Bank deposits: Pakistan finalises credit-positive protection mechanism: Moody's

Pakistan has finalized a credit-positive protection mechanism for bank deposits, says Moody's Investors Services. Moody's in its latest report on Pakistan stated that the State Bank of Pakistan (SBP) last Friday issued instructions enhancing the country's deposit protection mechanism through the Deposit Protection Corporation (DPC).
The establishment of this mechanism is credit positive for Pakistani banks because it will strengthen financial stability while improved depositor confidence arising from the protection will enhance the stability of banks' funding.
Moody's further states that these benefits outweigh the increased costs for banks, which are required to contribute to the mechanism. The DPC, a fully owned SBP subsidiary operational since 1 June 2018, was established under the 2016 Deposit Protection Corporation Act with authorized share capital of PKR1 billion ($8.2 million) and a mandate to support small depositors.
The new instructions, which take effect on 1 July, apply to both local banks (excluding deposits held at their branches and subsidiaries abroad) and foreign banks operating in Pakistan. The scheme also includes a separate Shariah-compliant deposit protection mechanism for Pakistan's sizable Islamic banking sector, which had a 14.5% market share as of December 2017. The central bank set the guaranteed amount at PKR250,000 ($2,050) per depositor per bank, broadly in line with Pakistan's very low GDP per capita of $1,543 in 2017 and well below the equivalent of €100,000, which is currently the guaranteed amount in most European Union countries. This shows that the scheme is mainly directed at small depositors. Given the exemption of certain depositor categories (government or government institutions, banks and corporations), Moody's estimates that 25%-30% of deposits will be covered under this mechanism. It further estimated that more than 80% of depositors, on average, would be repaid fully under the scheme in case of a bank failure.
The introduction of the fund will improve depositor confidence and lead to more stable and sticky deposits for banks, supporting their funding structure. Also, once the deposit insurance fund is properly funded, it will reduce contingent liabilities for the Pakistani government when it chooses to bail out troubled banks. This will strengthen the authorities' capacity to provide support to systemically important banks in case of need. Establishing the scheme is part of the government's aim to strengthen its financial stability framework. Moody's expects that all banks operating in the country will benefit from the deposit scheme, including Habib Bank Ltd. (B3 negative, caa11), National Bank of Pakistan (B3 negative, caa1), United Bank Ltd. (B3 negative, b3), MCB Bank Limited (B3 negative, b3) and Allied Bank Limited (B3 negative, b3).
The deposit protection afforded to National Bank of Pakistan, the country's largest public-sector bank (in which the government currently holds approximately a 76% stake), under the Banks (Nationalisation) Act will be removed.
Smaller banks will benefit more from the introduction of the scheme because it enhances their ability to attract new depositors with the extra benefit of the guarantee. The establishment of the fund will increase banks' costs because they will be required to pay periodic contributions to the fund.
The annual premium equals 0.16% of eligible deposits, with eligible defined as the aggregate of the protected depositors' total deposit amounts. This will be paid in four equal quarterly installments, beginning in third-quarter 2018.
Moody's expects that banks will be able to absorb this cost (which estimate equals 1%-3% of their pre-provision income), which will be partly offset by upward pressure on banks' margins as a result of recent policy rate increases of 75 basis points so far this year.