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Pakistan

Pakistan banks: FATF grey list status carries a silver lining

  • Moody’s flag Pakistan’s continued inclusion on the FATF grey list as credit negative for banks

  • We think the grey list status has mixed implications for Pakistan banks

  • To the extent that it accelerates the downsizing of international operations, it could be regarded as positive

Pakistan banks: FATF grey list status carries a silver lining
Rohit Kumar
Rohit Kumar

Global Financials/Thematics

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Rahul Shah
Rahul Shah

Head of Corporate & Thematic Research

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Tellimer Research
2 March 2020
Published byTellimer Research

Last week, Moody’s flagged Pakistan’s continued inclusion on the Financial Action Task Force (FATF) grey list as credit negative for banks. We think the grey list status has mixed implications, but to the extent that it accelerates the downsizing of the banks international operations, it could be regarded as a positive driver of improved capital discipline. 

In February, the FATF confirmed that Pakistan would stay on its grey list (we remain positive on Pakistan equitiesuntil at least June, when it conducts its next evaluation. Although Pakistan has been making efforts to address the deficiencies previously identified by the FATF, only 14 of a target list of 27 actions has been completed (though this represents a good improvement versus the previous review in October 2019, when only 5 actions had been completed).

Implications for Pakistan banks

We think this has implications in two specific areas for Pakistan banks. Firstly, it puts further pressure on their foreign operations, particularly in relation to trade finance and foreign-currency clearing. Secondly, we are likely to see a continued ramp-up in compliance-related costs as Pakistan (and its banks) look to check off further items from the FATF’s targeted actions list.

UBL, HBL are the most internationally exposed Pakistan banks

Regarding the banks’ international operations, we note that HBL and UBL are the most geographically diverse of the banks in our coverage. We have seen both HBL and UBL downsizing their international portfolio (including their New York branches) over the past few years (with UBL being more aggressive than HBL).

Figure 1: Foreign exposure of Pakistan banks – 2019

Source: Company accounts, Tellimer Research. Note: BAFL and MEBL are based on 2018 data.

Figure 2: HBL and UBL foreign exposure overtime

Source: Company accounts, Tellimer Research

Foreign operations barely profitable

In principle, we regard the downsizing of these operations as ROA-positive; the returns on these businesses (5-year average ROA of -0.6%) have significantly lagged those of their domestic operations (5-year average ROA of 2.4%).

Figure 3: HBL’s pre-tax ROA for domestic and foreign operations

Source: Company accounts, Tellimer Research

Figure 4: UBL’s pre-tax ROA for domestic and foreign operations

Source: Company accounts, Tellimer Research

Compliance-related costs have already risen sharply

In relation to the potential for compliance costs to keep rising, we note that the cost/assets ratio for banks with foreign operations, especially HBL, have already been on an upward trend for a couple of years now. However, we think a further downsizing of the international businesses could help bring these additional compliance costs under control.

Figure 5: Cost/asset ratio of Pakistan banks

Source: Company accounts

Investment conclusion

We think the FATF’s continued inclusion of Pakistan on the grey list has mixed implications for Pakistan banks. To the extent that it accelerates the downsizing of the banks’ international operations, it could be regarded as a positive driver of improved capital discipline. HBL and UBL could be key beneficiaries in this regard. Our top pick in the sector is UBL (strong earnings growth, resilient domestic asset quality). Among the smaller banks, our top pick is BAFL (continued margin expansion, focus on digital banking).