The State Bank of Pakistan (SBP) has in December, 2004, issued a voluminous book "Financial sector assessment 2003" (FSA), containing the details about the performance of the financial sector institutions for the calendar year 2003. These institutions include the scheduled banks, Development Finance Institutions (DFIs), investment banks, leasing companies, Modarabas, micro-finance institutions and the insurance sector.
The purpose of this write-up is to share a few of the contents of the report with the public and to put up an analysis on some points where considered appropriate.
According to the FSA, the financial sector grew robustly during 2003 adding Rs 542.7 billion worth of assets which represent an increase of 15.3 per cent over the asset base of 2002. The average spread for the financial sector (difference between lending and deposit rates) declined to 4.4 per cent in 2003 from 5.1 per cent in 2002. The overall credit extended by the scheduled banks increased from Rs 1042.2 billion at the end of the fiscal year 2002-03 (FY 03) to Rs 1350.9 billion at the end of the fiscal year 2003-04 (FY-04) which reflects credit expansion of Rs 308.7 billion during FY-2004.
The year 2003 witnessed easy availability of the credit at cheaper rates. However, as mentioned in the FSA, easy availability of the credit and the large investment portfolio of the government securities has made the financial sector more vulnerable to credit and market risks (page 2). An apprehension has been expressed that the absence of centralised credit information bureau to maintain the credit history of all individuals availing loans poses a problem for further development of consumer finance.
The lending to the SMEs grew by Rs 105.1 billion in FY-04 ie from Rs 145.5 billion at end June, 2003 to Rs 250.6 billion as at end June,2004 (page 4). The profitability of the financial sector also increased with the return on average assets (after tax) moving to 1.4 per cent in 2003 when compared to only 0.4 per cent in 2002 (page 2) which (1.4 per cent) is stated to be marginally higher than the generally accepted bench mark of 1.25 per cent.
How the large investment portfolio in the government securities has made the financial sector vulnerable to credit risks is not understood. There could be some market (profitability) risks in holding long-term fixed rate government securities by the banks and the NBFIs as an upward revision in interest rates could lead to capital losses as pointed out in the FSA.
In the footnote on page 13, it has been clarified that the data as of the 30th June, 2003 of the NBFIs, specialised banks has been added to the data as of the 31st December, 2003 of the banks to work out the consolidated position.
As the FSA has been published about one year after the close of the calendar year to which it pertains, the data about NBFIs and the specialised banks as of 31st December, 2003 must have been used. There is, prima-facie, no rationale in using half-year old data. Different closing dates of different institutions could hardly be any bar in compiling the data as on any particular date.
The FSA indicates that all major indicators of the financial sector have improved during 2003. Table I containing the comparative position of the years 2002 and 2003 of these indicators is appended:
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Table I : Major indicators [per cent]
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Head 2002 2003
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(1) Equity (excluding surplus/deficit ) 4.9 5.9
to liability
(2) Equity/liability ratio 6.8 7.5
(3) Equity/Asset ratio 6.3 7.0
(4) Average cost of deposit/borrowings 4.4 2.1
(5)Average return on advances/investment 9.5 6.6
(6) Average spread (5-4) 5.1 4.5
(7) Non-interest income to total income 19.1 30.6
(8) Liquid assets to total assets ratio 44.9 43.5
(9) Return on average asset (after tax) 0.4 1.4
(10) Earning assets to total assets ratio 79.1 81.9
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SOURCE: Table 1.2 page 15 of SBP Financial sector assessment 2003
As for equity/liability ratio, under item (1) the ratio for 2003 is 5.9 per cent while under item (2) it is 7.5 per cent. Under item (1), the ratio is far on the lower side. This may be because the effectual amount of the equity may be much lower presumably because of accumulated losses of a few banks and /or the deficit on account of revaluation of the assets. Thus the data given at item (1) should be more factual and dependable.
