Morning Call about Advances, Deposits and Investments – Arif Habib Limited

Karachi, November 30, 2012 (PPI-OT): SBP to decide banks’ fate: 5% or 6% PLS rate?

Banks want SBP to reconsider the increment

The SBP (State Bank of Pakistan) had imposed minimum rate of 5% on PKR/PLS saving accounts back in Jun’08 causing banking sector’s cost of deposit to go up from 4.2% to 5.2%, on average, that year.

According to Arif Habib Limited, however, this impact was mitigated due to a simultaneous monetary tightening, increasing the discount rate by 150bps from 10.5% to 12%. As a consequence, spreads grew 42bps to a whopping 7.50%.

Recently, the central bank again jacked up the minimum deposit rate by 100bps to 6% effective from May 1st, 2012. This decision was based keeping in view the rigidity in deposit rates despite imposition of minimum rate earlier, thus resulting in low saving-investment ratio in the country. However, the scenario was different on the monetary front this time around, as the SBP has opted for an expansionary monetary policy, relaxing policy rate to 10% (down 200 bps). This has so far resulted in banking spreads shrinking to 6.77% (latest by Oct’12).

Basing their argument on the shrinking spreads and contracting NIMs, banks have approached SBP to reconsider its last decision of increasing PLS to 6%. Furthermore, the recent removal of the minimum rate of return requirement by the SBP for Islamic banks and Islamic banking divisions of conventional banks has created a void in within the entire banking sector. This so-called favor for the Islamic banks has strengthened conventional banks demand for lowering their PLS rate too.

Banking spreads highest in the region, then why cut?

The SBP seems to be steadfast on its stance of keeping the PLS rate at 6% for conventional/commercial banks. The reason that justifies central bank’s stance is despite the increment, banks in Pakistan are still enjoying the highest spreads in Asian region; as evident in the below table. Therefore, the revision in PLS rate seems unlikely for banks, in Arif Habib Limited’s view.

Spreads in Asian Countries(CY12)








Sri Lanka








latest available spread

Source: Central Banks

Ups and Cuts cheered up depositor and borrower to certain extent

So far, CY12 has been full of surprises, to name a few; PLS increasing by 100bps to 6% w.e.f. May’12, the inflation levels continuously falling down in 2H, and back-to-back policy rate cuts (200bps to date). The favorable ups (in PLS rate) to some extent has contributed to beef up deposits while cuts (in policy rate) prompted borrower to scale up their borrowings, respectively, albeit more for working capital requirements than investments. This is evident in the recent figures released for aggregate advances, deposits and investments by the central bank.

Banking sector deposits by end of Oct’12 reached PKR 6,304 billion, an increase by 17% since Oct’11, primarily on account of forced increase in the deposit rates, as mentioned earlier. During the same period, while Advances witnessed a rise of 9%, banking sector’s Investments, continuing with earlier trends, still rose by a massive 39% to PKR 3,756 (since Oct’11) by end of Oct’12, showing sector’s reluctance to sparing more money for core lending purposes on account of credit risks.

Advances to Deposit Ratio (ADR) drops to 59.6% in Oct’12

With Advances being flat MoM, sector’s ADR increased 70bps to 59.6% in Oct-12, while drastically dropped when to compared 63.9% same period last year. The Advances currently stand at PKR 3,755 billion compared to PKR 3,443 billion last year. As mentioned before, YoY decrease in ADR can primarily be attributed to banks’ unwillingness to opt for private sector lending on fear of rising NPLs considering the exacerbating overall economic and energy situation. Moreover, government’s growing inclination towards the banking sector to finance its deficit (as it was required to maintain zero borrowing from the SBP on a quarterly basis) is crowding out the private sector. On a monthly basis, a marginal uptick in Advances was due to the seasonal effect.

Investments to Deposits (IDR) up 9% YoY in Oct’12

The Investment to Deposit Ratio also reached 59.6% by end of Oct’12. On MoM basis, the IDR has gone up 1.7%. This is primarily attributed to banks continuously investing more in T-bills and government securities rather than lending out to the private sector. The SBP, since Jul’12 has aggressively slashed discount rate as it was aiming to boost economic growth and private sector lending, however, trend has depicted no material change in either of them so far.

Further rate cut to result in

Going forward, Arif Habib Limited anticipates the current trend of banks’ preference going for safer investments in government securities to continue, even as the SBP has cut the policy rate by 200bps to 10%. Moreover, with another 50bps cut expected in policy rate in Dec’12, contraction in spreads will continue, hence NIMs are likely to shrink. Arif Habib Limited has already witnessed that, when the interest rates are softer, people with surplus money are not inclined to invest in not-so-profitable instruments and start venturing into risky opportunities. This is what Arif Habib Limited has recently seen; a steep rise in prices in the stock market with improved volumes (in commodities as well), and real estate values. If interest rates are cut further, this trend is expected to continue while banks may see their spreads shrinking further unless ease-off from PLS rate is provided by the SBP with the upcoming MPS, likelihood of which seems remote.

Leave a Reply

Your email address will not be published. Required fields are marked *