Banks continued making profits during the first half of 2021. They made profits not only on heavy investment in government debt securities but also on private sector credit.

Banks’ net lending to the private sector in July-June 20-21 got a boost during the second half ie January-June 2021 — when extraordinary monetary easing (carried out during March-June 2020) and fiscal stimulus package of the government had a fuller impact on credit demand with some time lag.

Between mid-March and end-June 2020, the State Bank of Pakistan (SBP) had cut its key interest rates, in quick instalments, by 650bps —from 13.25 per cent to 7.5pc. In the entire 2020-21 banks made net lending of Rs766 billion to the private sector. But the bulk of this lending was made in Jan-June 2021. Between July-Dec 2020, credit demand had remained slower as the economy was experiencing a pandemic-triggered recession. (In 2019-20 ie between July 2019 and June 2020 Pakistan’s GDP growth remained negative by 0.5pc).

With the pickup in credit demand from January this year, volumes of non-performing loans of banks should have increased which, in turn, should have increased provisioning against these loans. But that did not happen because of the easing of regulations of non-performing loans permitted by the central bank during March-June 2020 and even afterwards.

The central bank had selectively eased these conditions to provide temporary relief to the Covid-19 hit private sector. And, the federal government had backed up the move with credit guarantees and by picking up part of the interest payments on bank loans of these sectors including agriculture and small and medium enterprises (SME).

During the first half of 2021, after-tax profits of Pakistan’s 18 listed banks grew 13pc year-on-year to Rs134bn, according to a Topline Securities research report. The profits were up “on strong deposit growth, rising non-interest income and lower provisioning,” notes Umair Naseer who authored the report.

At uncertain times the banking industry should behave more responsibly. Banks already struggling with structural, regulatory or efficiency issues should work harder to address them. The central bank should watch more carefully what exactly is driving up profits of a few banks much faster than others

During the second quarter (April-June 2021), too, banks’ after-tax profits showed 14pc growth compared to the second quarter of 2020 and 8pc growth over the first quarter (Jan-March 2021), the report reveals. The 13pc year-on-year growth in banks’ post-tax profits in Jan-June 2021 occurred despite a modest 2pc decline in their net interest income because non-interest income increased and non-interest expenses shrank.

On face value, these numbers look good — if not impressive. But while looking at bank-wise breakup of after-tax profits in the 2Q2021, one notices that six out of the 18 banks rather reported a net decline in after-tax profits. And, even among the 12 banks that made post-tax profits growth in profit rates oscillated between a wide range of 1pc and 74pc.

This raises questions about the operational efficiency of the banks that made very little profits. This also raises questions about what actually helped those banks whose profit rates grew phenomenally. At uncertain times like when an economy is hit by a pandemic, the banking industry should behave more responsibly. And, banks already struggling with structural, regulatory or efficiency issues should work harder to address them. At the same time, the central bank should watch more carefully what exactly is driving up profits of a few banks much faster than others. It is heartening to note, however, that all 18 banks posted some gains in their net interest income in April-June 2021.

However, the size of their profits varied depending upon the size of the banks, their level of penetration in the government debt securities market and their outreach to the private sector borrowers. Will strong deposit growth, rising non-interest income and lower provisioning — the three key drivers of growth in banks’ profits in the first half of 2021 identified by Topline Securities — continue in the second half?

Well, that depends on (1) whether the economy remains on track to achieving 4.8pc growth targeted (2) whether higher tax collection and documentation drive gains more momentum or lose some steam and (3) low-interest rates stay till June. If the economic growth starts faltering or if the ongoing efforts for higher tax collection and documentation of business transactions weaken then growth in deposits should suffer.

A measured and gradual tightening of interest rates — if it is undertaken for some time to ease inflationary pressures — should not affect the non-interest income of banks. But a sudden and sizeable monetary tightening would. Banks normally focus more on non-interest income growth when their interest incomes remain low in a lax monetary policy regime. But the tightening of interest rates gives them room to increase banking spread and they may lose focus on non-interest income.

During Jan-June 2021, banks saw their interest rate spread squeezing —from 502 basis points in Dec 2021 to 486bps in June 2021. Further continuation of ultra-loose monetary policy may result in a bit more squeezing of the spread, thus keeping banks more dependent on non-interest income. This means non-interest incomes should grow more, making an impact on banks’ profits. Banks may see growth also in interest income if they come out of their comfort zone of investing heavily in debt securities and lending to the manufacturing sector and power generation, transmission and distribution firms. (Based on the stock of loans, these two segments of borrowers owed over 71pc of banks’ total loans).

Increased lending to agriculture, SMEs of all types including those in the manufacturing sector or wholesale and retail trade and all other least-served segments of borrowers can help them raise net interest incomes, reflecting positively on their overall profits.

Published in Dawn, The Business and Finance Weekly, September 13th, 2021