Banking Sector Gains Clarity Amid New Tax Ordinance

Confidence and Clarity for Banks Amid Tax Policy Changes

Pakistan’s federal cabinet has introduced significant revisions to the banking sector’s tax structure through a newly approved ordinance. The changes include:

1. Elimination of the ADR-related tax (10–16%) on income from government securities.
2. Increase in the corporate tax rate for banks from 39% to 44% for the tax year ending December 31, 2024.

The Corporate Tax Hike: A Mixed Outcome

While removing the ADR tax alleviates pressure on banks, the corporate tax increase brings new challenges. Here’s what the updated tax policy entails:

• Corporate tax rate:
  • 44% in 2024
  • Gradually reduced to 43% by 2026 and 42% by 2027
• Sector-wide earnings impact:
  • CY24: Estimated 10% reduction in banking sector earnings.
  • CY25: 8% earnings reduction.
  • CY26: 6% earnings reduction.

The government expects to generate PKR 62–65 billion in additional revenue from banks in 2024, helping meet its tax collection targets.

Clarity Restored: A Positive Sign for Investors

The removal of the ADR-related tax has brought much-needed stability to the banking sector. Over the past two years, banks have faced uncertainty due to shifting tax policies and regulatory changes. This reform allows banks to focus on core operations rather than meeting ADR targets to avoid penalties.

Key benefits include:

• Predictable earnings trajectories, giving investors confidence.
• Enhanced flexibility in managing lending activities.

While higher corporate taxes will negatively affect earnings per share (EPS) in the short term, the sector is better positioned for sustained growth with greater clarity.

Return on Equity (ROE) Outlook

The revised tax structure has led to an adjustment in expectations for the sector’s return on equity (ROE):

• Earlier projection: 20%
• Revised projection: 18.8%

Although this represents a decline, the newfound clarity provides a strong foundation for long-term performance.

A Balanced Perspective on the Future

The banking sector’s immediate challenges are offset by a clearer regulatory environment and the government’s commitment to gradually reduce corporate tax rates. This combination creates room for cautious optimism.

With the elimination of ADR-related tax burdens, banks can refocus on growth-oriented strategies, enhancing their lending portfolios and strengthening their market positions.

While short-term profitability may dip, the sector is well-equipped to navigate these changes and capitalize on future opportunities.