OPPORTUNITIES & CHALLENGES FOR THE BANKS
Jan 3 - 9, 2011
In contrast to the volatility in global financial markets since the inception of the GFC, financial markets in Pakistan have continued to strengthen primarily due to the low level of integration with global financial markets, and in response to the ongoing reform process, and provide requisite support to the financial system in performing its function of financial intermediation.
Specifically, the functioning of the money market in FY2010 gained strength from the ongoing policy measures and supported both the SBP monetary policy stance and financial sector stability. Although persistent increase in government borrowing from the banking system resulted in intermittent pressures on market liquidity during the year, robust deposit growth of the banking system partly offset the pressures.
The domestic foreign exchange market also benefited by strong growth in worker remittances, marginal increase in foreign investment flows, receipt of tranches of IMF loans and rising trade activities in FY10. As a result, country's overall reserves reached a level of US$ 16.9 billion by end-June FY10. These developments in turn allowed SBP to continue to liberalize the foreign exchange market. The most important measure on this front is the complete shifting of oil payments to the inter-bank market by December FY10. This policy shift was supportive in containing a further drain of SBP reserves. More encouragingly, the relative stability in the exchange rate during FY10, despite shifting of oil related payments, is primarily a reflection of the increasing depth of the inter-bank foreign exchange market.
Given the relatively gradual pace of implementation of capital market reforms, the equity market has not proved itself to be an avenue for raising funds and has operated more as a trading platform. Not surprisingly, the significant volatility seen in CY08 and subsequent gradual pace of recovery had little impact on financial stability, given its limited role in meeting the financing needs of the economy, and the bank-based structure of the financial sector.
The impact of the wealth effect however cannot be ignored, as indicated by the decline in value of investments in investors' accounts maintained with the Central Depository Company (CDC).
At the end of the day, an efficient financial system is one which is diversified, and in which all components function in meeting the financing needs of the economy. Not only does Pakistan's economy continue to have an undue reliance on the banking sector, the emergence of the government as the major user of bank credit has led to the crowding out of the private sector even as the economy is headed towards a gradual recovery.
In the current circumstances, while it may be prudent for banks to allocate their loan and investment portfolio in favor of public sector to maximize profits in the short run and minimize risks, a long term strategy requires an allocation of their portfolio in favor of the private sector, which is the main engine of growth and productivity.
At the moment, the flow of bank credit to the private sector remains hampered, and the basic objective of financial intermediation i.e. efficient allocation of resources, is not being met. A continuation of this trend, if not pre-empted and reversed on a priority basis, will negatively impact financial penetration and depth which is already at a low level.
GROWING NPLs CONCERNING BANKING SECTOR
The increasing concentration of loans to the power sector at 9.5 per cent of total loans as of end-June CY10 is an indicator of sectoral concentration. Notably, in periods of slow economic growth, banks prefer to lend to better performing economic sectors, and within these sectors, to strong corporate clients.
After the biggest ever increase in the stock of NPLs in the year 2008 alone the pace of deterioration in the quality of advances slowed down considerably in calendar year 2009, the Non-Performing Loans (NPLs) increased by 24.2 per cent to Rs432 billion by end-2009, and further by 6.4 per cent to Rs460 billion by end-June 2010.
Given the strong correlation of NPLs with economic activities, a major portion of the increase in NPLs since 2008 calendar year was primarily of a cyclical nature due to the deceleration in real GDP growth, with negative implications on incomes and hence the repayment capacity of the average borrower. The gradual process of economic recovery has had an impact in slowing down the accelerated pace of growth of NPLs in CY09.
Irrespective of the factors responsible for the rising volume of NPLs, the high infection ratio has implications for the overall financial performance of banks.
During CY 2009, banks booked Rs97 billion as loan loss expenses, lower than the amount of Rs106.1 billion booked in CY 2008. This slight reduction is in line with the decelerated growth of NPLs. However, these expenses carry implications for banks' profitability, especially when majority of the outstanding NPLs 65.5 per cent are categorized in the fully provided loss category. A substantial reduction in the proportion of initial categories in gross NPLs indicate that in CY2010, the provisioning requirement would fall, with a consequent positive impact on banks' bottom line.
The increased risk to the solvency position is also visible from the surge in the net NPLs to capital ratio of the banking system to 20.4 per cent, from 19.4 per cent in CY 2008, compared with only 5.6 per cent for CY2007. (AB)