The past 12 months have been tough for Pakistan's banks. The 1995 results show a general fall in margins as the government's regulatory regime tightened monetary conditions and raised the cost of funds. Vain efforts to sell a 26 per cent management stake in state-owned United Bank (UBL) also contributed to the uncertainty and have undermined public confidence in the management of the rest of the state-owned banks.

Yet the performance of the country's largest banks - most of which are still in the public sector - constitute only one aspect of what is fast becoming a dynamic, competitive and highly profitable market for the smaller, publicly-listed private banks. The private banks are recent creations, but are demonstrating that disciplined management and an ability to work niche markets can be highly profitable. They are unburdened by longterm non-performing loans and are increasing their market share.

Pakistan's banks fall into four categories:

The three remaining state-owned banks include UBL, Habib Bank and National Bank of Pakistan.

Two ex-public sector banks, Muslim Commercial Bank and Allied Bank were successfully privatised in the early 1990s and have rewarded shareholders with excellent earnings growth (see box).

Private commercial banks of which the largest are Faysal Bank, Askari Bank, Bank al-Habib and Soneri Bank are listed on the country's main stock exchange in Karachi.

There are 19 foreign banks.

Privatisation

The privatisation of UBL, the second-largest commercial bank, has been the main focus of interest in 1996. Finding qualified bidders for a 26 per cent management stake in the bank has proved difficult for the government's privatisation commission. A special government committee was established to negotiate the sale after only two candidates - Bahrain's Faysal Islamic Bank and the Saudi Bisharahil Group (SBG) - submitted offers. The sale to SBG was eventually agreed at Rs 15.19 ($0.44) a share, valuing the bank at just Rs 2,248 million ($64.8 million).

Then the central State Bank of Pakistan (SBP - central bank) replaced UBL's management on 20 April, in a surprise move that it said 'would improve profitability and reduce administrative costs ahead of privatisation.' However, to most analysts the sweeping change at the top, coming only weeks after acceptance of SBG's bid, suggested something much more serious. The bank's profits had fallen from Rs 275 million ($7.9 million) in 1993 to Rs 7 million ($202,000) in 1995 and were accompanied by allegations that both management and unions had been engaged in embezzlement and gross mismanagement. These suspicions were confirmed when 10 members of the bank's management and union representatives were arrested for alleged misappropriation of funds on 14 May.

The current situation at UBL remains unclear, but analysts expect the bank to remain under central bank supervision until staff costs are cut and debts are recovered. 'The government may try to privatise the bank in 1997,' says Nauman Sheikh, senior analyst at leading Karachi brokers Khadim Ali Shah Bukhari. 'But it is clear that there will be no sale until the bank is under proper management, expenses have been brought under control and there is better progress in bad debt recovery.

In the sector as a whole, the government's monetary policy had a negative impact on bank profits in 1995. The government raised discount rates in February and again in October while the SBP sustained open market operations. The combination tightened liquidity and pushed up interbank rates. Banks such as Askari, with no liquidity problems, were able to benefit, but the cost of funds rose for the sector as a whole. The SBP also raised the cash reserve requirement on rupee deposits by 3.5 per cent, adding to the squeeze on liquidity and cost of funds.

However, the removal of the credit deposit ratio (CDR) ran counter to the rise in interest rates, stimulating bank lending and unleashing an estimated Rs 65,000 million ($1,872.4 million) in fresh liquidity. The scrapping of the CDR was one of the economic liberalisation measures demanded by the IMF programme, but it was partially offset by firm instructions from the SBP that banks restrict credit to the private sector. Credit conditions and the gradual depreciation of the rupee against the dollar have fuelled inflation, which is now running at an annualised 13 per cent.

The main advantage that the newly-established private banks enjoy over their larger, public sector competitors is the freedom to operate without being constrained by the bad-debt portfolios that characterise the state banking sector. The most profitable of the eight listed private banks is Askari Bank, which is run by an experienced management team and backed by the Army Welfare Trust. Khalid Nazir, banking analyst at Karachi's AKD Securities, says Askari has established itself as the premier bank in the private sector.

Askari achieved a 19 per cent rise in net profits to Rs 173 million ($5 million) in 1995. The bank maintains a diversified loan portfolio, with 20 per cent in textiles, 15 per cent in non-textile manufacturing and 32 per cent in trade finance. Only 15 per cent of its loan book has a maturity longer than a year. Through a 50 per cent rights issue in January, the bank raised its capital by Rs 450 million ($13 million), bringing the deposits/equity ratio to 7.8 in 1996, compared to a maximum of 12.5 set by the SBP.

At Askari Bank, as in the sector at large, analysts are forecasting slimmer margins in 1996. Lending rates are expected to increase slightly from the present 16-20 per cent but will be matched by rises in the cost of funds, keeping the interest spread about the same.

Last year was also a tough year for foreign banks in Pakistan. The cumulative results of the largest 14 foreign banks show a decline in pre-tax profits from Rs 5,500 million ($158.4 million) in 1994 to Rs 4,100 million ($118.1 million) in 1995. The figures show a 14.5 per cent growth in deposits to Rs 134,000 million ($3,860 million) and a 36.7 per cent rise in lending at Rs 82,000 million ($2,362 million). Much of the fall in pre-tax profits can be attributed to interest costs, which rose sharply from Rs 10,000 million ($288.1 million) to Rs 13,500 million ($388.9 million) in the year.

Only three of the foreign banks with more than Rs 2,000 million ($57.6 million) in deposits - Habib Bank AG Zurich, Bank of America and ANZ Grindlays - saw a rise in pre-tax profits in the year. The worst performances were recorded by MashreqBank and HSBC (see table).

Tariq Hussein, country treasury planning manager at ANZ Grindlays, told MEED that the main reason for the poor performance of foreign banks in 1995 was the falling interest income from foreign exchange deposits. 'This trend is set to continue in 1996/97,' he says. 'ANZ performed better than many of the other foreign banks because it has at least one third of its deposit base in rupees. Most banks are trying to compensate by increasing volumes.'

There is intense competition in the sector and foreign banks offer additional security in a turbulent country. 'Investors are looking for stability and in Pakistan, we certainly represent that,' Hussein says. He adds that the bank benefits from noninterest income through its business in the fast-developing power sector and in privatisation.

Outlook for 1996

In the expectation of continuing tight medium-term monetary policy, bank sector analysts forecast a fall in the rate of deposit growth across the sector to about 20 per cent in 1996. Loan growth is also expected to fall by about 50 per cent, in order to conform with SBP guidelines on credit. The partial recovery of the textile sector in 1995/96 is unlikely to offset the banks' long-term liabilities. Indeed, analysts at Karachi-based Taurus Securities expect provisions to rise in the coming' year to offset increased write-downs in this key sector of the economy.

The earnings outlook for the banks as a whole is comparatively bleak, with Taurus projecting growth of 13 per cent compared with 26 per cent in 1995. Abid Naqvi of Taurus says that growth in the sector will come from increased ancillary business, branch expansion and a reduction in corporate tax rates. 'The competitive position of each bank will critically depend on its ability to build a stable, low-cost deposit base,' he says.