The author declares that this research paper is original work. All the papers, reports and other material consulted during the preparation of this paper are duly acknowledged. The author understands the plagiarism policy at Lahore School of Economics and has followed good academic practices. Saba Javed Hayat
I would like to express my sincere gratitude to my supervisor; Professor Fareed. A. Fareedy who guided me at every step in writing this research paper. I truly appreciate his enduring patience, encouragement and intellectual insight during the formulation phases of this paper. His feedback for each query broadened my perspective about this research and made it a priced endeavor for me. I would also like to thank all the authors/researchers whose work has formed a foundation to this research. A sincere effort has been made to acknowledge their work wherever cited in this paper. Lastly I would like to thank my parents; Muhammad Javed Hayat and Zahida Javed, for their unequivocal support and great patience at all times. For any errors/inadequacies that may remain in this business research paper, the sole responsibility lies on me.
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ABL Allied Bank Limited ALM Asset Liability Management CBG Corporate banking Group CLA Corporate Law Authorities DCMS Debt Capital Markets and Syndications Division DMU Decision Making Unit FI Financial Institution IBG Investment Banking Group MCB Muslim Commercial Bank NAV Net Asset Value OMO Open Market Operations PBC Pakistan Banking Council SBP State Bank of Pakistan T1capital Tier one capital UBL United Bank Limited YTD Year to Date
The banking industry in Pakistan has been through the inception, nationalization and post nationalization phases. During all the phases, it has been involved in managing the three core portfolios; deposit portfolio, loan portfolio and investment portfolio. The management of asset and liabilities as under ALM has become a key feature for the commercial as well as specialized banks in Pakistan. Due to global integration of financial markets and systems, the impact of mismanagement can lead to severe repercussions for the financial institution. Moreover, in this time the banks are also more prone to external financial distress than ever before. The financial system of Pakistan comprises of private commercial banks, specialized banks, public banks, foreign banks, NBFIs, leasing companies, insurance companies, securities firms and the like. The commercial banks; irrespective of their ownership structure, play a crucial role as the other channels are yet under developed and as per State Bank of Pakistan, almost 80% of money supply is held by these banks. The apex body for the banking sector is State Bank of Pakistan which sets the prudential regulations for their working. The financial system is too bank centered in Pakistan and hence the multitude of impact of activity in this sector has significant ramifications for the economy at large. In present economic condition of Pakistan, Banking industry is facing a multitude of macro factors that are causing a constriction in the core business of banks as the involuntary defaults are leading to impairment of the loan portfolio. Electricity shortages, devaluing currency, heightened inflation and political unrest is severely impacting the business of the banks. Hence forth the banking industry is undergoing a shift in asset mix; away from loan portfolio towards investment portfolio. It can be safely stated that on the supply side, banks are taking a foot back from lending and are showing a preference to maintain higher liquidity. Moreover on the demand side, corporations are facing macro problem prevalent in economy and an uncertain business environment. According to Banking Surveillance Department at SBP, the profitability of banks has increased by 23% but it has been attributed by top five banks according to the asset structure. The increase in profitability is maintained by shift in asset mix towards quality investments primarily government t-bills and treasury bonds. It seems that banks are less eager to extend loans to the private sector and are more excited to invest in the risk free government papers in the presence of very high impairments on their existing loan portfolios. Although at present, the idea of the shift in asset portfolio mix is generating adequate income considering the macroeconomic situation prevailing in the country but it is also shifting the focus away from the development of parallel banking channels which can contribute to non funded income leading to more profitability.
The business research problem is “to evaluate the investment portfolio of United bank Limited to determine the nature of shifts in asset towards risk free government securities at the expense of lower development of alternate delivery channels and core banking functions as potential avenues of profit for the bank. ” Commercial banks in Pakistan are steering towards increasing their investment portfolio and squeezing their loan portfolios in the past few to evade the economic repercussions in local economy after the outset of financial crisis in global market in 2008 which had its contagion effect on the local financial market despite the weak linkages between the two markets. As per Moody’s Rating Agency (2012), large banks in Pakistan have around 430 percent of T1 capital as direct exposure in government bonds while the exposure in Public sector enterprises is another whopping 139 percent of T1 capital. This enlarged exposure influences their risk profile in foreign market as the banks will have to face more stringent conditions in the international markets. The core function of lending has also been neglected despite the fact that lending to private sector, as an activity, is usually able to generate higher spread due to involvement of higher risk. The foremost attention is geared towards investment in risk free securities which give a good return as the PLS account’s deposit is kept by the State Bank of Pakistan at 6%. Hence banks are earning good spread and are continuously increasing exposure to government securities as the government is increasingly financing its debt through the stated instruments. Moreover the continued focus on development of Investment portfolio is taking the focus away from the development of alternate delivery channels for the majority of unbanked population of Pakistan which account for around 85% of population. Although the a few banks are taking a foot ahead with the development but the volume wise expansion in alternate profit generating avenues is very small. According to Qayyum (2005), these channels are also low risk addendums but the development focus has been very small due to development of other areas particularly investment portfolio as a low risk prospectus. The gravity of situation is immense as it will determine the future profitability of banks as the rates on deposits are practically fixed by the central banks and the differential can be earned by higher interest and non interest income.
