CRITICISM of the banking sector largely centres on the prernise that banksare not adequately performing their core duty of acting as financial intermediaries. Their over-investment in Pakistan Investment Bonds has been widely credited for the big rises in profits seen during 2014.

With the start of the new year, its pertinent to ask whether 2015 will be any different for banks, at least in terms of the principal source of their revenues. Falling yields on government debt securities have encouraged some proponents of private sector lending, who believe banks will simply have to lend more to sustain last year`s profit levels.

Yet, only recently has the attention shifted to developments taking place in the money market that suggest that 2015 will be, after all, business as usual for banks. From December 1, 2014, to January 23, the State Bank of Pakistan injected a massive Rs4.3trn into the banking system through open market operations. The reason for this, say some critics, is that the government and the central bank want to keep facili-tating banks` unending appetite for PIBs.

After being lampooned by an English daily that accused it of being an `errand boy` for banks, the SBP issued a statement in which it mainly attributed the need for the cash injections to the government retiring its central bank debt.

`The government has been retiring its borrowings from the SBP. As a result, the liquidity shortage in the system has increased considerably.

To meet this, the SBP has been injecting liquidity through its open market operations, consistent with its monetary policy stance,` it said.

But from July 1, 2014, to January 9, the government retired Rs448.2bn of its SBP borrowings on a net basis, but borrowed around Rs703.5bn from scheduled banks.

Faced with restrictions imposed by the IMF on borrowing from the central bank, the government instead of getting its fiscal house in order has been borrowing heavily from commercial banks through high-cost PIBs.

This exercise, which gathered steam from late-2013, has now virtu-ally drained banks` cash balances, forcing quite a few of them to turn to the central bank for meeting their day-to-day liquidity needs as well as to be able to participate in future PIB auctions.

`Obviously that`s what`s happening. But having said that, the SBP is still trying to maintain a balance. One way they`re doing so is through the [50bps] penalty they charge on institutions that borrow from the discount window more than a certain number of times in a period,` said one senior banking source. But the low penalty hardly seems to be doing the trick.

And there appears to be no change in the government`s underlying fiscal situation that would warrant a reversal of this trend. According to the schedule of auctions for JanuaryMarch, the SBP hopes to raise a cumulative Rs150bn from the sale of PIBs.

Banks` investment outlook: Given this scenario, it is unlikely that banks will voluntarily give up on this lucrative investment avenue.

`Investing in PIBs has become a trend; so regardless of a drop in yields, banks are likely to keep going after them,` said a sector source.

`Lower interest rates have traditionally led to a decline in industry-wide profits. But the impact will vary from bank to bank. For instance, if one bank decides to sell its PIBs this year, it will book huge gains that will likely take its profit beyond those of 2014,` he added.

Yet, a few sector analysts have recently argued that the relatively higher margins available on loans toprivate sector businesses should entice banks to go for higher lending in times of declining interest rates.

`While investment yields are inevitably headed downwards over the medium-term, we think the market is assigning no weight to potential recovery in credit demand by 2016.

This should boost banks` hitherto absent ability to pursue higher credit spread,`wrote KASB Securities analyst Farid Aliani in a December report.

`Credit recovery is likely to be supported by large-scale borrowing in the energy sector as at least 2,5003,000MW of coal power projects are targeting financial close by the end of 2015. Additionally, short-term solutions to energy shortage, including LNG imports, have the potential to improve industrial activity and revive some credit demand immediately,` he added.

`Interest rate is one factor that determines the quantum of bank lending. I think a more important one is stakeholders` confidence in the economy, governance and growth prospects. This would matter more than, say, a 50 or 100bps cut in the policy rate,` cautioned a senior market watcher.

Equities: One investment avenue that is likely to receive renewed attention from banks is the roaring equity market. In the first two weeks of this year alone, banks and DFls bought a net Rs28.65m worth of equities.

Income from capital gains and dividends are likely to partially offset any declines in core incomes.