Mar 8 - 14, 2010

Reportedly growth in deposits has remained subdued mainly due to rate of return which does not commensurate with the inflation rate. Banks also attribute sluggish growth in deposits to higher rates being offered by Central Directorate of National Savings. It may be partly true but bulk of the investment in its schemes comes from those who do not use bank services.

The best review of the banking system comes from periodical reports of the central bank, latest being the quarter ended September 30, 2009.

According to a banking sector analyst, bulk of the deposits still remain with 'big five' who are neither interested in mobilizing more deposits nor lending. Since their cost of funds is very low they prefer to invest in market treasury bills and Pakistan Investment Bonds. However, the exceptionally high exposure in equities market is a point of concern because lately equities market has remained under pressure.

Some of the financial institutions also ventured into Sukuk but experience is disappointing. Many of the companies issuing Sukuk have defaulted and are seeking restructuring. It may not be wrong to say that Shariah compliance was looked at only and hardly any attention was paid of the financial conditions of the issuer.

Deposits of the banking system declined marginally by 1.7% during the quarter. Disaggregated analysis of the deposits shows that over the quarter decline was largely contributed by financial institutions deposits and current accounts. However, the overall composition of deposits remained more or less stable at previous quarter's level.

Banks made good the decline in deposits through borrowings which increased by 11% by the end of quarter. However, the internal composition of borrowings changed from unsecured to secured borrowings as the increased level of GoP papers allowed the banks to replace their unsecured borrowings with secured ones. The buildup of year to date profits, capital injections by a few banks for meeting the minimum capital requirements (MCR), and improvements in revaluation surpluses led to a stronger increase in shareholders' equity and net worth. Accordingly, the leverage of the system slightly came off.

Advances of the banking system declined slightly during the quarter under review. Unlike last quarter's strong growth in public sector advances, the decline was observed both in public and private sector advances. Due to low aggregate demand in the economy as well as abroad, high borrowing costs on account of tight monetary policy, unresolved political and security issues, and the heightened credit risk in the economy, banks' lending to private sector reduced significantly. This reduction has been mainly taken up by public sector enterprises and commodity operations. Though aggregate advances showed reduction during the quarter under review, dynamics of different components and end-uses of advances show some instructive trends. The corporate sector, specifically the private sector corporations in energy & power sector, has in fact increased the bank borrowings while reduction in overall advances portfolio mainly came from small and medium enterprises and consumer finance. Accordingly, the segment-wise composition of advance with slight change remained dominated by corporate sector. The end-use analysis of advances shows that reduction in advances mainly occurred in working capital finance, while fixed investments and trade finance showed increase. This development indicates some revival in the entrepreneurs' confidence in the economy. Moreover, the reduction in working capital in itself could be traced to the reduction in commodity prices.

Investments, particularly the investment in government papers and bonds of public sector utility corporations, have been attracting increased preference of banks since the last quarter of CY08. During the quarter under review, the investments again posted a strong increase of over 13% mainly in the government papers followed by bonds of public utilities and a marginal increase in equity investments. The further breakup of GoP papers indicates that short-term market treasury bills were the focus of banks' preference. The level of longer term Pakistan investment bonds, which are subject to higher market risk and carry limited eligibility for the statutory liquidity reserve requirement, remained stable. However, banks ability to ensure smooth flow of credit to productive sectors of the economy and build up their portfolio of earning assets remained largely dependent on their ability to mobilize additional deposits and divert assets from liquid assets to loans and advances.

The asset quality of the banking system further deteriorated during the quarter. Owing to a number of factors including the continuous recessionary trends, poor law and order situation, energy shortfall and uncertain external environment, the system has been experiencing a consistent and significant increase in NPLs for quite some time. Since there was a reduction in overall lending portfolio of banks, the infection ratio (NPLs to loans) of the system further inched up.

The group wise analysis shows decline in advances of all groups except specialized banks. Foreign banks' portfolio in relative terms witnessed the most significant decline. However, the relative share of different groups in the overall loan portfolio remained stable. Similarly, the reduction in loans and advances was prevalent in all banks, irrespective of their size.

The decrease in lending is shared both by private and public sector. Advances to private sector continued its declining trend. However, there was a marginal decline of one percent in public sector lending, which is contrary to last quarter growth of nearly 68%. The declining trend in lending to private sector can be associated with a combination of higher financing costs, the risk aversion by banks and attractiveness of risk free avenues of government papers, bonds of and lending to public sector enterprises. However, the composition of public sector and private sector advances in overall mix showed negligible changes on QoQ basis. Domestic and foreign composition of advances shows that the decline in overall advances has been somewhat neutralized by a healthy increase of over 16% in foreign advances.

Outlook of the commercial banking sector is highly dependent on the performance of the economy. Forecast of less than 3% growth of GDP, persistent load shedding of electricity and gas and investors' shyness do not bode well for the sector. Growing NPLs will also continue to haunt the bankers.