However, nowadays the capital adequacy is assessed on the basis of equity: asset ratio which currently is 8 per cent. Viewed from that angle, the banking sector is still short of the required international standard. This may be due to the shortfall viz-a-viz the large-sized public sector banks. As the public sector banks are now reported to have become profit earning.
SBP has called upon the smaller banks in the private sector to raise capital to Rs 1.5 billion in 2004 and to Rs 2 billion in 2005, the overall position in this context may have slightly improved during 2004 and may be that the international standard will be reached in 2005.
The spread ( item 6 of Table 1) between average lending and deposit rates which is also taken as banks' intermediation cost has been indicated to have been decreased from 5.1 per cent (2002) to 4.5 per cent (2003). The data contained in the SBP annual report for FY-04 (AR FY-04), however, substantially differs. A comparative position of FSA and AR FY-04 is contained in the Table II appended:
Table II- Lending / deposit spread as of 31/12/2003.
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Rates Source* Source **
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(A) Lending 8.01 6.6
(B) Deposit 1.57 2.1
(C) Spread 6.44 4.5
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[A-B]
It will be seen from Table II that as per AR FY-04, the spread at end 2003 is 6.44 per cent while the FSA puts it at 4.4 per cent ie 2 percentage points lower. Here, it can be argued that the data contained in AR FY-04 is in respect of scheduled banks only while in FSA the given data includes that of the scheduled banks, Non-Bank Financial Institutions (NBFIs) and micro-finance institutions.
However, the deposit (plus borrowings)/ advances ( plus investment) base of NBFIs, and micro-finance institutions which number 2 only at the present, is not so large that it could make a difference of 2 percentage points in the spread.
Para 3.3 of the FSA outlines various methodologies for determining the 'spread' but none of them appears to have been used in compiling the data given in Table 1.2 of the FSA. It appears that separate methodologies/ bases have been used in calculating the 'spread' in FSA and AR FY-04.
The wighted average lending / deposit rates base has been used in AR FY-04 while in the FSA, only the average lending deposit rates have been used. That being the position, it would have been prudent for the SBP to have used the same methodology/ base in calculating the identical data presented in two different reports. Obviously, the weighted average rates should be considered more representative.
The profitability of the scheduled banks markedly improved during 2003. The pre-tax profit increased from Rs 19 billion (2002) to Rs 44.8 billion. The profit of the DFIs also rose from Rs 4.9 billion (2002) to Rs 11.3 billion and that of Investment Banks from Rs 3.3 billion (2002) to Rs 4.6 billion (source: Tables 3.A-1 and 3.A-2 of FSA). As the largest sector of the financial institutions comprises "scheduled banks", their profit position is given in Table III appended:
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Table III Banks' profitability during 2002 and 2003 [Billion Rs]
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Category of banks 2002 2003
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Income Expenses profit Income expenses Profit
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1 2 3 4 [2-3] 5 6 7 [5-6]
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Public sector banks 66.3 55.4 10.9 57.6 41.4 16.2
DPBs* 76.7 64.8 11.9 76.6 52.7 23.9
Foreign banks 24.4 17.8 6.6 18.7 11.6 7.1
Specialised banks 13.7 24.1 (-) 10.4 13.2 15.6 (-) 2.4
Total 181.1 162.1 19.0 166.1 121.3 44.8
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The increase in the credit has no doubt been the main reason for increase in the banks' profitability, the squeeze of the depositors is also one of the main factors. The weighted average deposit rate went down from 2.12 per cent [end FY-03] to 1.29 per cent [end FY-04) -a reduction of 39.15 per cent while the weighted average lending rate reduced from 9.70 per cent [end FY-03) to 7.48 per cent representing reduction of 22.88 per cent only [ please refer to statistical Tables 6.9 and 6.10 AR FY-04]. Thus reduction in the deposit rates was almost twice that of lending rates. The deposit rates also stood at much lower than the government's acknowledged inflation rate.
