Editor’s T note
his publication essentially offers an objective assessment of subjects such as private sector credit, housing scheme financing, companies’ financial performances, Islamic finance, NBFIs and Modaraba sector, lending to SMEs and central bank’s role. In addition to very well researched articles, there are interviews of those who head big business concerns or strongly represent the areas discussed in this publication. One of the most important aspects of this financial review is the fact that it is being brought out in a period in which the nation is going to witness the second unprecedented elected civilian transition as a result of the general elections scheduled for the latter part of next month. Any comment on the state of economy or inter-related disciplines therefore requires us to be extremely careful insofar as our articulation is concerned, lest any political party describes our outlook as biased or prejudiced. To begin with, let us make it clear at the outset of argument that although economics and finance are often taught and presented as separate disciplines, they are inter-related and inform and influence each other. Moreover, we also wish to explain in this space that business and economics go side by side, wherein, businesses offer
products and services that generate economic output and economics determines the supply and demand of such products in an economy. It is generally believed that the country’s economy is in dire straits owing to a variety of factors, including the worsening external account and widening fiscal deficit, although it can be argued to be in better shape than what it was in 2013. The caretaker setup that has emerged following the completion of the five-year PML-N tenure is struggling to deal with a slew of challenges on the economic front; it is, however, important to recognise that an interim setup cannot be as powerful and resourceful as an elected government that enjoys the peoples mandate and has to its advantage a fairly long tenure. Be that as it may, a large number of businesses are said to be adopting a ‘wait and see’ approach to their strategies or decisions at this point in time, although many experts plausibly argue that such an approach, at times, carries a higher risk than the action being avoided.
ALI KHIZAR
now Banks must bank
T
he private credit to GDP has reduced from 27 percent in 2008 to a mere 17 percent in 2017. There has been no meaningful change in deposit to GDP ratio in the last decade, which is currently at 39 percent. Both these are amongst the lowest in the region. In the last ten years, government has remained the biggest client of commercial banks; and to maintain spreads on low yielding government securities, banks have focused on enhancing CASA ratios. It is a two way sword; not only the private sector is crowded out but banks’ liability profile is also shortened to elude long term credit to infrastructure, private projects and mortgage financing. The infrastructure financing problem is lately being dealt with higher lending to public sector entities including credit by domestic banks to government owned power plants and gas marketing companies’ network expansion. The agenda for the next five years should be to focus on private business lending to extract economic juice from infrastructure expansion. It is hard to take private credit to GDP to neighbors’ levels (India:50%, Bangladesh:45%); but the target should be nothing less to at least reach the 2008 level. Meanwhile, financial inclusion efforts using micro banking and digital tools are yet to translate in enhancing deposits to GDP ratio. The target should be to touch 50 percent in five years which is where Bangladesh is today. It is pertinent to note that Pakistan’s central bank is better in many aspects from Bangladesh and other similar economies. The data dissemination is timely and of better quality, the research and policy capacity is better. The banking regulations and enforcement are up to the mark, and depositors’ money is well guarded. The regulator was strengthened and modernized in early 2000s and that has shown immediate results. But in the last decade, political influence grew on central bank - skewed the policymaking to favour federal government which is the biggest client of the banking sector.
This conflict of interest has pushed banking back from its core job of channelizing deposits to private sector lending; especially to SMEs. The financing to SMEs has always remained low in Pakistan. At best, it was 17 percent of private credit in 2004 while today, the ratio is a mere 7 percent. The problem is twofold. Lending to private sector is low and within it SMEs share is shrinking. Banks are relying on same old clientele and the comfort that it gives has built a sense of complacency. Banks have carried stagnated loan books for years and years, despite low interest rates and favorable economic conditions. The banks often complain that there is shortage of good borrowers. Yes, there are demand side issues as well. The informality in SME and commercial sector not only makes banks uncomfortable to lend but also the businesses are reluctant to access formal financing in the fear of taxmen