Banks Investment in Government Securities is more than 90%

Commerce banks' investments in government securities in the past 14 years have been fantastic, rising to more than 90% by the end of 2020, mostly owing to cheap and risk-free profits.

In its Financial Stability Review (FSR), the State Bank of Pakistan analyses the investment shares of banks in different government long-term to short-term securities, which rose from 76.74% in 2007 to 90.65% in 2020.

The most recent statistics available have indicated that by March 2021 Rs 11,39 trillion had been invested in different government securities, including Market Treasury Bills, Pakistan Investment Bonds, and Government Ijara Sukuk. The remaining less than 10% was generally parked in other financial instruments, including mutual funds, financial certificates, etc. The study therefore noted that the percentage of total assets investments had increased to 47.50 percent in 2020 from 24.74 percent in 2007.

In the past fourteen years, the banks' investment return (ROI) has changed depending on the policy rate, from 6% to 12%. The securities ROI now stands at 10%, whereas the policy rate for a very sustainable time was at 7%.

In addition to the government help for meeting its budgetary obligations during the period, profit margins owing to the rate dynamics and decreased demand for funding by the private sector also contributed to portfolio development.

The rate dynamics have also influenced the investment portfolio's structure, because the investment of the banks follows the same favourable tendencies when the government gives higher interest rates following rising policy levels.

In truth, this pattern also reflects Pakistan's business cycles and underlying imbalances in its budget deficits and government demand for bank loans.

As interest rates increase, aggregate demand, in particular private-sector loan demand, smoothes up and makes investment in risk-free assets more profitable for banks. As a result, government securities portfolios of banks have built throughout the years.

With more of their money invested in public securities in the course of time, revenue from these risk-free securities added more to the overall interest income. In 2020, government securities' interest income share grew to 49.26% from only 13.75% in 2007. These figures show the rising importance of revenue in the profitability of banks resulting from investment in government securities.

Upon recognition of the importance of government security returns, the banks tried to achieve an optimal portfolio composition that properly accounted for higher income-generating long-term bonds.

In addition, the government's aim to enhance its debt maturity profile also helped modify the mix of the banks' investment portfolio. As a result, the percentage of Long Duration (LT) securities investments grew to 45,20% in 2020 (13,38% in 2007), whilst the short-term (ST) exposure of banks decreased to 38,13% (57.68% in 2007).

Increases more government reliance on banks

The study shows that in the past 14 years the government has progressively grown the dependence on the financial sector for its budgetary requirements and therefore had a bearing on the banking sector balance sheet structure.

The percentage of interest gains from government securities in overall interest income in the calendar year 2020 had grown to about 50 per cent (CY20). The interest income of these securities largely depends on the amount of investments defined by government funding requirements and the existing policy rates.

At CY20 the rise in securities tenure resulted in greater government-owned securities returns even though the policy rates were considerably reduced throughout the year.

It is important to highlight that the continuity of fiscal deficits and the strong demand for bank loans may have influenced banks' appetite for risk and may have undermined their actual financial intermediary economic function, and this may has far-reaching consequences for the country's future economic growth.

Nevertheless, it is important for efficient financial communication between general savers and private sector businesses, to achieve a balance between financial stability and proper risk-taking. All parties must thus adopt a holistic strategy.

Banks must improve their lending responsibilities for the private sector, especially private businesses and high-potential sector sectors like small and medium-sized businesses and agriculture and hypothec finance.

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