its franchise, it expanded domestic deposits by 19%, well ahead of the market. At the same time, it expanded its investments, concentrated in government securities, by 44%. UBL Omni remains the market leader in branchless banking, and a significant generator of fee income. 

The Institute of Bankers Pakistan and a local media group organised the first Pakistan Banking Awards in 2015 and gave the overall award for best bank to UBL. The citation described it as “the most significant contributor to national development”. 

Top five pakistan banks by Tier 1 capital

New sources of income 

MCB Bank is the fourth largest bank in Pakistan by assets ($9.7bn) but first, by some margin, in return on assets (4.2%). It is also the clear leader in regulatory capital, with a BIS capital ratio of 20%. Pre-tax profits increased by 9.7% in 2015. Like its peers, but perhaps more so, it benefited from securities-related interest income and capital gains. It managed to grow its mobile banking customers by 43%, started wholesale operations in Dubai and launched an Islamic subsidiary. Credit Suisse analysts described MCB as the best bank in Pakistan and one of the three best in Asia. 

Allied Bank is the smallest by assets ($9.5bn) of the big five but is, like them, a nationwide institution with more than 1000 branches. Its pre-tax profits grew by 10% in 2015. CEO Naeem Mukhtar, whose family is the bank’s majority shareholder, used to write computer code many years ago, which may explain why one of the bank’s strengths is in IT and information analytics. That in turn feeds into its reputation as a shrewd investor. While the value of its equity portfolio took a hit from lower oil prices, it realised “significant” income from its bond trading activities. 

Mr Mukhtar defends his bank’s exposure to government stocks. “We operate a classic banking model,” he says. ”When we have surplus liquidity, we automatically invest in government paper. And we have had surplus liquidity for the past six or seven years.” In that time, he adds, because of the energy shortage, clients have been operating below full capacity and have had a lower appetite for borrowing. 

Government paper pile-up 

Full-year figures from SBP for the Pakistan banking sector as a whole show that, while net investments rose by 30% to Rs6880bn, net advances were only 8.3% ahead, at Rs4450bn, which more or less sums up the current Pakistani banking model. 

Pakistani banks have for some years now deployed the majority of their deposits into higher yielding government paper. In its year-end quarterly report, SBP noted a shift in banks’ preference towards the end of the year for longer term government bonds, in anticipation of lower interest rates. The central bank eventually cut the policy rate by 25 basis points to 5.75% in May, surprising some since inflation had ticked up in April. 

In the first quarter of calendar year 2016, this trend continued. Assets rose by 1%, fuelled mainly by investment in government securities, while overall advances had a seasonal decline, thanks to net retirements against commodity and small and medium-sized enterprises (SME) financing. In its annual report for 2015, SBP noted that the credit-to-gross domestic product (GDP) ratio in Pakistan is lower than most of its emerging market neighbours. 

Private sector credit 

Indeed, commercial banks’ credit to the private sector as a percentage of GDP has more than halved from 27% in the 2008 financial year to 13% in 2015. After the credit boom of 2005 to 2007, these are historic lows. In countries such as India, Bangladesh and the Philippines the ratio is already higher than it was in 2007, while in Pakistan it is still falling. 

The profile of these private sector loans is revealing. The sectors that contribute the most to GDP do not, as might be expected, get the biggest share of credit. Services account for 59% of the economy but only take 17% of the loans. Manufacturing accounts for 20% of GDP but 63% of credit. Agriculture provides 21% of GDP and takes only 9% of credit. 

A look at the size of borrowers sheds more light on this phenomenon. Large loans (Rs10m or more) make up more than 80% of the total, but their borrowers are only 1.8% of all borrowers. “This suggests that bank credit is heavily skewed towards big corporations, while consumers and SMEs are underserved sectors,” the central bank says. 

The reasons for this arise from both the demand and the supply side. The most obvious supply-side constraint is the presence of a dominant borrower, in the shape of the government, which has a classic crowding out effect. In the SBP’s regional comparison with Bangladesh, India, Malaysia, Philippines and Sri Lanka, Pakistan’s government borrowing from the banking system as a percentage of GDP is the highest of all. 

