In October 2024, several Pakistani banks have been making efforts to increase their Advances to Deposit Ratio (ADR) to at least 50% to evade a government-imposed additional tax. This move has resulted in a notable trend where banks have begun lending at considerably lower rates to boost their loan books and meet the desired ADR threshold.
The Push to Avoid Higher Taxation
The urgency among banks to increase their ADR stems from an additional tax policy, originally introduced in 2022 and extended into 2023. The policy aimed to encourage lending to the private sector, thus supporting economic growth. The tax penalizes banks with lower ADRs by imposing higher taxes, thereby incentivizing them to lend more and maintain a balanced ADR.
Reports indicate that some banks have offered loans with interest rates as low as 3-4%, significantly below the current benchmark 6-month Karachi Interbank Offer Rates (KIBOR) of 14.7%. This represents a lending rate over 1,000 basis points lower than the market rate, highlighting the eagerness of banks to lend and avoid the tax penalty.
As of June 2024, the banking sector’s average ADR was at 40.26%, with only three banks—FABL, SBL, and AKBL—meeting the 50% ADR threshold. These banks reported ADRs of 54.68%, 68.13%, and 53.36%, respectively, thus exempting them from the additional tax.
Banks at Risk of Tax Penalty
Several banks with ADRs above 40% but below 50%, including MEBL, BOP, HMB, and ABL, face the risk of an incremental 10% tax if they fail to reach the 50% target. More critically, 12 other banks with ADRs below 40% are expected to be hit with a 16% additional tax. Among the banks most at risk are UBL, SCBPL, BML, BOK, and MCB, with ADRs of 25.22%, 28.2%, 28.53%, 31.36%, and 33.07%, respectively.
Low ADR and High IDR: A Contradiction
One of the key reasons behind the low ADR among certain banks is their strong focus on investments rather than lending. As of June 2024, the average Investment-to-Deposit Ratio (IDR) of the sector stood at 85.47%, with some banks investing more than 100% of their deposits. This suggests that banks are choosing to place their deposits into secure government-backed investments like Market Treasury Bills (MTBs) and Pakistan Investment Bonds (PIBs) instead of lending to the private sector.
Banks such as UBL and NBP, which have high IDRs, favor investments in government securities due to their stable returns. However, this approach limits their ability to expand lending, resulting in lower ADRs and exposure to the additional tax.
The Struggle to Boost Lending
The introduction of the additional tax aimed to address the sluggish credit uptake in the private sector, as evidenced by a significant drop in car financing for the 26th consecutive month to Rs227.3 billion in August 2024. High borrowing costs, alongside banks’ reluctance to extend loans, have contributed to this decline in private sector lending.
To meet the ADR threshold, banks must now rapidly expand lending at lower rates, a strategy that could attract borrowers and improve liquidity in the market. However, with deposits in the banking sector growing at a rapid pace—up 17.9% year-on-year to Rs30.78 trillion in August 2024—the challenge lies in matching this growth with corresponding lending volumes.
Central Bank Policies and Market Outlook
The State Bank of Pakistan (SBP) has already begun easing monetary policy, reducing the policy rate by 450 basis points since June 2024. With inflation now at 6.9%—the lowest rate since January 2021—the central bank is expected to continue slashing rates to stimulate economic activity. However, lower interest rates are likely to shrink banks’ interest margins, a trend that has already been observed in the second quarter of 2024.
Further complicating the outlook for banks is the government’s move towards debt reprofiling. On September 18, 2024, the government surprised the market by rejecting all bids for its Market Treasury Bills, signaling a shift towards controlling borrowing rates. This was followed by a buyback of T-bills worth Rs351 billion, with another auction scheduled for October 9, 2024. With market participants eager to invest in government bonds, yields are expected to decline, potentially impacting the returns on banks’ investment portfolios.
Banks’ Confidence Amidst Challenges
Despite these challenges, several banks have expressed confidence during their corporate briefings that they will be able to meet the ADR target by December 2024, thus avoiding the higher tax. However, the task remains daunting, as banks navigate the dual challenge of maintaining sufficient lending volumes while managing the impact of declining interest margins on their profitability.
The sector’s race to meet the ADR threshold highlights the balancing act required to comply with regulatory requirements while maintaining profitability in a dynamic economic environment. The coming months will be critical for banks as they adjust their strategies to align with changing policies and market conditions.