Home Banking The Regulatory Trend in the Pakistan Banking Industry Post 2007-08 Crisis

The Regulatory Trend in the Pakistan Banking Industry Post 2007-08 Crisis

by internationalbanker

By Emily Frost – International Banker

The financial crisis of 2007-08 hit the global market hard and also impacted the Pakistan banking industry. The slowdown in the banking industry was witnessed in the final quarter of 2008, when the deposits of Pakistan banks started falling. Not only that, provisions for loan losses went up, and so did yields on government securities. All of these changes made the banking industry unstable, and losses started piling up.

While customers gradually started moving away from taking loans, the increased discount rate did not help their cause. People started depositing money in banks rather than investing in business ventures, while banks started to move away from their core lending businesses due to increased NPLs (nonperforming loans). Hence banks witnessed an increase in their IDRs (investment-to-deposit ratios) after the financial crisis.

Ever-increasing government borrowing—for financing budgetary deficits—has also kept banks tilted towards investments that offered risk-free, attractive yields. This trend is evident by the constantly declining ADR (advance-to-deposit ratio), which went from 68 percent in 2009 to 45 percent at the end of September 2016. During the same period, the IDR went up exponentially from 36 to 69 percent at the end of September 2016. In terms of overall balance-sheet growth, deposits grew with a CAGR (compound annual growth rate) of 14.7 percent, inflating total banking assets from PKR 5.6 billion to PKR 15.1 billion from 2008 to September 2016. This handsome growth in the banking sector can be attributed to the attractive yield on government securities and minimization of NPLs due to excessive investment in securities.

During this period, banks naturally witnessed a lot of regulatory changes that took place as the State Bank of Pakistan (SBP) reinforced its hold on the banking sector. Over the last decade, Pakistan banks have seen numerous regulatory changes; unfortunately most of them have adversely affected banks in Pakistan. The following major regulatory changes took place, impacting the banking sector:

  • In June 2008, the State Bank of Pakistan introduced a minimum return on savings of 5 percent. As a result, this increased the cost of funds for banks, as they now had to offer a greater return to those holding savings accounts, cutting into their spreads.

  • After Pakistan was removed from emerging-market status in December 2008, the SBP introduced an interest-rate corridor of 300 basis points to allow better control and implementation of the monetary policy. The banks’ reverse-repo rate constituted the ceiling, and the repo rate constituted the floor.

  • In February 2013, the SBP narrowed the interest-rate corridor down to 250 basis points from 300 basis points. This resulted in again narrowing the borrowing and lending spreads for banks.

  • In another huge move, the SBP linked the minimum return on savings accounts to its repo rate, such that the minimum profit could not be below 50 basis points for banks. This pegged the minimum rate of return on savings accounts to the repo-rate level, which basically increased the cost of funds for banks.

  • In June 2014, the SBP introduced an adjustable tax on cash withdrawals from banks. This took away the incentive for people to engage in free-of-cost banking transactions, and customers moved onto non-banking cash transactions, which hurt banks in terms of deposits.

  • In May 2015, the SBP introduced a target rate between the floor and the ceiling of the interest-rate corridors. Additionally, the width of the interest-rate corridor was also decreased by 50 basis points to its new level of 200 basis points. This further squeezed the interest spreads for banks, and it is estimated that cumulatively, these changes decreased banking spreads by a minimum of 100 basis points.

  • Again, in June 2015, the SBP made another huge announcement for banks at the time of the 2016 budget. It so happened that the State Bank had increased tax rates on capital gains and dividends on securities to 35 percent. Previously, capital gains and dividends were taxed at 12.5 and 10 percent respectively, and given this massive new tax introduction, the EPS (earnings per share) of banks took a major hit.

  • Another major regulatory development at the time of the 2016 budget was the imposition of a one-time super tax of 4 percent on 2015 bank earnings. This tax was implemented to generate funds to help temporarily displaced people and was supposed to be a one-time-only imposition. But given the circumstances, the State Bank had to extend it to 2016, and so it cannot be ruled out that this tax will be extended again.

The regulatory developments for Pakistan banks have been anything but positive over the course of the last decade. The State Bank of Pakistan has seemed intent on making life tough for the banks operating in Pakistan, regulating this industry at a suffocating rate. One cannot rule out the fact that some of these changes were necessary given the market conditions and the SBP’s job to promote fair business practices in the financial sector; but there is no guarantee that these regulations will start to loosen up in the future.

In terms of future outlook, interest rates are indeed at an all-time low in the market, and it is expected that they will see a slight increase in the upcoming 12-month period. This increase may have a much-needed positive effect on Pakistan banks’ funded incomes, and the spreads for banks may yet increase in the future, owing to the fact that banks are once again tilting back towards increasing lending.


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