It is important to study the topic as the banks’ core function is intermediation of funds which is primarily exhibited by the deposit and loan portfolio. The normal operations of banks have been geared towards these two sets but by under the post reforms regulations of State Bank of Pakistan, the banks are allowed to manage their foreign currencies and can actively manage their investment portfolios. Though there is limit on overall investment portfolio as a percentage of total assets but the classification within the portfolio is not barred. Hence the composition is based on the sole discretion of banking authorities. Due to present high returns on risk free investment portfolios the profitability is on rise but the changes in discount rates can switch the odds and the lack of focus on other profit generating avenues will be studied. The study will draw attention to fact that is the shift towards risk free securities is causing a huge impact on the performance of financial markets and will give response to the myths pertaining to power of large banks in influencing capital markets. Moreover the study will draw attention to a newly evolving low risk phenomenon of alternate delivery channels in the banking sector and its prospective role in case of adverse situations for the investment and loan portfolio.
Investment portfolio Glossary Banking & Finance by Shakil Faruqi, Published by State Bank of Pakistan. Investment in a variety of assets, mainly financial assets such as shares, stocks, bonds, government or corporate securities, bills, commercial papers & other financial instruments, real estate and investment in property. T-bills Glossary Banking & Finance by Shakil Faruqi, Published by State Bank of Pakistan. Short term debt issued by government to raise funds for the government or to regulate money supply through OMO of central bank. Impaired Loan Glossary Banking & Finance by Shakil Faruqi, Published by State Bank of Pakistan. A NPL with over dues of principal and interest for 90 days and beyond; or when a loan is secured by impaired collateral or with a loan security of doubtful value, which turns out insufficient to cover the accumulated over dues. Advances/Loan Portfolio Glossary Banking & Finance by Shakil Faruqi, Published by State Bank of Pakistan. Of a bank or lending institution consists of all loans; disbursed and outstanding of different maturities; various types of loans extended to various types of borrowers of banks; the amount of loans advanced. Securities Markets Glossary Banking & Finance by Shakil Faruqi, Published by State Bank of Pakistan. Is market for stocks, bonds and other securities, composed of buyers and sellers of securities, and market makers who may conduct their transactions at stock exchange, or OTC, not necessarily tied to a specific place
United Bank Limited (UBL) is my Decision making unit as it is one of the six large banks of Pakistan and has a commanding market share. UBL has tried to keep up with the innovative image by working on project Genesis, Bloomberg Electronic Bond platform and Enterprise Banking Suite while keeping a track of costs as the overall economic conditions are rather challenging. Moreover it has been actively participating in the expansion of investment portfolio through purchase of risk free investments. Hence a research study conducted on the expansion in investment portfolio in the recent years can be of great use across banks with similar size, operations and ownership structure.
According to the United Bank Limited Annual Report 2010, it has a vision “to be a world class bank dedicated to excellence and to surpass the highest expectations of the customers and all other stakeholders” and mission of setting “the highest industry standard for quality, across all areas of our operation, on a sustained basis” by optimizing “people, processes and technology to deliver the best possible financial solutions to our customers” to “become the most sought after investment and be recognized as the employer of choice.”
To achieve this long-term vision UBL has formed a firm stance by adopting six sets of core values including “Honesty and integrity, Commitment and dedication, Fairness and meritocracy, Teamwork and collaborative spirit, Humility and mutual respect, and, Caring and socially responsible”.
UBL has wide banking operations in retail, Islamic, corporate, investments, international and branchless categories.
Retail banking at UBL encompasses branch banking business, domestic deposits, consumer lending, commercial lending and Agri-Lending. According to Banking Surveillance Department’s Quarterly Performance Review (Dec, 2012), retail banking grew exceptionally in 2011 with 17% increase deposits and with addition of 87 full branches and 14 sub branches. CASA and fee income also followed an upwards trajectory. It also established Signature Priority Banking in nine lounges across Pakistan and introduced a Platinum Credit card for affluent customer.
According to Banking Surveillance Department’s Quarterly Performance Review (Dec, 2012), under Islamic Banking, UBL Ameen is becoming a priority product in the niche. Low cost deposits have exhibited a growth of 85%. On contrary the customer deposits have risen by 15% only. Ameen is striving to become the most reliable and efficient Shariah Compliant Islamic Banking Solution Provider.
Corporate Banking has become a core function at UBL as loan book is managed proactively with enhanced focus on NPL recovery in the current difficult times by the Corporate Banking Group (CBG). Moreover with great relationship model and focused operations bank is able to provide quality services to corporate clients for their needs of trade financing, home remittances, cash management etc.
Investment banking is primarily geared towards overseas markets as the markets are slowing down in Pakistan. The biggest contribution of fee income under investment banking came in from Debt Capital Markets and syndications. Then the project and structured finance business has made some major contributions to the fee income under investment banking area.
International banking is conducted majorly in the UAE and Qatar markets as there are positive sentiments within the banking industry. There is cautious approach held in Bahrain and Yemen. CBG is working well across countries and the lending portfolio is unimpaired largely. Retail portfolio is adequately provisioned but the residential mortgage portfolio in Dubai saw a rise in provisions due to new requirements by Central Bank.
Branchless banking is also on rise as Omni is turning into a profitable venture as its Dukaan network has increased from 2300 to over 4600 outlets. Moreover it has also launched Global Net-banking product in 2011 to lay the foundation of internet banking platform and integrate the system internationally.
