The government has introduced major changes in Federal Budget FY23 for the banking sector, which will significantly impact the industry’s bottom line. These changes include 1) an increase in the corporate tax rate for banks, 2) an additional 2% tax on poverty alleviation, and 3) an increase in the tax rate on interest income on government securities.
As per the Finance Bill, the corporate tax rate has been increased from 35% to 45% from the tax year 2023 and onwards (CY2022 and forward), and the super tax of 4% has been abolished. Hence, the tax rate has increased by 6%, from 39% to 45%, which will impact earnings from 2022 onwards.
An additional 2% poverty alleviation tax has been imposed on the banking sector (banks with earnings of Rs300mn and above) from the Tax year 2022 onwards (CY2021 onwards) as per 7CA of the Seventh Schedule of Income Tax ordinance.
§ Furthermore, the tax rate on the interest income from government securities with banks having an ADR of 50% or more is increased from 35% to 45%. For banks with ADR of 40-50%, the rate has risen to 49% from 37.5%; for banks with ADR of less than 40%, it is increased to 55%. The Finance Bill also clarifies that this tax will apply on total income attributable to real investment in government securities and not on additional income.
Implementing the said tax rate increase on a certain ADR threshold will apply retrospectively from CY2021 onwards (Tax Year 2022 and forth). It will likely lead to a higher effective tax rate of around 53% in 2022 and will settle down to ~48% in 2023.
Since the SBP amendment Act 2021, the government has to rely mostly on commercial bank borrowing to finance its fiscal needs, resulting in a rise in secondary market yields on government securities. We believe that to limit banks from taking undue advantage of the given situation; the government has imposed higher taxation on banks, especially on the interest income from government securities.
The above-announced measures will impact the sector’s profitability by around 20% for 2022 and 15% for 2023. Banks will now gradually try to shed high-cost deposits and look to increase exposure in advances to minimize the impact of these measures. Banks may also contest this huge increase in taxes from relevant authorities.
After these measures, Topline Banking Universe earnings are expected to grow by 10% in 2022 and remain flat in 2023. We maintain our ‘Overweight’ stance on the banking sector as it trades at attractive PE of 4.3x and PBV of 0.6x.
Courtesy- Topline Securities