catching them. Banks evaluate credit based on cash flows while SME businesses lack financial capabilities. The banks see credit and other histories while the businesses are operating on cash and informal contracts. The policy incentives for businesses should be to move from closed and opaque financial structure to have documented stream of cash flows. Concurrently, banks are required to move beyond name lending. The SBP mandatory lending is an effective tool. Unlike SMEs, the agriculture loan share did not fall after the 2008 crisis. In the last two years, SBP indicative targets for SMEs have yielded some results; but still a long way to go to reach the peak. These are baby steps; the core of the problem is government borrowing which is required to be diversified from the commercial banks. The idea is to bring competition to commercial banks in T-Bills and PIBs. The mutual fund, pension funds and NSS counter should expand not only to enhance savings but to buy government bonds as well. Once there are more players, the debt capital market is developed and the natural progression is corporate debt market. All the savings and funds money
will eventually end up as deposits in banks. In order to attract deposits, banks have to compete with state institutions and mutual funds. This will make banks to work on rebuilding time liabilities to improve liability maturity profile. The higher deposit base amid low demand of fiscal borrowing would compel banks to lend to private sector. The return on private sector is higher and banks can earn decent spreads on expensive deposits by deploying to SMEs. The other leg of the problem is that consumer lending is concentrated in automobiles financing whereas the much needed housing finance has remained neglected. There should be mandatory targets on it along with refinancing facilities. The better liability profile will also help in enhancing long term housing finance. These are medium to long term solutions which require clear cut policy focus for enhancing formal financing and increasing domestic savings. In the short to medium term, the coming quarters are dicey for banking. At one end, rising interest rates may improve margins on sticky low cost deposits. At the same time, the fear of higher NPLs will make banks cautious to lend. The macroeconomic stability is the key for banking sector to aggressively lend to private sector. The twin deficit problem is not good for banking industry. The core to the stability is bringing fiscal house in order. It is easier said than done. Don't expect any miracle in 2018-19, as the momentum is likely to slow down and clearance of energy circular debt and other fiscal and quasi fiscal operations will let the treasury teams dominate. Liabilities folks will continue the fight for gaining low cost deposits.
The writer is Head of Research at BR Research. He can be reached at ali.khizar@br-mail.com FINANCIAL REVIEW 2018
05
ZUHAIR ABBASI
‘INVESTMENT’
BANKING
"Investment" banking IDR
ADR
80% 70% 60% 50% 40%
Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17
30%
06 FINANCIAL REVIEW 2018
Liquidity parking lots Advances
Investments
developments, which could be expected to lead a new round of growth, once the benefits start trickling down.
Deposits
*growth
50%
Can rate hike spur investments?
40%
Discount rate (LHS)
30%
16%
20%
14%
10%
12%
0%
10%
-10%
CY10
CY11
CY12
CY13
CY14
CY15
CY16
CY17
Make no mistake – banks have a duty to shareholders, that of maximizing profits. And they are doing it rather dutifully. Absence of alternate avenues to invest and save, seems to be playing in favour of banks. Name one bank where the teller would bother telling you to rather invest in high interest yielding instruments. In the days of efficiency, cost control and low yields, current account is all where the focus is, even if it requires refusing interest bearing deposits. That is because, liquidity is not an issue. It is not as if private sector credit has suddenly reached sky-high. So banks could still deploy whatever deposits they have to whatever blue chip borrowers are there, and park the rest in government papers. And yet make decent profits, if not exuberant ones. The ever-ready borrower in form of the federal government has been one constant for many a years now.
Less infectious, more confident NPL growth
8% 6% 4% 2% 0%
CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17
45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
A few others maintain that the impetus will have to come from the government, and the usual textile, sugar, and now power businesses, can only raise the bar to a certain extent. Most believe it could be a government backed, well thought out housing scheme, that could kick start a fresh round of genuine borrowing. Ideally, banks should not hesitate should such an opportunity arise, for a number of them have been complaining of lack of quality borrowers. The quality is usually referred to strong collaterals – and looking at the love affair with the sovereign government backed securities – any such government backed projects should ideally be welcomed. Especially, when the loan books are clean as the infection ratio sits at an all-time low of 8 percent.
