Banks to comply SBP equity investment rules

KARACHI (November 03 2003): The decision of the State Bank of Pakistan to restrict investment in share market would force several banks to unload their positions in a year period because their contribution as per their equity portfolio has gone up as high as 71 percent.

According to a report of KASB Equities, the financial statements of banks indicate that most of the larger banks are sitting on investments substantially higher than the limit set by the central bank. Average ratio of the banks' investments to their equities comes to around 25 percent whereas the higher range is 71 percent and 4 percent the lowest.

These ratios look worse if banks' investments in NIT units are added. Average ratio is close to 49 percent, whereas 136 percent and 6 percent are the upper and lower ranges.

Most of these numbers may see changes as the market has come down significantly from the June 30, 2003 levels. “However, our view is that still most of these ratios are well above the SBP's desired level,” the report said.

The report said that the unstable market throughout last week could be attributed to the central bank's latest initiative to put restrictions on banks' exposure in the stock & TFC investing.

The SBP has restricted banks' exposure in these two categories to up to 20 percent of their total equity, whereas a bank cannot take an exposure of more than 5 percent in a single stock.

Moreover, the banks now cannot even own more than 30 percent in any company's paid up capital.

The banks will have about a year to adhere to these rules. “We favour the central bank's move to regularise the stock investing by the banks. The new limits are substantially better than earlier speculated figure of 10 percent of banks' capital base in the equities.”

Change in the rule and its background: A similar speculative wave was seen in the recent past when the central bank sought bankers' opinions on stock investing along with the proposal that such investments should be around 10 percent of the capital base.

The market over-reacted while the issue was eventually calmed down after the clarification that these were just proposals and nothing is being implemented.

Most of the bankers are of the opinion that they have been under the impression that the central bank would be announcing a few measures to regularise the stock investing early next year, and all the violating banks would be given adequate time to adhere to the new rules.

However, the central bank took them by surprise by making this announcement at least 3 months earlier though it has given almost a year to fully implement it.

KASB view on these changes: We favour SBP's initiative and are of the opinion that this will be an effective long-term measure which will help both the banking sector and the capital market.

From banks' perspective, this will eventually force the banks to concentrate their core function of financial intermediation with less focus on speculative money-making tactics.

Capital markets will also be better off in the longer term as the banks' treasuries usually are hot money providers, and generally lead to higher price volatility in the stock market. A more disciplined approach from banks would reduce this volatility and will provide stability to market performance.

In our view, the timeline given to the banks is adequate and banks can plan a gradual sell-off.

MARKET IMPLICATIONS: Undoubtedly, the initial negative reaction from the market is understandable. We are of the opinion that this initiative will have negative repercussions for the market in the short to medium term.

Instead of making further allocations to the market, the banks would first be streamlining their existing investments in the stock market.

At the same time, the government's current divestment plan through stock exchange will suffer owing to this development

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