A PESTEL analysis of banking industry is conducted to know about the banking industry in Pakistan. This environmental analysis helps to understand the business problems more intricately and to recognize threats, avoid shocks, identify opportunities, and develop better long-term and short-term planning. The political impact on the banking industry is sizably reduced after the practical autonomy of central bank whereby the State bank of Pakistan has autonomy in making policies for the banking sector. But political forces do play in auction of t-bills and government securities in terms of acceptance amounts as the government is doing more than 60% deficit financing from commercial banks. Economic factors like interest rate discounting by 150 bps and depreciating rupee dollar exchange rate is shifting the dynamics of the industry. Social factors have a slightly growing part to play as the social class which now can access banking products has started to widen up. Financial inclusion through alternate delivery channels is a possible gateway ahead. Technologically the industry is at par with international standards where the top banks in industry are keeping themselves automated by using systems like Symbols, Unibank, LOS programming and other financial integration software environmental factors have no direct impact on the industry but they can indirectly impact the banks by causing damages to their clients. The legal status of banks at large is secured by SBP wher the banks are penalized as per the prudential regulations and special courts are also available in case of financial indiscipline on part of FIs or their clients.
Banking industry in Pakistan has played a significant role in the progression of economy. It has been impacting the growth of various sectors in economy and hence is not just a sector but a system. According to Wachtel (2001), banks perform core function of intermediation and hence investing is a secondary function. The division depends on the central bank regulations and risk return profile. Jaffe and Levonian (2011) say that banks determine asset allocation based on the risks and associated costs as well as their usage in generating value. Haque (1997) says that nationalized banks had lower efficiency due to non diversified group of assets. In view of Qayyum, A. (2005), the degenerated banking industry at inception was turned into publically owned enterprise in nationalization phase. Later it was privatized slowly to generate a mix of public and private owned banks. In nationalization phase the banking industry was primarily involved in servicing the needs of government with secondary focus on the corporate businesses. Moreover nationalization wiped out the private sector. According to Khan, A H. (1995), due to marked regressive effects in economy, nationalization policy was repealed. Qayyum, A. (2005), further says that initially banking industry was regulated by SBP, PBC and CLA. In pre reform era, PBC was regulating the commercial banks of public sector and CLA regulated the capital markets and SBP was the apex body. After that SBP assumed the complete role in regulating the commercial banks in Pakistan. In his view, the SBP was later required to perform quarterly performance review of all banks. Later the banks were regulated under the revised Banking Companies Ordinance (1962) and amended State Bank of Pakistan Act (1976). After this, SBP rose as apex body for commercial banks with SECP as regulatory body for capital markets.
The banking sector underwent nationalization giving complete control of operations and portfolio management to the government. According to Qayyum, A. (2005), this period was marked by concentrated ownership of assets, initiation of overly subsidized credit schemes with political motivations, restriction on private commercial banks, introduction of credit ceilings and controlled interest rate regime which lead to demise of banking system in Pakistan. The tax rate of 35% also contributed to increases in lending rate during the nationalization phase. Hayat, S. (2011), discusses that correction in the banking system practices was brought about by the financial sector reforms which were done in two sets of phases. The first phase of reforms were introduced in 1991 opening doors of banking business to private investor to reduce to negative sentiments created by nationalization. Accordingly, foreign first tier banks were allowed to make entry in the market. State Bank played a crucial role to regulatory as well as planning body to reduce the ramifications of nationalization and planned the recovery path for the banking system at large. The second phase was marked with suspension of Banking Council and State bank of Pakistan became the sole regulatory authority. International ratings like CAELS and CAMELS were introduced. The important reforms pertained to privatization, equity sufficiency model for the banks, better corporate governance and subsidized financing of non conventional sector. According to State Bank of Pakistan (2011), Banking Sector Strategy (BSS) has been strategized for the coming decade. BSS focuses on ten core areas that include implementation of a financial inclusion program, Strengthening consumer protection, Strengthening competition and efficiency, strengthening and consolidating the banking sector, Strengthening prudential regulation and supervision, introduction of a framework for consolidated supervision, development of a financial safety net, Strengthening of powers of SBP to maintain financial and monetary stability, deepening financial intermediation and developing the financial infrastructure, especially payment systems.
According to Financial Sustainability Review (2011), “The asset base of the banking system has soared by 8 percent (Rs. 577 billion), the most significant rise in a half year since 2007, on the back of a robust increase in investments, overwhelmingly in government papers”. This justifies the issue at hand and overall investment in the government papers. Overall banking deposits have increased by 9.4% aggregative. Moreover profits are rising and the overall contribution of top five banks in Pakistan is falling. Hence the smaller banks are also showing amore contribution in aggregate banking profits. A surprising element is that the earning from investment in government securities has become 30% of total interest income as compared to 24% in last year. The trend in government securities expansion beneficial to government as it is able to keep the deficit financing within SBP prescribed limits. But according to Financial Sustainability Review (2011), this trend is not sustainable as it subdues the core function of intermediation and its profitability is hinged upon the discount rate. Further Financial Sustainability Review (2011) says that “rise in investments (22.4 percent) outpacing the growth in advances (1.04 %) by a wide margin, advances to deposits ratio (ADR) of the banking sector has further come off, dropping from 61.4 to 56.7 percent during H1-CY11.” This shows that banks have adequate liquidity and also shows that banks are risk averse to the total advances to private sector. Private sector investment is crowding out and trend can be reversed only by better macro economic conditions. NPLs are rising progressively despite contraction in the loan portfolio. Credit risk pertains high and infection ratio though high is well curtailed. Capital adequacy as determined by CAR is showing favorable movements in the numerator and the denominator. This has improved the solvency profile of banks as CAR has increased from 11% to 14%.
