The banking industry in Pakistan has its own way of dealing with customers, under a seemingly tough regulator overseeing its businesses and operations. Ironically, one such phenomenon that has gone unnoticed is that a majority of banks discourage new and existing customers from investing money in profitable instruments such as Term and Fixed Deposits.
On the flip side, banks encourage their new and existing customers to open a current account or savings account with a very minimal profit rate. This strategy was pointed out in a study conducted by the State Bank of Pakistan (SBP).
According to the SBP, the growth of deposits under fixed and term accounts in the banking industry went down to two percent by the end of the financial year 2017-18 from 10 percent year-on-year growth in 2016-17 and 12 percent in 2015-16.
Term/fixed deposits’ share in overall deposits of Rs. 13 trillion declined to stand at 21 percent by the end of FY18.
A fixed or termed deposit (FD) is a financial instrument which provides investors with a higher rate of interest than a regular savings account, until its maturity date. It may or may not require the creation of a separate account.
Banks avoid offering profitable options to customers because of their increasing cost of managing interest expenses. The trend started since the imposition of deposit rates a few years ago that limits banks’ ability to cut their interest expenses.
A balance sheet review of a selective pool of banks also shows that adjusting deposit portfolios is a common strategy to minimize interest expenses. In fact, many banks have boasted in their annual and quarterly statements of “tapering off”, “shedding”, or “optimizing” their high-cost deposits, the report said.
Banking customers are also choosing different options to save or invest their money outside the banks to get a good profit or interest rate against their savings and investments; hence the deposit mobilization growth of the banking industry is going down.
The deposit growth slowed down to 8.8 percent in FY18 from 12.4 percent a year earlier. A common explanation is the presence of very low interest rates, which has created a disincentive for depositors to place their funds in banks. Moreover, since overall M2 growth has decelerated, a slowdown in deposits also seems logical.
Withholding Tax on Non-Cash Transaction Restricts Deposit Mobilization
Not only have banks’ strategy, lower interest rates, and slow M2 growth caused a lower deposit mobilization of the banks, but a major factor is withholding tax on non-cash transactions, which have been detrimental for the banking industry in managing their deposits on a sustainable basis.
Due to withholding tax on non-filers, people avoid depositing cash in the banks once money is transferred from one bank account to another. Also, the newly created money for the general public and businesses is not re-entering the banking system. This has several disadvantages, including but not limited to, negative effects on economic growth and lower liquidity with banks to carry out financial intermediation.
The deposits of the banking system (including government deposits) grew by 13.7 percent in terms of compounded annual growth rate during FY12-FY15; the CAGR then declined to 11.4 percent during FY15-FY18.
Self-employed (i.e., small businesses) and ‘other personal’ deposits (excluding those of salaried persons) have the biggest share in deposits (36.3 percent by June 2018), and the growth in these deposits almost halved during FY15-FY18 as compared to FY12-FY15. The deposits share of sectors such as manufacturing, real estate, commerce and trade firms has also been lukewarm.
SBP Recommendations for Banks and Government
SBP has repeatedly advised banks to increase their deposit-taking efforts and has also enforced floors on deposit rates – it is extremely important to reconsider the taxation regime.
Being a regulator, it does not suffice for the central bank to give advice to banks merely but to set a target for banks, monitoring their operations and penalize the banks failing to meet their targets and working on an unfavorable strategy.
The central bank believes that the removal of withholding tax on non-cash transactions will be particularly helpful for deposit growth in the banking industry.
It is also expected that with a reversal in monetary policy stance, liquidity dynamics may change in the interbank and this could induce banks to focus more on expanding the deposit base.