The State Bank of Pakistan (SBP) hiked the policy rate on Monday by 25bps taking the benchmark policy rate to 7.25% from being 7% previously. The tightening of the monetary policy is believed to be detrimental to the profit margins of most businesses, however, it is seen as a positive sign with regards to the banking sector of the country.

The central bank brought about this shift in policy after maintaining the benchmark interest rate at 7% for the past 15 months. The Monetary Policy Commission (MPC) hinted that it will continue increasing the rate in the future as well in light of the current economic conditions. Research Analyst at Topline Umair Naseer said that earnings for banks are expected to rise by 20% in the time span of 2021-2023 in comparison to the 13% recorded during the first six months of the current fiscal year FY2021.

Banks were quick to raise the cost of borrowing way higher than the amount they pay to the SBP on loans. The rate charged by one bank to another on the disbursement of a loan that is the Karachi Interbank offered rate (Kibor) and the rate of return on the investment by the banks in government debt securities – T-bills were raised by 36 bps by during this week.

Market participants and research houses have projected the benchmark interest rate to increase up to 8-8.5% by June of next year FY22 as the central bank keeps increasing it by 25bps in every Monetary Policy Announcement held every two months.

Apart from the increasing interest rate and Kibors, banks are expected to make more profits as the growth in bank deposits from account holders and the government’s increasing borrowing from commercial banks would lead to immense support for the financial institutions.

This surge in the policy rate, however, will negatively impact most banking customers in the private sector.

It must be noted that even though Pakistani banks have experienced significant profitability in the first half of the current year, they have not performed well when compared to the KSE-100 index. The banking index (BKTI) went down by 4% while the KSE-100 index grew by 4 % this year.

Naseer further commented that ” “Key factors behind the underperformance include foreign selling, preference for Shariah-compliant non-banking stocks by investors and single digit policy rate,”. He added “We believe that with the beginning of monetary tightening by the State Bank of Pakistan, banks are anticipated to be back in limelight. We expect the State Bank of Pakistan (SBP) to continue to tighten the monetary policy and gradually increase the policy rate by 75 basis points till June 2022 to 8% which will bode well for the banking sector’s net interest margins (NIMs).”

Head of Research at Ismail Iqbal Securities Fahad Rauf projects an increase of 125bps taking the interest rate to 8.5% by June 2022.

Naseer said that the research house had also observed a more than expected rise in Kibor and T-bill rates in comparison to the rise in the policy rate. Reiterating the fact that these factors will contribute to a high profit margin for banks.

The hike in minimum profit rate is only by 25bps, however, the increase in interest earnings on assets is expected to be even higher.

 The banking sector fared well in the first six months of 2021 with a 13% growth in profitability in comparison to the first half of the preceding year. This growth surpassed expectations. As explained by Naseer, “This was primarily due to improved asset quality and lower provisions (bad and non-performing loans) along with better than anticipated deposit growth.”

Deposits in the month of June saw a growth of 22% bringing the number up to Rs19.8 trillion in comparison to the same period last year. By September 10 of this year, the deposit growth rate increased to 17%, as the growth momentum continued. He added that compared to 1.1% net NPL in June 2020, the ratio improved to 0.6% during the same time this year.

 “Thus, we revise our deposit growth assumption to 15% for 2021-2023 against a previous projection of 13%. We also incorporate the impact of lower NPL ratio and higher than expected rise in KIBOR and T-bill rates and consequently, our banking universe earnings are revised up on average 20% for 2021-2023,” he said.

It should be kept in mind, that the increase in rate might make it difficult for the banks to raise their lending to the private sector that is the advance to deposit ratio to 50% or above in order to prevent having to pay additional taxation of 2.5-5% in this year.


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