Banks: all eggs in the governments basket

Aided by growing exposure in government securities yielding a double-digit risk-free return, the local banking industry is on a roll. With the banking industrys investments in sovereign instruments growing by leaps and bounds, the industrys (all commercial banks) Investment to Deposit Ratio (IDR) increased to 55 percent at the end of November 2011, a jump of 16 percentage points compared to the same period a year ago. The rising fad for sovereign investments can be gauged from the latest statistics revealed by SBP, suggesting that scheduled banks accounted for nearly 71 percent of the total sovereign instruments outstanding, including Treasury bills, Pakistan Investment bonds and Ijara Sukuk, as of 30th October 2011. Having a high exposure in sovereign instruments it sounds as comfortable as an old shoe for the financial intermediaries, since it not only compensates local banks with steady cash flows, but also relieves fears of deterioration in asset quality. But, whether the local industry is missing the big picture? The Moodys Investors Service-one of the largest international credit rating agencies-has painted a detailed picture in its latest outlook on the countrys banking system. The renowned credit rating agency has kept the countrys banking industrys outlook at negative, highlighting that "negative outlook reflects two key drivers (i) the weak operating environment; and (ii) the likelihood that the banks will increase their already high exposures to the Pakistan government". On top of that, since the country is wrestling with a higher budget deficit, the rating agency believes that the "banking sector will further increase its already significant exposure to the government and public sector". Although the growing risk-averseness has resulted in growing exposure to a single entity, the local market is of the view that countrys banking system is still far away from the risk of default on the sovereign instruments. "The banks do not face the risk of insolvency, since sovereign instruments owned by the banks are denominated in the local currency," said an analyst, adding that as long as the government borrows, the sovereign instruments will continue to act as a money spinner for banks. The real danger, however, lies with the government which is, in effect, borrowing trouble, since heavy borrowing from banks will result in high inflation and a weak currency.