Commercial banks are investing heavily in the financial markets of Pakistan, mostly in currency and money markets. According to Faruqi, S. (2011), banks have monopolized the short term money markets including t-bills market, funds market and repo market. They are also active in government bonds market investing heavily in T – bills. He further says that banks are not active in the stock market of Pakistan for the investor risk and SBP imposed regulations. This breaks the myth of banks controlling the stock markets. According to Watchel, P. (2001), large banks tend to avoid undue exposure to securities market and invest only in less risky securities: t-bills, government bonds and AAA rated bonds. In reality, even though individually the exposure to stock market is small but is considered aggregative, the exposure to securities market is substantial reaching to around one third by the end of last year. Faruqi, S. (2011) says that average annual growth rate has been around 20% over the decade. It was faster in second half of decade where it outpaced the asset growth rate of 14%. In 2010, the investment was at around 43% of the total investment hence implying that the banks are preferring to enhance their exposure to securities market than to enhance their exposure in the credit markets.
Investment portfolio is concentrated in government securities and within those mainly in t-bills. As per Financial Sustainability Review (2011), more than 50% of investment portfolio is held in t-bills. Though it is difficult to gauge the overall investment flow as it is short term but stock follows of t-bills rose from 106 billion rupees to 1120 billion rupees over the last decade. According to Faruqi, S. (2011), there is considerable reshuffle of securities as well as size of those securities with a primary focus on shorter term t-bills. Moreover banks are also investing in government bonds; t-bonds and Sukuks. Faruqi, S. (2001) says that the proportion of investment in investment portfolio is declining and has taken a nosedive from 41% in start of decade to 11% in the end of decade. The proportional share of investment in securities to total assets of banking inclusive of all types of assets has grown from 16 percent in 2000 to 28 percent in 2010. There has been a steady shift in composition of banks in favor of securities. Faruqi, S. (2001) says that rise share of investments has occurred with corresponding decline in share of banking credit and other asset, mainly cash balances held, inter-bank lending and loans to financial institutions and the like. Even though the overall exposure is rising in the end, but exposure is very volatile in case of both for long and short term securities. The exposure of securities of entire banking system is reported at 30 percent of securities market.
According to the Infosyst Limited Report (2011), “Channelize through channels” is the new mantra for present day banks, which older days relied exclusively on the branch network to fulfill transactions, sell products and acquire customers. Before ADCs, expanding the business meant adding more branches at high real estate and licensing costs. Channels like the Kiosk, ATM and Internet Banking have enabled banks to reach a broad consumer base across geographies with little time and effort. Valluri (2011) says that in international market, there is a growing demand for channel and supporting technology. Banks are integrating channels in order to guarantee accuracy and integrity of transaction data. Channels are means of customer service as well as the means for sales and customer acquisition. With wealth banking customers becoming more technology savvy, their usage of alternate channels of banking is increasing. Banks are also investing in mobile banking applications to enable wealth banking customers transact over smart-phones. As per the Infosyst Limited Report (2011), banks around the world are searching for solutions that can reduce costs without impacting customer service. It is important that banks efficiently manage vendors for different service delivery channels along with the versions of software. Although alternate channels are not the most effective at generating new sales, they improve customer satisfaction and retention. With the help of technology, the banking industry can develop or expand into new channels to survive in the current competitive environment. Any new channel involves cost and in alternate channels, technology plays a vital role in terms of providing a near to branch experience to the well-informed wealth management customer.
According to Aurora (2012), UBL has developed alternate delivery channels slowly by providing the opportunity to customers of using the internet banking, kiosks, ATMs and branchless banking. According to Branchless Banking Regulations announced by the State Bank of Pakistan (SBP) in June 2011, introduced a Level ‘0’ branchless banking account to bring the low income segment into the financial services loop.Â As one of the two major providers of branchless banking services in Pakistan, UBL Omni was the first to introduce Level 0 accounts. (Telenor EasyPaisa is currently in the preparatory phase of launching these accounts.) According to the latest edition of the SBP’s Branchless Banking Newsletter (April-June 2012), UBL Omni’s Level 0 accounts have been so popular that the branchless banking segment experienced a record growth of 37% in the second quarter of 2012 in terms of the number of mobile banking accounts opened. The Newsletter says that “the growth is attributable to a notable increase of 370% in Level 0 accounts opened entirely by UBL Omni.” Apart from the Level 0 accounts and ATM card, UBL Omni has achieved a great deal more in the last two years giving the new campaign stronger legs to stand on. Chapter 3: Financial Analysis – United Bank Limited UBL has been able to achieve higher net income year on year basis and it has been able to generate Net Income of around 15.5 billion and has a large pretax profit amounting to 24.2 billion. Despite the turbulent situation in the economy due to fiscal indiscipline, inflationary pressures and power outages, UBL has managed to grow by 10% in its domestic network and has showed 37 percent increase in the pretax profit.
Source: Published Annual Reports of UBL (2007-2011). The five year data analysis shows that UBL has been able to increase its overall interest income with a slight dip in 2010 and an 18 percent increase from last year. Similar results have transferred into total net revenue as the interest expensed out was not of the line. After accounting for operational expenses and other losses, the pre-provision profit was also 24% higher than last year. Provisioning done under both the general and specific heads, lead to 37% rise in pretax profit showing that lesser provisioning was required by the regulatory bodies due to better quality assets.
Source: Published Annual Reports of UBL (2007-2011). Due to very high net income in comparison with the last years’ figure, the bank was able to generate a very high return on its assets base. Due was partly due to controlled expenses, prudent lending and increase in better quality investments. Moreover the proportion of earning assets in balance sheet is 87% hence the return received are high on every rupee invested as asset.
