Performance of Pakistan Banking Sector

Banking industry begins to show signs of slowdown After witnessing a strong growth during last few years, the banking industry has now started showing signs of slowdown, as deposits, assets, investment and profitability of banking sector is on decline while credit risk, market risk, interest risk, NPLs and advances are widening. According to the assessment of the State Bank of Pakistan’s Quarterly Performance Review of the Banking System (July-September 2008), released on Thursday, due to deteriorating macroeconomic factors the performance of the banking system on asset quality and earnings has slightly declined.

Banking industry deposit component witnessed a significant decline of Rs 124 billion or 3 percent during the third quarter of 2008. Therefore, the share of deposits in overall funding structure declined to 73. 8 percent from 76 percent in last quarter, the report said. The SBP revealed that profitability of the banking system remained steady during the quarter though return indicators that slightly declined due to higher provisioning and operating expenses. The banking system posted a before tax profit of Rs 20. 7 billion during the third quarter, translating into year to-date profit of Rs 82. billion whereas after tax profit stood at Rs 54. 9 billion in September 2008. The credit risk has somewhat increased since the previous quarter. The Non Performing Loans (NPLs) of the system increased by Rs 36 billion over the quarter. The increase in NPLs has been across all the banking groups except for foreign banks, the report said, adding that “the market risk profile of the banking system is also predominantly affected by the interest rate risk. ” During the quarter under review total assets of the banking system slightly declined as the deposits base contracted.

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The Sept-08 quarter witnessed a significant increase in advances that grew by Rs 167 billion and their share in total assets inched up to 56. 1 percent, exceeding Dec-06 levels. Over the quarter assets declined by Rs 4. 2 billion to Rs 5,509 billion while assets observed strong increase of Rs 292 billion in Jun-08 and Rs 67 billion. March-08 quarter also reflects some slowdown in the banking sector, which has witnessed strong growth for the last few years. However, interestingly, the decline in assets in the September quarter is less than decline observed in the corresponding quarters of the previous two years, the report added.

On the back of high inflation rates, which pushed the real lending rates into negative, the demand for bank credit continued to increase and the banks’ asset profile further shifted from investments to loans and advances, thus constraining the banks’ liquidity profile. However, key financial soundness indicators and results of the stress testing exercise suggest that the system by and large maintained its satisfactory performance as well as the resilience towards the major risk factors. The report said that withdrawal of deposits was largely made up by increase in interbank borrowings.

However, on the asset side, loans of the banking system posted a strong increase of Rs 167 billion (5. 7 percent) while investment portfolio further shrank by Rs 94 billion. Resultantly, the liquidity profile of the banking system came under further pressure as the ADR (advances to deposit ratio) and liquid asset ratio further deteriorated and posed serious challenge of asset-liability management especially for banks operating with high ADR, it added. This situation was further compounded by a tight monetary policy that was in vogue, though later on relaxed during post quarter liquidity stress.

Net infection ratio and NPL coverage ratio slightly deteriorated to 1. 9 percent and 79 percent, respectively, which though still remain within acceptable and ameliorated level compared with the situation that was prevailing in corresponding quarter of last years. The pre-tax return on assets declined to 2. 0 percent (2. 3 percent in June-08 and 2. 2 percent in CY07). Incidentally, this slight fall in overall earning of the banking system has also to do with the exceptional losses posted by a couple of banks.

However the report said that though key financial indicators for the quarter under review indicate slight drop, by and large the banking system has maintained the momentum of satisfactory performance that it achieved during the recent years of strong economic growth. The indicators suggest that the system is well placed to maintain this momentum and is financially sound to withstand any plausible shocks in the key risk factors. The post quarter liquidity crunch, in particular, has signified the importance of prudent asset-liability management for the banks in tight monetary policy regime.

The SBP said that despite slowdown latest interim post-quarter statistics on key financials indicate that unlike established trends of strong growth, the asset base of the banking system is likely to remain stable during the last quarter of the outgoing year. The SBP took a number of measures, which are expected to facilitate the sound operations of the banking system and incentivize the banks to rationalise their asset-liability profile and further improve their risk management capacities.

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