What the budget offers to the banking sector

With banks’ earnings already battered by incessant rate cuts and spread attritions, the Federal Budget FY14 has offered little in the form of a helpline to the aggrieved sector.
Now with the banks required to provide FBR with online access to all their transactions besides providing the particulars of deposits worth Rs10 million or more, they might not be able to provide their customers the desired confidentiality. However, according to market sources, the chances of the government actually being able to extract such information out of the banks are thin.
Banking laws don’t allow infringement of customers’ secrecy. Even if the Parliament alters the secrecy laws, which is a rare scenario, the impact on banks’ deposit base and profitability would be little, said industry insiders.
They further underpinned that the majority of the clients holding deposits worth Rs10 million or above are the corporate clients. For such clients, bank transactions are inevitable as cash transactions render their expenses unallowable.
Tracking Rs100,000 and above in credit card payments might put a cap on credit card transactions; however, it given other payment options available, that too won’t irk banks much.
However, market sources underpin that threats to customer secrecy might encumber banks in attracting new depositors, hence keeping the undocumented economy at arm’s length from banks.
The recent budget increased WHT on cash withdrawals worth Rs50,000 and above from 0.2 percent to 0.3 percent. This is expected by some of the market participants to boost inter-bank transfers and restrict cash withdrawals; yet the impact is not expected to be profound as according to sources, most of the transactions that entail huge amounts are business-related transactions which are independent of tax enhancements.
Federal Excise Duty (FED) of 16 percent on all the financial services from financial institutions has been imposed which was previously applicable only on financial services from banks. This measure is expected to create a level playing field within the financial industry, yet it might shed some of the client base of mobile banking services which mainly constitutes the residents of areas with low bank outreach. The imposition of 16 percent FED might trigger them to revert back to cash-based transactions.
Keeping the tax on dividends on investments in money market funds and income funds intact at 25 percent against scheduled 35 percent for FY14 is a positive sign for banks as it continues to provide banks with 10 percent arbitrage opportunity.
But while the budget measures are not directly expected to create major headwinds for banks, the inflationary nature of the budget could cause changes from the monetary policy-front.
With the budgetary measures expected to trigger inflation soon, discount rate is sure to turn its gaze up to contain money supply. Even if it doesn’t start immediately, monetary tightening seems an inevitable phenomenon somewhere in CY14 which indeed will be a good omen for the banking sector.
Not to forget that in the recent budget, the government has been vocal to increase reliance on inexpensive foreign borrowing and public savings to finance fiscal deficit. This will enable banks to channel their liquidity to private sector investment programmes.
Given the claims hold any reality; the banks will be able to garner healthy margins through high yielding private sector lending although it would require banks to undertake smart moves to contain NPLs.
Yet with the government’s planning to cut back its reliance on SBP, whether commercial banks are left with enough liquidity for the private sector is still to be seen.

Question marks loom over external resources
Financing a fiscal deficit of the anticipated 8.8 percent is a daunting task, and the government’s objective of bringing it down by 2.5 percentage points would seem too optimistic without relying on significant amount of additional financing.
Intentions can be judged by the allocation of Rs576 billion for external resources in the Budget 2013-14, which is 50 percent higher than budgeted in the previous fiscal year (2012-13) and more than double the revised figures.
While some expectations from the privatisation proceeds budgeted at Rs79 billion have built up after the Finance Minister’s speech, it is hard to dispel concern over the long backlog of Etisilat land transfer and privatisation receipts.
And while some market veterans see that the failure of timely flows of the privatisation proceeds and programme loans would necessitate the country to enter into an IMF programme, what is more familiar is re-entering the latter to provide some comfort to the international investors and donors.
Saim Ali, an economist at Standard Charted Bank, points out two clear indications of the country heading to the Fund in the near future: with the aim of reducing the fiscal deficit by 2.5 percent and the budgetary allocations of a significant $1.1 billion for programme loans versus only $65 million 2012-13 revised figures, it seems that the government is all set to approach the IMF.
Recall that the country was out of the IMF programme by the end of 2010 after which there have been no significant lending by international agencies and countries.
Though Saim further conceded that the government has a better option of going to relatively inexpensive IMF funding than the expensive Eurobonds, reduction in the spreads of credit default swaps (CDS) and existing Eurobond yields can offer a silver lining.
A big catch in the external resources is the share it makes in financing the deficit. Historically, the country’s fiscal deficit has been primarily financed through internal resources and that too through bank borrowings. Only 1 percent of the fiscal deficit was financed through the revised external resources for 2012-13, whereas 99 percent of it was financed through the domestic resources and that too 80 percent through bank borrowings.
‘The latest target of financing 10 percent of the deficit through foreign flows is wishy-washy’, reckoned Muhammed Sabir, the principal economist at Social Policy and Development Centre (SPDC), while talking to BR Research.
And rightly so, this 10 percent target for 2013-14 includes the Etisilat privatisation proceeds waiting to be materialised since 2006. What Sabir declared as other looming questions were the purpose of Rs99 billion parked in China Safe Deposits and the fate of 3G auction.
With targeted external resources subject to risks, and revenue collection so ambitious, a lot depends on the execution capability and materialisation of external loans, grants and proceeds, failure of which will just exceed domestic bank borrowings all the more.

Islamic banks in liquidity spurt
Deposits held by Islamic banks in Pakistan have witnessed an impressive growth spurt in recent years. However, with the rapidly accelerating Islamic banking market, there comes a flush of surplus liquidity which harshly puts the brakes on the enthusiastic deposit mobilization drives of Islamic banks.
Islamic banks in Pakistan, with no access to SBP discount window facility, used to work with the constraint of only being able to place their surplus funds with other Islamic banks under inter-bank Musharakah and Waqalah agreement.
The treasury head of a renowned Islamic bank told BR-Research that inter-bank lending/borrowing didn’t turn out to be an efficient liquidity management tool as most of the Islamic banks faced excess liquidity. Hence, it’s not easy to find a party with a short (selling) position.
Due to limited investment avenues available in the face of a flare of Shariah compliant money, Islamic banks earn lower returns on their funds, which is a drag on their competitiveness.
Besides, conventional banks having Islamic windows don’t have a separate Islamic treasury department to manage Islamic liquidity flows in a Shariah compliant manner without mingling them with conventional funds.
To address the issue, Islamic sovereign bonds called Ijarah Sukuks were introduced by SBP. Although a welcome development, Ijarah Sukuks didn’t solve all of the issues. Industry insiders highlighted that because of the long-term nature of Ijarah Sukuks and short-term nature of deposits, Islamic banks suffer from massive asset/liability mismatch. This is besides the interest rate risk they face when they invest long at a fixed rate and have their liabilities frequently re-priced.
Market sources underpinned that although Sukuks can be traded, most are held to maturity, due to limited investment options available. Islamic banks can also manage their liquidity through equity placements as long as the equities are also Shariah compliant.
Industry insiders strongly urge the development of an active Islamic money market via short-term sovereign instruments and secondary market via Islamic repo agreements. Tri-party repos could be a solution to combat the prohibition of buy-back agreements in Islam.
Besides, lender of last resort facility is also imperative to enable them to manage their operations efficiently. SBP is also looking into the development of an Islamic Interbank Offered Rate (IIBOR) to act as a benchmark for pricing of various Islamic banking products.
Market participants are quite confident with the impending developments to improve the yields of Islamic instruments which would be a good omen for their profitability and a kick-start to their expansion plans.