Source: Published Annual Reports of UBL (2007-2011). Moreover the return on equity is substantially large. Despite a slight fall in 2009 in return on equity due to macroeconomic financial turmoil, UBL has been able to move ahead and is rising again on the trajectory. According to the the largest shareholding in UBL is of Best-way group which have a commanding share of 51%. The next largest shareholder is State bank of Pakistan (SBP) with a shareholding of 19.5% and the next in line is general public with 13.7% stake in equity.
Source: Published Annual Reports of UBL (2007-2011). Due to the cost management efforts at UBL, it has been able to achieve higher profits as compared to last year. It has managed to control the growth in the administrative expenses to increase its branch network. It has slightly improved its cost to total revenue ratio from 42% to 40% due to its quarterly target of cost to income ratios. Moreover, the personnel expenses have also decreased over 5 years from 20% in 2007 to 16% in 2011. The heaviest cost that the bank pays is one pertaining to tax and is binding upon the bank. In 2011, 36% of pre-tax profits were given as taxes.
Source: Published Annual Reports of UBL (2007-2011). The date analysis shows that despite the macroeconomic instability, the bank was able to achieve a growth rate of 11.2% in its assets in 2011 as compared to 2.42% in 2009 where the growth was only 2.42%. It is interesting to look at the growth in advances/ finances as the last three year growth rates are negative with – 1.98% in 2011. On the other hand, the growth in investments has been phenomenal in last two years with 48% growth in investments in 2011.
Source: Published Annual Reports of UBL (2007-2011). The break-up of total assets into finances and government securities shows that roughly 60% assets were the advances while only 18% of assets were government securities. By the end of last year, the trends seemed to revert back where the total finances were only 46% of total assets while government securities amounted to a staggering 33% of total assets. This shows that UBL is restraining back from the risky loans in the present economic times and it is investing heavily in the government securities to reduce its exposure to risky lending.
Source: Published Annual Reports of UBL (2007-2011). The overall investment growth is also huge based on year on year basis. The last two years have witnessed an investment increase of 79% and 48% respectively. The primary investment is done in government backed securities for both long term and short term but basic focus is on shorter maturity investment securities like government t-bills.
Source: Published Annual Reports of UBL (2007-2011). The Net Interest margin Ratio is fairly stable for the time frame of 2009 to 2011 at around 60%. The ratio is stable because the increase in net interest is being matched by the increase in the average earning assets due to increase in the regional network.
Source: Published Annual Reports of UBL (2007-2011). The bank is having a maintained spread of around 6% during the past four years. The spread in 2007 was larger due to increased lending at better rates. Since banks are looking to have safer and lesser risky securities by which they can make sufficient profits, hence the spread is falling due to change in risk absorption willingness of UBL in expanding its loan portfolio.
Source: Published Annual Reports of UBL (2007-2011). The reason of constriction in loan portfolio can be gauged from the impaired lending growth rates. These are also referred to as non-performing loans in different texts. The growth rate in NPLs has been phenomenal due to large amount of involuntary defaults owing to the electricity crisis and stammering price inflation. The growth in NPLs has been 261% in 2010 and 83% in 2011 showing that the amount thereof is substantially large and hence explains partly the reason of constriction of loan portfolio.
Source: Published Annual Reports of UBL (2007-2011). The NPLs as percentage of gross finances are highest in the last two years with standing at 3% in 2011 but due to increase in the equity as per the SBP regulatory requirements and Basel III forming its footsteps for regulation, the NPLs as percentage of equity have fallen to 3% (2012) from a high of 15% (2007). Similarly their proportion is smaller as percentage of equity adjusted for revaluation of held to maturity financial instruments.
Source: Published Annual Reports of UBL (2007-2011). The provisions (both for specific and general purposes) have been made and they were able to cover the NPLs to 100%.
Source: Published Annual Reports of UBL (2007-2011). United Bank Limited is able to cover its regulatory requirements of capital adequacy. Hence the bank is adequately capitalized in form of both tier 1 and tier 2 capital to absorb any losses and act as a cushion for financial shock. The bank has been able to generate a Capital Adequacy Ratio of 14.88% in 2011 which is above the minimum requirement of 13% by State bank of Pakistan. Moreover the tier I CAR has improved from 10.3% to 10.4% from 2010 to 2011. The equity is 9% of total assets in 2011 and due to positive revaluation impact the adjusted equity is 10.2% of total assets.
Source: Published Annual Reports of UBL (2007-2011). The deposits mostly composed of current deposits (almost 50% – 70 % of total deposits) and to maintain liquidity is a core function for the management to ensure the fluency of daily operations. The total liquid assets as percentage of total deposits and borrowing are on a rise since 2008 from 32% to 55% in 2011.
Source: Published Annual Reports of UBL (2007-2011). The liquidity risk is closely monitored in Basel III Accord due to its contagion effect on entire financial system. The gross loans as percentage of deposits have fallen from around 80% to 56% over a period of last five years. It shows that the liquidity position is rather satisfactory as higher advances can increase liquidity risk. The demand deposits are increasing as percentage of total deposits. These are practically no cost deposits and banks look for them. Even after including SBP Refinancing Facility in extending loans, the liquidity risk is not substantial due to SBPs availability of lender of last resort provided that the SBP has second highest commanding shareholding of UBL. Chapter 4: Financial Analysis – (Peer Analysis of UBL with MCB and ABL) The choice of reference DMUs (Decision Making Units) was taken based the size of bank, similarity in operations and branch network. Two closest peers of United Bank Limited were Muslim Commercial Bank Limited (MCB) and Allied Bank Limited (ABL).
