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The impact of declining banks’ profits on financing

Jan 30,2021 - Last updated at Jan 30,2021

Bank profits declined significantly during 2020, with exceptions for a very limited number of banks that achieved a noticeable increase in their profits for explanatory reasons. The results of the banks were affected by the negative economic repercussions imposed by the Corona pandemic on the local and global economy, the slowdown in global trade, and the decline in interest and commission rates.

The banks ’results for the first three quarters showed a decline of more than 68 per cent. As a result, concern prevailed among all segments of society, especially the economic sectors and questions were raised that: What is the effect of profits on the volume of liquidity in banks and the economy? Does the decline in banks’ profits have a direct impact on the ability of banks to grant credit, extend loans and financing to the economy?

In fact, the main factor that affects banks' ability to provide financing to the economy is the availability of liquidity. What affects liquidity in the first place is the growth of deposits in various forms, as they are the main component of liquidity in the economy. What affects deposits is the volume of economic activity, the volume of transfers, aid and export revenues and most importantly, the granting of credit from banks and other financial institutions.

Every loan or new financing is a new deposit that flows into the liquidity component. It is of interest to mention that credit facilities have grown by 6.7 per cent during the first eleven months of 2020. However, this growth in credit has not been reflected in the growth of deposits. This is due to the fact that a large percentage of liquidity appeared in the form of cash in circulation in the hands of the general public. A large percentage of the population has withdrew part of their deposits, and kept it in their wallets or safe boxes at home to meet their needs at the time of closures during 2020.

As for the mechanism of how a decline in banks’ profits impact liquidity, it is as follows: When banks announce their profits, about 38 per cent of it is transferred to the treasury, which is equivalent to the rate of tax imposed on banks, and a percentage of it is distributed to shareholders and the remaining part is reinvested in banks to cover various forms of capital expenditures. What is paid in the form of tax reaches banks again through salaries and wages that the government pays to public sector employees, and what is distributed to shareholders is transferred abroad to non-Jordanian shareholders, and part of that is transferred to local shareholders goes to deposits in banks and enters into liquidity.

With this understanding and within this transition mechanism, banks' ability to provide financing is affected by the decline in their annual profits. However, due to the fact that the relative importance of the volume of deposits from bank profits to total deposits is low, the impact of the decline in profits on the ability of banks to provide financing to the economy is also low.

What supports this argument is the growth of deposits in banks by 3 per cent in the first 11 months of 2020. Three per cent is a bit small; it reflects the decline in the general economic activity. However, if the negative repercussions of the pandemic continue to affect the economy and economic sectors, it will reflect more negatively on the profitability of banks and their ability to provide financing to the economy.

In such difficult circumstances and prolonged shutdowns for large sectors of the economy, a priority for banks becomes to maintain a solid capital base, allocate provisions and cover debts to protect the credit facilities portfolio. However, the questions that arise are: How long will the banks be able to meet this priority? And if the negative effects of the pandemic prolonged, will banks still be able to provide financing, and what are the other financing alternatives available to various economic sectors?

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