Banks lack focus on commercial banking

Productive deployment of excess liquidity amid rising bad loans remains the biggest cause of concern for Pakistani banking executives, since the start of 2009. Although, return-on-equity for commercial banks improved a bit in the first half, after nose-diving consistently in the last two years, the banks inability to convert incremental deposits into lucrative advances has eaten the potential gains of commercial lenders as well as hindered private sector output growth.
Unlike their global peers, Pakistani banks have had an adequate capital base to cover risky assets with the ratios improving even more in the six months ending June. But these ratios do not speak for prudence of these bankers; rather, they expose their lack of potency as asset quality ratios have been deteriorating since the start of 2009.
In January - June 09, the deposits of banking system increased by Rs 319 billion (8.4%), out of which only Rs 28 billion on net basis were deployed in advances, as virtually all the incremental supply was used to plug the government revenue-expenditure gap. The investments (read government borrowing) increased by Rs 368 billion (38%) in first half of 2009, while on the other hand, advances-to-deposits ratio declined by 590 basis points to stand at 69.6 percent.
This explains the grim position of our economy, where commercial banks are merely routing the liquidity emanating from foreign flows, commodity operations and private domestic savings to finance the government machinery and security related expenses.
Yes, crowding out! It can be argued that to follow neo-classical models of government interventions in recessionary times is optimal, but only if it is on development projects to spur economic growth in the future. In Pakistans, its worse, as a significant chunk of government spending is channelled to public bureaucracy, adding to inherit inefficiencies of the system.
Lets revisit a basic undergrad course called Commercial Banking 101. The job of bankers primarily is to channel money from the hands of savers to that of private investors, while earning decent spreads. But Pakistani bankers havent been doing that of late; they have been mostly channelling private savings to public investment ie the government.
Here comes the role of the regulator to streamline banks core business. But then, there is little hope of remedy when the central bank, under the influence of a government shepherded by the IMF, is running a monetary policy in support of excessive government borrowing.
Now, a little on the industrys overall performance in the first half CY09; the profit after tax for 24 commercial banks declined by 31 percent, year-on-year, between January and June. It is interesting to note that ROE (average equity and surplus) increased by 170 bps to 9.5 percent in first six months of 2009.
This implies that the banks have adequately taken the bad loans and investment deficit out of its books, although 30 percent of bad loans are still on their balance sheets, which was reduced to 15 percent at the end of 2007. These bad loans have increased many bounds from 3 percent of capital in 2007 to 17 percent by June 2009.
Net interest income of the banks remained sluggish - exhibiting a growth of mere 11 percent. While this is explained by poor lending performance, a more concerning element is increasing share of core earnings in operating revenues by 260 bps to 73 percent in the last six months - non-interest income increased by 9 percent, year-on-year during the period.
This either implies bankers inability or lack of business opportunities to generate fee commission and other income. However, to the good of banks, they managed to operate more effectively, as cost-to-income ratio declined by 20 bps to 50.1 percent by June.