Source: Published Annual Reports of MCB, UBL and ABL (2011) The return on assets ratio shows that the United Bank Limited is able to generate more profit per unit of input due to its higher earning ability and better cost controls than its peers.
Source: Published Annual Reports of MCB, UBL and ABL (2009 & 2011) The growth in total assets for MCB and ABL has remained fairly close to 15% from 2009 to 2011 but UBL assets have shown a lower growth rate of 2.4% in 2009 but around 11% growth in 2011. The gross finances have experienced a negative growth rate in case of all three DMUs. Even though the trend is persistent for past three years in case of MCB and UBL, ABL had an expansion in finances in 2009. Moreover NPLs for all banks have a positive growth rate in both years but NPL management should be a cause of concern at UBL. Investments have been on rise for all the three DMUs with 150% growth in investments of ABL. Customer deposits are also growing steadily with sharp rise in UBL customer deposits. Equity growth is also in appropriate over all years.
Source: Published Annual Reports of MCB, UBL and ABL (2011) The earning spread as measured by the differential in asset yield and cost of funds is positive for all banks showing that they are profitable in their interest earning operations from the lending portfolio and investment portfolio while capping their interest expense in their deposit portfolio.
Source: Published Annual Reports of MCB, UBL and ABL (2011) The NIMR/avg. earning assets is also large for all banks and is largest for the MCB bank due to larger net interest margin.
Source: Published Annual Reports of MCB, UBL and ABL (2011) Other operating income as percentage total net revenue is also higher for ubl showing that UBL is able to better manage its non core activities. ABL is closely following UBL at .21 and .24 respectively.
Source: Published Annual Reports of MCB, UBL and ABL (2011) The CAR ratio above 13% for all banks as it shows that all banks have sufficient tier I and tier II and they are fulfilling the regulatory requirements of SBP.
Source: Published Annual Reports of MCB, UBL and ABL (2011) Capital adequacy measured from the ratio of equity as percentage of total assets shows that the MCB has highest proportion of its assets financed by equity and hence explains the 40% CAR. ABL has managed to keep 7.3% equity as percentage of total assets and for UBL it is 9%. This snapshot across DMUs validates the snapshot received from CAR.
Source: Published Annual Reports of MCB, UBL and ABL (2011) After adjusting for the impact of revaluation of securities, the adjusted equity of all three banks comes closer to each other. The sharp difference in equity and adjusted equity shows deficit on revaluation of assets on the balance sheet of CB.ABL and UBL have both received a net positive revaluation surplus.
Source: Published Annual Reports of MCB, UBL and ABL (2011) All three large banks have almost 33% of their assets parked into risk free government securities. MCB has invested the most heavily in risk free securities due to the growth trends in impaired lending.
The research problem is to “evaluate the investment portfolio of United bank Limited to determine the nature of shifts in asset towards risk free government securities at the expense of lower development of alternate delivery channels and core banking functions as potential avenues of profit for the bank.” Currently the commercial banks in Pakistan are routing towards expansion in their investment portfolio on expense of their loan portfolios in the past few years as a means to evade the economic repercussions in local economy. The trend is more pronounced in the larger banks as evident by the recent downfall in Moody’s rating of five Pakistani commercial banks while maintain a negative outlook for them in the near future. The reason stated in a published article in The News International (2012, July 19) explains that “the five affected banks hold sizable direct and indirect exposure to Pakistani government, which links the strength of their balance sheets closely to that of Pakistan’s, whose downgrade to Caa1 implies a greater probability of default over the short term”. According to Moody’s Rating Agency (2012), these top banks have around 252 to 430 percent of T1 capital direct exposure in government bonds alone. Exposure in Public sector enterprises is another 63 to 139 percent of T1 capital. This enlarged exposure influences their risk profile in foreign market as the banks will have to face more stringent conditions in the international markets. The stated situation is grave because our financial system is a part of global financial system in terms of inter-related transactions. A fall in credit rating makes the banks’ foreign currency deposit ceiling to lower further. This will impact their financial activities in the international financial markets as the foreign banks look at the rating very seriously before establishing a contact. The core lending function has also taken a back seat in present times even though it is usally able to generate higher spread due to higher risk involved in lending to private sector. The major concentration is geared towards the risk free securities which are giving a good return provided the ceiling of interest expense on PLS accounts for banks is kept at 6% by the State Bank of Pakistan. Hence banks are earning good spread and are continuously increasing exposure to government securities as the government is increasingly financing its debt through the stated instruments. Moreover the continued focus on development of Investment portfolio is taking the focus away from the development of alternate delivery channels for the majority of unbanked population of Pakistan. Although the a few banks are taking a foot ahead with the development but the volume wise expansion in alternate profit generating avenues is very small. The gravity of situation is immense as it will determine the future profitability of banks as the rates on deposits are practically fixed by the central banks and the differential can be earned by higher interest and non interest income. According to Faruqi (2011), this expansion in investment portfolio is predicted to be a temporary phenomenon which will revert back as the economy gains momentum. They say that the fiscal consolidation can take place on part of government if fiscal discipline is observed. They say that capital inflows can be managed by the buoyant remittances inflow and hence the reliance on investment is a temporary phenomenon. As the economy improves the exposure to loans will outnumber the total exposure in investment portfolio. But another school of thought led by risk analysts at Moody’s considers it as a more of a permanent phenomenon where the banks are geared towards getting the fee based income from investment portfolio expansion while avoiding the credit risk portion tagged with lending activities. This school strongly believes that now the unfavorable operating environment is here to persist as trade deficit is rising and capital inflows are falling due to political uncertainties and enduring structural inflationary pressures.
