Financial Data and Comments: The critical and important data pertaining to the country's banking sector, over the preceding few years, and relevant to this article is appended at the end of this article, Annexure No I. During the two years period, as of December 31st 2002 through December 31st 2004, the following significant events took place:
1. The Total Loans increased by 47.69% while Total Deposits by 42.43%
2. The Net Interest Income increased by 31.75%
3. Even though the Non Interest Income increased by 45.5%, as a percentage of Total Loans it came down from 2.82% to 2.77%
4. The Pre Tax Profit surged by 208%. However the returns for the saving accounts holder came down from 3.48% to 0.93%
5. As Non Interest Income as a percentage of Total Loans has actually decreased in this period, the entire profitability growth has been driven by higher loan volumes coupled with expanding spread.
6. Further, between December 31st 2004 and 2005,Total Deposits increased by just 8.42 %, from Rs 2,410 billion to Rs 2,613 billion, while Total Loans increased by 18.52%, from Rs 1,728 to 2.048 billion, respectively.
7. As the Chart indicates the period between December 31st 2004 and June 30th 2005 while the Average Weighted Lending Rates increased by 153 basis points, the Average Weighted Savings Rate went up by only 42 basis points - that is, less than one third.
8. Thus, the anxiety would be even higher, particularly with respect to meeting the expanding credit needs of the country and the potential tightening of the commercial banks' total resource base. This graph more vividly depicts the above-mentioned changes in the country's banking sector.
A further analysis of the attached data (Annexure No I) as well as the above graph indicates:
1. Most significantly, for the year ended December 31st 2005 the total saving account deposits have declined from those as of June 30th 2005.
2. From June 30th 2005 the total saving accounts deposit base for the first time ever has actually come down, from Rs 1, 264 billion to Rs 1,203 billion - a decrease of almost 5% in a six months period!
3. This could probably reflect that after all the market forces have started playing their perceived role.
4. Any banker would be concerned as this segment of the deposits has been the core element in the commercial banks total deposits. The above figures indicate that from December 31st 2004 till December 31st 2005 there has been nominal growth, just 1%, in the total savings account category.
As stated in the preceding pages the extraordinary profitability levels are primarily a function of the loan growth. This is fully illustrated by the appended graph.
INTEREST SPREAD AND MARKET DYNAMICS Presently, the area of determining the lending rates is to a large extent based on the market dynamics. However, with respect to the deposit rates the area is exclusively at the sole discretion of the banks' management.
The predominant contributor towards the commercial banks' deposit base, the saving accounts holders, are either too small or too dispersed or unaware of the prevailing market rates to play any role whatsoever in the process of determining the applicable rate. In other words these customers for all intents and purposes are "captive" customers.
More worrisome is the impression that with respect to fixing the rates for saving accounts either the anti-competitive forces are in action or, more worrisome, there is some form of an apparent collusion within the commercial banking sector. Neither one of the situations is desirable nor beneficial nor durable and warrants immediate correction.
There is an argument by some policy makers that the prevailing interest spread is neither "exorbitant" nor "excessive". The average Lending Rate, as of June 30th 2006, was about 14 % and the prevailing rates for new deposits, with tenor not exceeding 90 days, were about 91/2 to 101/2%. Thus, the interest spread at that time was less than 5%.
I, for one, differ with this argument. This comparison is on the one hand of Average Lending Rates, ie the prevailing average rate for majority of the borrowers, and on the other hand, the 30/90 days Deposit Rates, ie the incremental cost of funds, for limited, selected and rate sensitive customers.
Thus, it would technically not be appropriate to compare the two rates. While one is the average rate for a majority of its customers, the other is the incremental rate for limited number of customers.
More significantly, on the asset side this Average Lending Rate covers the majority of Borrowers (and thus more than 60% plus of the asset base), on the deposit side, these categories of deposits, 30/90 days Deposits, constitute less than 10% of the total deposit base of all the commercial banks. Moreover, these funds are like "hot money" that flows immediately to whichever bank offers the highest return.