Misfire-impact of WHT on banking transactions
Advances growth
Currency in Circulation (Rsbn)
20%
Private Business Deposits (Rs bn)
4500000
15%
4000000
10%
3500000 3000000
5%
2500000
0% -5%
Investments growth
2000000
CY11
CY12
CY13
CY14
CY15
CY16
CY17
1500000 Ju n Au -14 g O -14 ct De -14 c Fe -14 bA p 15 r Ju -15 n Au -15 g O -15 ct De -15 c Fe -15 b Ap -16 r Ju -16 n Au -16 g O -16 ct De -16 c Fe -16 bAp 17 r Ju -17 n Au -17 g O -17 ct De -17 c Fe -17 b18
W
hile the banking story most narrated of late has been the pickup in credit demand, it cannot undermine the hard fact that even in such times of low spreads, banks have not been too shy of investing heavily in government securities. Yes, it may not be growing at the rate of yesteryears, but is still growing substantially. The 16 percent year-on-year growth in investments versus 18 percent in that of advances in CY17 tells there is still ample excess liquidity banks are looking to park safely. These are supposedly times of economic growth momentum, renewed confidence, CPEC wave, and low interest rates which should theoretically discourage investments over advances. But the end result is more assets utilized for investments in absolute terms, as the IDR was sitting at an all-time high of 67 percent by the end of December 2017. But that did not make headline news, for the ADR, after nearly six years managed to touch 50 percent. The last two years have seen advances growth slightly outpacing investments. This came after a six year long period of massive outperforming of advances by investments. All this while, the deposit growth has surprisingly slowed down. CY17 saw a deposit growth of barely 10 percent year-on-year, which is the lowest in ten years. Plot it against the highest GDP growth in a decade, and try making sense. Some of the slowdown could be rightly attributed to the imposition of withholding tax on banking transactions, which backfired, and has instead resulted in lower deposit growth and a much increased currency in circulation. Deposit growth has also slowed down with the slowdown in spreads, which came down from 603 basis points by December 2014 to a record low of 485 basis points by December 2017. Add to the picture, the ever increasing obsession of adding low cost deposits-only policy of most banks, and the reasons of low deposit growth despite high-ish GDP growth start becoming clearer. And banks have been doing rather well, in terms of maintaining high CASA ratio, as evident from sustained profits, even in times of record low banking spreads.
You would think the banks’ lending practice has a lot to do with a country’s GDP growth. It ideally should, as a positive correlation of 0.9 between GDP growth and ADR around the globe tells. But in Pakistan’s case, the number has averaged 0.52 – call it correlation if you would. Bank indicators in Pakistan do not necessarily always make sense – case in point is the muted deposit growth in a rising GDP scenario. On credit demand, the jury is divided. There is a camp that still opines that the pool of borrowers is too narrow, too concentrated, and has not grown beyond a select few, those who bank with everyone. There is another camp which thinks that Pakistani market has come of age, and credit demand should pick up, and so should the number of genuine and fresh borrowers. The optimism seems to have stemmed from the ongoing CPEC related
But there could be a catch. And that is the interest rates. The discount rate cycle may well have bottomed out, and most macroeconomic indicators and global events hint that the rates will rise. That could mean added pressure on NPLs, and could mean more reluctance to lend. In theory, high yields should be an open invitation for banks to lend more. But, as has been observed in the past, banks would rather opt for investing in government papers on lucrative yields, with zero risk – than worry about lending to a riskier sector at higher rates. Don’t forget banks have been smart in finding enough ways to work around with a thinner topline. The writer is Deputy Editor Research at Business Recorder. He can be reached at zuhair.abbasi@br-mail.com
INTERVIEW
Tough times ahead SIRAJUDDIN AZIZ | Former CEO, Habib Metrolpolitan Bank “The interview was conducted while Sirajuddin Aziz was still the CEO of Habib Metropolitan Bank” BR Research: Take us through your journey at Habib Metropolitan Bank (HMB) and how have the last few years been in terms of performance? Sirajuddin Aziz: To be honest when I joined this institution I had a very little idea that I would be able to turn around things. The whole positioning of the management at that point was being in a cocoon, looking at one particular niche market segment alone. I think I had the opportunity to look at it from a different point of view having worked in an institution where I turned things around and helped it grow. We were largely viewed as a Karachi centric bag, with a close to zero presence elsewhere. When I took over we had about 160 branches and today we have around 320 branches. In terms of city coverage, we have grown from 19 cities to 97 cities. BRR: Has the presence in north also increased? SA: It is greater than south and for good reasons. I can explain this in terms of pure economics, because this bank was recognized in Karachi as trade finance bank and so we were dealing with either a buyer or a seller who had a counterpart in north. So, we were missing out on one leg of the transaction there. Planting those branches has kept the transaction flow within the bank. So, we are now able to capitalize on money flow and when there is enough generation of money flow in an average of pool of funds, which are less costlier than deposits. That has helped in terms of deposit compositions - in 2012 the deposit base was Rs180 billion and we closed last year at Rs520 billion. We have a share of about 4% of the market share, in terms of the deposit market today. BRR: Do you continue to position your bank as a trade finance bank or has it also changed over the years? SA: Not at all. We still continue to position ourselves as a trade finance bank. In addition to it, we have branched into several other things such as commercial lending, SME sector, etc. We are also working on the alternative delivery channels, creating processes and providing corporate solutions for cash management services. BRR: How much has your ADR composition changed from 2012? SA: It should be almost the same because the deposit growth has been very fast and so for the same reason the ADR would be in the region of 40-45 percent. BRR: With the interest rates being down there is a push on the private sector credit. Have you increased your presence in some sectors in terms of advances following the interest rates? SA: Not for reasons of decline in interest rate climate. There are good borrowers available in the marketplace, that is why we expanded our loan book. Otherwise, I had kept a stagnant loan book for 3 years at the cost of profitability. My limitation about the economy is that there are far and few projects coming in and local entrepreneurs are still shying away from borrowing money. It is only the existing clientele that wants more and more, there are no fresh borrowers coming into the marketplace, unfortunately.