This business research aims to find answers to following myths about the banking industry in Pakistan and to find that whether the development of two most promising sources of profitability i.e. Alternate Delivery channels will continue to increase profitability of banks. The Myths along with relevant hypothesis are stated below. Whether the expansion in investment portfolio significant in amount and growth rate. Ho: Investment portfolio expansion is insignificant. H1: Investment portfolio expansion is significant. Whether this portfolio is actually geared towards the investments in the risk free government securities. Ho: Investment portfolio is not geared towards risk free government instruments. H1: Investment portfolio is geared towards risk free government instruments. Whether the profitability from investment portfolio is adequate and is this phenomenon sustainable in the dynamic financial environment while comparing with the loan portfolio. Ho: Profitability of investment portfolio is not adequate and sustainable in relation to loan portfolio H1: Profitability of investment portfolio is adequate and sustainable in relation to loan portfolio Whether the development of alternate delivery channel will result as an alternate sustainable profitability source. Ho: Alternate delivery channels will not be an adequate and sustainable profitability source H1: Alternate delivery channels will be an adequate and sustainable profitability source
The above stated business research objectives clearly specify that the one method of research will not be suffice for the accurate and valid conclusion hence a combination of research methods will be applied as Hansen & Cottle (1998) have stated that a good research should not restrict to one method but should employ the research method that is most appropriate be it a singular method or a combination of methods. According to Saunders, M., P. Lewis, et al (2007), both the quantitative and qualitative facets of research method is necessary for this business research paper as “Mode Two Knowledge” is produced by this paper which is practical and applied knowledge coming from the rigorous analysis of business situation. Study settings are natural and hence are non-contrived. For this reason for this paper a deductive, interpretivist and objectivist approach is used and Greener (2008) defines these three terms as generation of research from a theory, power of subjective analysis of situation and ability to look into facts as they are respectively. Henceforth to test the first two research objectives, a completely deductive and quantitative analysis is required to formulate a numerical basis for the approval/disapproval of hypothesis. The last three questions require a combination of qualitative and quantitative research methods with major focus on deductive qualitative primary analysis. For the secondary/Content analysis, data is collected from published reports banks under study had no knowledge of the possibility of this study hence there are no artificial setting in the data pool. Cross sectional data is collected on three banks; United Bank Limited, Muslim Commercial Bank and Allied Bank Limited, over FY 2009 to FY 2011. The content research explores past three year trend in the investment portfolio in terms of capitalization and components at UBL while also discuss the investment funds managed by United bank Limited in both money and capital markets. To generate adequate response for the last two research objectives, qualitative/survey research methods are adopted under which two experience surveys, twenty five questionnaires and one focus group is conducted. Questionnaires are conducted in the investment banking department and credit disbursement departments.
The data is collected from duly audited financial statements of banks and official website of State Bank of Pakistan. Due to divergent interest of researcher and collector, the data is assumed to be reliable and without any significant bias.
The content research is conducted to know the growth actual break up of investment portfolio of banks to know the exact allocation to risk free and risky investments over past five years from (2007 to 2011). Furthermore the pattern of securities held in UBL investment funds is analyzed to infer about the preference of fund managers at United Bank even for general investment purpose.
31-Dec-11 31-Dec-10 31-Dec-09 31-Dec-08 31-Dec-07 PKR mio PKR mio PKR mio PKR mio PKR mio
Source: Published Annual Reports of UBL (2007-2011). The investment portfolio of United Bank Limited has been expanding continuously since 2007. In FY 07 to FY 08 the growth in portfolio was minimal due to the turmoil economic situation and instable domestic capital and equity markets. But as the situation improved, banks increased their exposure gradually in FY 09 at rate of 17.2% but from FY09 to FY 10, the growth momentum was 64.7% year on year basis. This was primarily because of sudden increase in NPLs from the debtors of the bank who were not able to maintain their businesses given the inflationary pressure, fall in international business opportunities, slowdown in foreign direct investment and political instability. This portfolio remains profitable for UBL and the positive market conditions for the investments encouraged the bank to prudently invest in the money, capital and equity markets in the upcoming years. The trend persists in FY 11. It is interesting to state that all large commercial banks have taken huge exposures in the investment side of their balance sheet over the past three years. The exposure in each market and each type of product is explored further in the study.
Government Securities 31-Dec-11 31-Dec-10 31-Dec-09 31-Dec-08 31-Dec-07 PKR mio PKR mio PKR mio PKR mio PKR mio Federal Government Securities 235,037,038.00 160,179,234.00 77,673,427.00 82,375,853.00 86,029,117.00 Others
4,385,444.00 4,333,444.00 Foreign Securities 29,239,118.00 24,590,740.00 20,281,469.00 21,238,594.00 5,827,330.00 Provision for diminution in value of investments (2,726,226.00) (2,658,000.00) (2,252,653.00) (2,536,770.00) (351,191.00) Deficit on revaluation of available for sale investments (2,763,193.00) (3,320,862.00) (3,046,955.00) (9,781,967.00) (365,741.00) Deficit on revaluation for trading investments (43,750.00) (38,365.00) (3,006.00) (19,547.00) (15,755.00)
Source: Published Annual Reports of UBL (2007-2011). The data clearly shows that the entire investment portfolio is heavily geared towards investing in federal government securities which are issued by the central bank. Almost 80% of total investments go into government securities. Of the total government securities invested in, more than 80% is invested in federal government low risk securities irrespective of total proportion of government securities in the investment portfolio and the size of total portfolio. It is worthwhile to notice that bank is facing losses on the values of securities both in held for trading portfolio and available for sale portfolio and has been making provisioning all along.