If the government has relied on the domestic banking system to finance its persistently large fiscal deficits over the years, this has suited the banks just fine. The ostensibly risk-free government is a more attractive proposition than the risky private sector – Pakistan also has the highest percentage of NPLs among the chosen countries. 

Low private credit demand 

If the supply of private sector credit has been reduced, so too has the demand. High lending rates constitute one deterrent. Pakistan has the highest three-year average real cost of borrowing in the group, bar Bangladesh. Low financial awareness is another, with only 25 in every 1000 adults borrowing from commercial banks, according to World Development Indicators (see microfinance story on page XX)

As Mr Mukhtar points out, structural issues such as energy shortages and the security situation have forced businesses to operate below their optimal level, which has dampened their desire for credit. Research shows that most people in Pakistan prefer to avoid borrowing money and, indeed, that three-quarters of them have never done so. Most of those who have, have tapped informal sources. 

Pakistanis who say they might think of borrowing would do so for short-term bridge financing, such as settling bills, paying for emergencies or weddings, or to buy land. This, says the SBP, reveals a “huge” demand among middle-income groups for consumer, auto, leasing and housing finance. As the SBP points out, however, banks are not geared up to meet this demand. 

Islamic banking's rise 

One segment of the Pakistani industry that does not want to invest in government bonds, at least not of the conventional variety, is Islamic banking, which continues to build market share. The 22 Islamic Pakistani institutions, with nearly 1800 branches between them, have total deposits of Rs1271bn, which is 13.1% of all banking deposits, according to latest SBP figures. Their assets are worth Rs1511bn, a share of 11.2%. The SBP is targeting 20% penetration by 2020.

"The industry will only reach maturity once we have hit 50% or 60%, so there is huge potential," says Hasan Bilgrami, CEO of BankIslami Pakistan, the second largest Islamic bank in the country after Meezan. Bank Islami now has 317 branches and assets of Rs174bn, having paid a nominal fee in 2015 to acquire troubled KASB Bank. "Our biggest challenge is we don't have any Treasury paper, and no products to manage interest rate risk or positions on the yield curve," says Mr Bilgrami. 

Islamic banks are allowed to buy conventional government securities if they must, in order to meet liquidity requirements, but they would generally prefer sharia-compliant instruments, which are in short supply. Outstanding official sukuk and bai-muajjal total Rs637bn. Net issuance to the end of May 2015 was R37.6bn. So, Islamic banks carry more loans than investments, and their investments-to-deposits ratio was 31%, against 69% for the overall industry during the comparable period. "Islamic banks really are performing intermediation," says Riaz Riazuddin, the deputy governor of the SBP. "They are raising deposits and extending credit to the private sector, unlike their commercial brethren. So their contribution to the economy is much more than their weight in the overall banking sector." 

Setting up new business 

Islamic lending to corporates is continuing to force down spreads. One commercial banker says that Islamic corporate pricing is 75 to 100 basis points inside conventional assets. All of the big five commercial banks have felt the need to compete in the Islamic sphere. After considering an acquisition, MCB Bank has finally decided to start its own Islamic subsidiary. HPL now has 45 standalone Islamic branches and Mr Dar says it may look at creating a subsidiary. NBP wants 150 Islamic branches by the end of 2016 and is also talking of setting up a subsidiary. 

The big banks will inevitably lend more to the private sector. As the budget deficit reduces, the government is borrowing less and on better terms. At the same time, CPEC (see economy story on page XX) is creating lending opportunities for domestic banks, which they are already starting to exploit. 

Like NBP and UBL, HBL already had a representative office in Beijing. Now it has received a licence to open a branch across the Chinese border in Urumqi, the largest city in Xinjiang province. It is the first south Asian lender to whom this privilege has been extended. 

HBL's Mr Dar says his bank is involved in most of the CPEC-related energy financings that have been arranged so far, though there have been no drawdowns yet. He does not regard the weakening of the government security crutch as a threat. “This is still a hugely unbanked economy, so banking is growing at a faster rate than the economy itself," says Mr Dar. "There is so much out there – the question is how much can you handle. The room to grow is huge."

Was this article helpful?

Thank you for your feedback!

Read more about:  Asia-Pacific , Asia-Pacific , Pakistan , Regulations