EDITORIAL: Due to the imposition of the Advance to Deposits Ratio (ADR) tax by the federal government, banks have started reacting by engineering their balance sheets to avoid the tax.
The tax is based on the ADR on the last day of the calendar year. If the ADR is below 50 percent, additional income tax will be applied.
To avoid the additional tax, banks have begun lending to non-banking financial institutions (mainly DFIs), private corporations, public sector entities, and others at sub-par rates to enhance their ADRs by December 31st.
Borrowers, in turn, are taking advantage of this by resorting to arbitrage; investing loan funds in government-backed securities that are risk-free.
Another measure banks have implemented is the imposition of service charges on checking account deposits at a rate ranging from one to five percent on large deposits. Some banks have imposed a floor of Rs 1 billion, which can go up to Rs 5 billion.
This disruption in the overall ecosystem reportedly prompted the State Bank of Pakistan (SBP) to intervene. Sources say the SBP asked commercial banks to remove service charges on deposits, as they were causing unnecessary inconvenience to depositors and incentivising them to move to the cash economy.
The currency in circulation is already high, and these charges would have worsened the situation. In exchange for this, the SBP has agreed to adjust the minimum deposit rate (MDR) for conventional banks. The MDR was imposed in 2008-09 with the objective of providing adequate returns to retail and small depositors.
Prior to the recent SBP circulars, banks were required to offer a minimum rate of 1.5 percent below the policy rate on savings deposit accounts, while Islamic banks had no such MDR.
MDR has now been removed from all conventional banks on deposits from financial institutions, public sector enterprises, and public limited companies. This is a welcome move as it preserves the objective of providing adequate returns to individual savers and small businesses, while removing the undue burden on banks. In return, banks are reversing the service charges they had recently imposed on deposits.
The SBP deserves to be commended for the promptness with which it moved to redress the adverse situation created by levying of service charges on bank deposits. Another important measure taken by the SBP is the application of MDR on deposits (excluding those from financial institutions, public sector enterprises, and public limited companies) at Islamic banks. This MDR is set to be equivalent to at least 75 percent of the weighted average gross yield of all pools of that bank.
The pendulum has now swung back into balance. The SBP made a wise decision by ending the undue advantage previously enjoyed by Islamic banks over conventional ones. The practice of offering MDR for sophisticated investors is also being phased out, as these investors should be placing their funds in government securities and other savings instruments on their own.
However, the core issue remains the ADR tax, which still needs to be addressed. It is a bad policy, and the SBP’s recent decisions aim to mitigate the adverse effects of the ADR tax on the overall banking ecosystem. On the surface, the government’s objective is to increase credit to the private sector.
However, the real goal of the FBR appears to be generating more revenue by taxing the profitability of banks at a higher rate. Instead of distorting the market with a tax on balance sheet items, they should simply increase the tax rate, as that would have less of a negative impact.
The desired objective of pushing banks to lend more to the private sector lies beyond the jurisdiction of the FBR and encroaches upon the domain of the SBP, diluting the SBP’s independence after recent amendments to its Act.
The SBP had to intervene. If the ADR tax continues, the SBP must take additional measures to maintain equilibrium in the system. Therefore, the FBR should revisit the tax and stop intruding into the SBP’s domain immediately.
Copyright Business Recorder, 2024
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