Listed Companies 6,193,076.00 3,638,227.00 3,639,088.00 6,229,255.00 3,449,960.00 Unlisted Companies 445,474.00 445,382.00 441,574.00 441,465.00 441,106.00
Source: Published Annual Reports of UBL (2007-2011). Equity investments including mutual funds form a very minute part of total portfolio ranging between 2% to 6%. Maximum exposure (almost 90 %) is taken in listed securities due to their active secondary market and potential to unload at a better rate and in quicker time.
TFCs/PTCs – Listed 2,686,884.00 2,437,296.00 2,667,774.00 1,309,341.00 985,184.00 TFCs – Unlisted 3,291,556.00 26,833,263.00 24,570,114.00 5,778,897.00 6,000,195.00
Source: Published Annual Reports of UBL (2007-2011). Bonds, TFCs and PTCs are also an integral part of investment portfolio. TFCs if issued by good companies are invested in even without their listing on stock exchange. UBL has a larger exposure in unlisted TFCs as the banks usually syndicate while helping to issue TFCs. Their concentration varies based on maturity of TFC and the frequency of initiation. Hence they are not the deciding factor in the investment portfolio composition.
Mutual Fund units 2,114,075.00 164,662.00 191,299.00 211,583.00 262,201.00 Preferred Shares 477,816.00 463,977.00 188,895.00
Investment in associates 18,859,065.00 9,584,140.00 9,123,028.00 5,101,611.00 8,249,575.00 Investments in commercial papers 50,438.00
Sukuk Bonds 1,534,237.00 2,235,268.00 2,640,040.00 1,549,648.00 685,000.00 Debentures 4,392.00 4,392.00 4,592.00 6,676.00 8,300.00 Participation Term Certificates 10,661.00 19,202.00 26,838.00 38,205.00 46,920.00
Source: Published Annual Reports of UBL (2007-2011). The investment in other securities is also not a heavily argued subject as the denomination in each sub category is based on risk return profile of each category and the small PKR denomination that each of them has. In other investments, the most significant item is investment in associates and UBL has two associate companies in which it has continues to keep a old by taking its investment placed over there. The overall exposure in other investments has not been more than 8.00% over past five years.
UBL has been continuously managing investment funds in both money market as well as capital market to generate profits. The fund activity gives a brief about how these funds are managed, their objective and the asset allocation. The allocation of resources within the funds will also give a view about how UBL perceives its investment objective to be. A few funds managed by United Bank Limited are discussed as under.
According to Fund Manager Report (2011) this fund grew by almost 16% to PKR 4.9 bio due to high investor confidence. The objective of this fund was to generate competitive return with minimum risk. Hence the composition of asset allocation is given in the table below.
Placement with banks 11%
Cash 10% Source: Fund Managers Report (Dec, 2011) This fund has constantly outperformed the bench mark of 10.67% and its YTD comes out to be 14%. The government securities have constantly made a higher profit and yielded a better return despite small risk attached to them.
This fund is primarily geared towards investing in low risk assets to achieve comparatively higher daily returns while managing high liquidity. The ULPF generated a return of 11.14% while the benchmark as defined in Fund Manager Report (2011) was 10.24%. The asset allocation of fund is given below
Placement with banks 28% t-bills 67% Cash 5% Source: Fund Managers Report (Dec, 2011) Again this fund has a very high proportion of risk free t-bills and its calculated YTD is coming out to be 12.06% which is very high than the benchmark of 10.24%.
It is an open ended fund with objective of providing competitive returns with moderate level of risk. The fund size has been around PKR 5 bio ass per Fund Mangers Report (2011). The asset allocation as per NAV comes out to be as following.
Placement with banks 15%
Cash 9% Source: Fund Managers Report (Dec, 2011) The calculated monthly YTD comes out to be 13.34% and surpasses the benchmark rate of 12.66% even though almost 70% investment is done in low risk return instrument like t-bill while 7% in government bonds proving that the rate of return on these instruments are considerably favorable for the banks.
UBIF was established with objective of long term, superior, risk adjusted returns by investing in medium to long term fixed instruments. The asset allocation as per NAV comes out to be as following.
TFC/SUKUK 36% Placement with NBFIs 4% Cash 9%
Others 25 Source: Fund Managers Report (Dec, 2011) As per calculation, the YTD came out to be -30.18% due to pressure from restricting of corporate TFCs and Sukuks. But fund tried to pull its string by investing almost half of its NAV in the government securities to curb losses. The investment in t-bills doesn’t fall in the medium to long term criteria of maturity defined in fund objective.
The UIIF is an Islamic aggressive fund with objective to gain superior returns from the fixed income instruments as well as money market instruments. The asset allocation as per NAV comes out to be as following.
Cash 20% Others 6% Source: Fund Managers Report (Dec, 2011) The YTD calculations again give a negative return of -14.46% and benchmark is 9.08%. This return is distressed as one of the major issuer had been undergoing restructuring hence incremental provisioning had to increase.
UVIF was formed to invest in diversified shariah compliant securities portfolio. The aim is to gain respectable medium to long term gains. The asset allocation as per NAV comes out to be as following.
Equities 64% SUKUK 20%
Cash 11% Source: Fund Managers Report (Dec, 2011) YTD comes out to be 0.06% while the bench mark is at 0.9% showing trouble in managing this fund due to market volatility, political instability and investor risk aversion in more riskier products. The analysis of fund managers’ portfolios clearly
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