On the other hand, the balances in the savings and other interest bearing deposits account combine together to constitute more than 70% of the total deposit base and these deposits have been and are till now a stable source of funds. However, the average weighted saving accounts deposit rate as of June 30th 2005 is only 1.24% per annum and this category of depositors constitute more than 50% of the banks' deposit base.
In a competitive environment the market forces do ultimately correct the aberration, either by lowering the Lending Rates or by increasing the Deposit Rates. However, the actual fact, particularly of the preceding 2 to 3 years has been that this interest spread has actually increased instead of decreasing. In other words, it appears that anti-competitive forces are at play.
Interestingly, one of major international bank operating in the country recently announced the interest rate on savings accounts for the period July to December 2006; it was just 0.50% per annum.
Admittedly, this approach may be attractive for the commercial banks to adopt on the short term basis, but is this desirable on the long haul? As stated above, it appears that the commercial banks' senior management is primarily interested in realising its short term objective, ie excessive or exorbitant spread that generates extraordinary profitability levels.
It is probably, therefore, not concerned about the returns to the majority of its depositors or the long term economic interests of the country or the potential implications on its core deposit base. This short term objective of the commercial banks, thus, to a significant degree, challenges one of the primary responsibilities of any Central Bank, ie to protect, safeguard and defend to a large extent the overall interest of the depositors.
GROWTH OF MUTUAL FUNDS - US MARKETS This prevailing situation in Pakistan, to some extent, is synonymous to what was prevailing in the US market prior to 1960s where the commercial banks were the primary, if not the predominant, recipients of deposits and savings both from the individuals as well as institutions.
Due to its own set of circumstances coupled with a rather fragmented market, the rates available from the US banking sector prior to 1960s, were on the low side and thus from this angle the present situation in the country's banking sector is somewhat similar to the one in the US Banking Industry in the 60s.
In 1960 the US banking Industry had $228 billion in deposits while the Money Market Mutual Funds (MMMF) had nil; by 1980, the deposits with the banks had increased to $1,182 billion and with MMMF to $76 billion and by 1995 these were $2,552 and $745 billion with the banks and MMMF, respectively (Figures taken from an article by Krosner, S. Randall and Straham, E. Philip "Regulation and Deregulation of the US Banking Industry: Causes, Consequences and Implications, August 2005)."
In other words, in these fifteen (15) years while the total amount of deposits with the banks increased by 215%, those with MMMF multiplied by almost ten times (increased by 980%). Further, if the overall size of the Financial Assets within the US Financial Sector Industry is examined the impact of the change is even more pronounced.
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In US $ Billions
1990 2004
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Money Market Mutual Funds 493 1,880
Mutual Funds 608 5,425
Commercial Banks 3,337 8,487
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Total Financial Assets 36,639 109,183
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Source: US Bureau of Census
As is vivid from the above, within these fourteen years the Total Financial Assets in the US have almost tripled in size. Simultaneously, the share of MMMF and Mutual Funds which was just 3% in 1990 has more than doubled to 6.69% in 2004.
Conversely, in the same period the share of the Commercial Banks in the US Financial Assets has decreased from 9.1% to 7.77%. More importantly, the total size of the Financial Assets with MMMF and Mutual Funds was almost 86% of that with the Commercial Banks in 2004 compared to just 33% in 1990.
The aggressive marketing by mutual funds coupled with the introduction of various instruments and products, as alternative products in that market as compared to the standard products of the commercial banks, giving a significantly higher yield to the saver/investor impacted the commercial banks deposit base profoundly.
Thus, in today's US financial markets the commercial banks have a significantly lower share of the overall national savings and deposits compared what was the position just three decades back.
With the rapid development now taking place in the country's mutual funds sector, a similar situation too could take place. Thus it is imperative the commercial banks operating here take proactive measures to protect and defend their turf prior to similar significant erosion by competing forces.
(To be concluded)
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