BRR: They are not coming or the banks are not really going that extra yard to market? SA: No, I don't think they are really coming because all the banks are sitting at high liquidity and who does not want to lend money to good borrowers. Entrepreneurs are not there, and they are not there because they want all debt finance. So, if he is willing to put his $20, then I will my put $80. BRR: But there are entrepreneurs in the market with 100 percent equity and they do not need financing at all. SA: Those are far and few. And mostly in the SME sector. SME is a semi is a little dangerous business in Pakistan. There NPL ratio is in excess of 30 percent. BRR: You mentioned there is no appetite for borrowing. Banks are highly liquid they are hungry to lend to corporate but corporate are not really looking to capture that? SA: Yes, because there is so much money coming that they have a choice to pick and that's why the rates are going down in the corporate sector. BRR: How much of your loan book is commercial, corporate and consumer? SA: It is 50-50 between commercial and corporate. We are not doing consumer. We are going to launch auto financing, but that would be under the Islamic mode of finance. BRR: You mentioned to have moved away from being textile heavy to other sectors. So which other sectors are you now mostly catering to? SA: We have moved significantly in the energy and telco sectors. We are now also involved heavily with public sector entities, mostly involved in food businesses. Although the spreads have dropped considerably, it is fair lending and you have a government guarantee. BRR: What kind of financing requirements are arising from telco sector? Is it expansion related? SA: It is a good mix of network expansion, bridge financing, and receivable financing. Now they are coming up with the tower sharing model, which is a major move. BRR: What are some other areas, particularly related to the trade related business? SA: The reason why we are popular in the market areas is because we are dealing with chemicals, polyesters, filaments, grains and so on. BRR: So, do you also engage or plan to engage in import financing of electronic items , given the size and growth of the market? SA: We have stopped all of that. We do commodities because we are assured of the usability of grains for instance. If it is a food item, it won’t go to waste and that gives me the comfort. I think the market has hit the banks very badly when it comes to electronics. BRR: The construction sector has been the highest growing sub sector in the last few years. Are any of your plans revolving around the construction sector?
SA: We are averse to lending to construction projects. But when it comes to related industries, we are more than willing to do that. For instance, electrification of a project is of high interest to us, because it has more assurance than a real estate project, as the main project manager would release funds against our guarantees. BRR: Will you finance a subcontractor? SA: Big projects will mostly bid for a subcontractor. They will get 3-4 bids and the lowest price will be selected. The employer, which is the project owner will give the contractor a guarantee or a contract with specified terms. This is the basis on which any bank will finance the contractor. BRR: How do you do the pricing for performance guarantee? SA: It is usually in terms of the total contract value of roughly 25 percent. Bid bond is in the range 5-10 percent, performance guarantee are usually in the range of 15-25 percent, the advance payment guarantee are 40-50 percent. Then climb up the ladder and have completion bonds and retention bonds, which are 10 percent each. BRR: In the past 10 years, we have not seen DFIs doing much. Why can’t the commercial banks fill the void? SA: There are commercial banks willing to do it. BRR: Why aren't you doing it? SA: I will be uncomfortable in doing something that does not relate to my balance sheet management. I should have resources of 10-20 years to do such things; my deposit profile is in the region of 1-3 years. I don't want to create such large funding gaps. BRR: So, you have a low maturity profile? SA: Most commercial banks will have a low maturity profile. Our CASA is about 60 percent. If I have to mismatch my funding gap, I should do it where I am assured of the security in the transaction. If I have a three-year deposit, I am willing to buy a 10 year PIB; it is something I am assured to get money at the end of the tenure. In a construction project, I am not assured. BRR: Is there any other segment you have developed ties with? SA: Oil is also a major segment where we have participated actively in the last 4-5 years. The acceptability of your name as a financial institution is very important. We have built those relations over the years. Initially, we could do only one LC and now I can do about 2-3 every month. It has been a major growth area for us for the last 4-5 years. BRR: What is your outlook on the economy? SA: I see difficult times ahead. I foresee that our dependence on oil is not going to go away, it is rather going to grow. I think, oil supply is going to be a major issue for us, because of geopolitics. We have to fix the current account deficit. Until and unless you do that, nothing else will work.
Interview by BR Research. FINANCIAL REVIEW 2018
07