It will be seen from Table III that the profit of the public sector banks marked an increase of 48.62 per cent. It increased from Rs 10.9 billion (2002) to Rs 16.2 billion (2003). Two major banks in the public sector during 2003 were National Bank of Pakistan (NBP) and Habib Bank Ltd (HBL); the latter was privatised in 2004.
It transpires from the annual reports for 2003 of these banks that NBP earned Rs 2 billion from stock trading while HBL's score on this account was Rs 2.7 billion. Apart from that in the case of HBL, a sum of about Rs 2 billion was written back in the expenses on account of actuarial adjustment. This aggregates Rs 6.7 billion.
The writing back of the expenses was obviously one time operation. If we exclude Rs 6.7 billion on account of these items, the 2003 profit of the public sector banks will be in the proximity of or lower than that of 2002. It will be recalled that in the year 2003 there was no limit on the banks' deploying funds in the bourses which enabled NBP/HBL to earn huge money.
While credit goes to the Treasurers of these banks for earning huge money for their institutions, the bourses are admittedly the speculation shops and the tide can reverse at any time despite expertise and competence of the concerned bank officials.
Therefore, realising the gravity of the situation, SBP in the beginning of 2004 issued directives precluding the banks from investing more than 20 per cent of their capital and free reserves in the stock and the banks were asked to regularise the position by the end-October, 2004. The banks may have complied with the SBP directive by now.
There were also reports that the banks were getting their high yield government securities replaced by the low-yield securities for booking instant profit. It is not known how far NBP/HBL benefited from this process in 2003 but the private banks may have certainly booked substantial profits in 2003 through such deals: though the extent of such profit is not publicly known. Notwithstanding that, the private Pakistani banks have shown remarkable profitability of over cent per cent.
The foreign banks operating in Pakistan could not show much increase in the profitability. The increase over 2002 is merely 7.5 per cent. The FSA has not analysed in detail the causes of increase/decrease in the profitability of the scheduled banks. However, there was a time when country's balance of payments was in grave dilemma and consequently the foreign banks used to be called upon by the SBP to bring funds under foreign currency accounts scheme and they used to oblige on their own terms including placement of rupee counterpart of such deposits with SBP @ 16-17 per cent p.a. interest and waiver from the requirement of complying with capital adequacy regulations of the SBP, etc.
This was country's compulsion as the Pakistani banks did not have access to the vast foreign currency resources. With the improvement in the foreign exchange situation; particularly in the aftermath of 9/11, this lucrative source of foreign banks' profitability is now the story of the past.
As for the credit expansion, FSA puts the figures of the outstanding credit at Rs 1350.9 billion (end FY-04) compared to Rs 1042.2 billion (end FY-03) which means credit expansion during FY-04 was of the order of Rs 308.7 billion (p 3 FSA).
These figures are at variance with the data given in AR FY-04 because as per Statistical Table 6.3 p-60 AR FY 04, it works out to Rs 272.512 billion [outstanding credit at end FY 04 Rs 1242.384 billion minus Rs 969.872 outstanding at end FY 03]. These figures must at least have tallied in the two documents because only the collection of data was involved and adoption of any specific methodology was not warranted.
At page 4 of FSA, credit expansion in the SME sector has been put at Rs 105.1 billion [ Rs 250.6 billion at end FY-04 - Rs 145.5 billion at end FY-03). Other sectoral distribution of credit expansion during FY-04 has not been given in the FSA. However, Table 2.5 page 18 of AR FY-04 puts the credit expansion in the agriculture sector during FY-04 at Rs 6.1 billion while consumer financing expansion stood at Rs 75.6 billion during FY-04 (page 84 AR FY-04).
Thus total credit expansion in SME, agriculture and consumer financing sectors aggregates Rs 186.8 billion which leaves a sum of Rs 121.9 billion only [Rs 308.7 billion - Rs 186.1 billion] for the rest of the economy including public sector enterprises, large scale manufacturing, imports and exports etc. Can that be the real position?
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