CAUTIOUS INNOVATIONS MITIGATE RISKS
SAAD ANWAR HASHMI
Jan 23 - 29, 2012
Despite the economic downturn and growth rate having dropped to 2.4 percent last financial year, banking sector of Pakistan continues to rack up profits, and expand asset and deposit base.
According to the SBP Financial Stability Review, the total banking assets increased from Rs577 billion in FY10 to Rs7.7 trillion as of June 2011.
Deposit base was Rs6 trillion in June 2011, up 9.3 per cent over last year. The profit before tax of the banking sector in FY10 was Rs105 billion and recorded at Rs77 billion in 1HFY11. As of June 2011, equity in the banking sector was Rs722 billion. Banks also are maintaining a CAR of 14.1 percent, which is over and above the required threshold of 10 percent capital adequacy ratio (CAR) over risk weighted assets.
Return on assets (ROA) of the banking sector was recorded at 2.1 percent in FY11 compared to 1.8 percent in FY10 whereas return on equity (ROE) was recorded at 21.9 per cent in FY11 compared to 17.7 per cent in FY10.
Lending of banks in both consumer and corporate sectors was insignificant, where the current portfolio was managed to reduce NPLs and focus on asset quality.
Banks accumulated Rs31.4 billion in infected assets in 1HCY11 as compared to Rs27.8 billion during same period last year further pushing non-performing loan ratio (NPLR) from 14.7 percent in 1HCY10 to 15.3 percent in 1HCY11.
Overall, NPLs rose from Rs550 billion in CY10 to Rs580 billion in 1HCY11.
Further, lending has been largely curtailed where fresh advances are only provided based on more stringent and minimum risk acceptance requirements to ensure minimization of risk and maximize asset quality.
In order to place deposits unutilized through advances, investments in government backed securities increased which ensured a risk free return and profitability for the banks to further aid banking stability. Government securities account for 34 percent of banks assets in 1HFY11 compared with 28 percent in FY10.
Government papers offered a yield between 11.5 percent to 12 percent to assist banks in placement of residual income in risk free investments.
The government used such inflows to finance its deficits whereas commercial banks were guaranteed a high return without incurring any risk.
Banks lost their prime ability as financial intermediaries based on such market dynamics. Furthermore, this again discouraged banks for taking on excessive risk through conventional lending.
Though these investments do provide banks avenues to maintain their growth, government borrowing at such levels results in crowding out effect, which is witnessed year on year.
According to the SBP, domestic debt and liabilities (DDL) reached Rs6.8 trillion through three calendars auctions through Ijara Sukuk, Pakistan Investment Bond (PIBs) and Market Treasury Bills (MTBs). The federal government plans to borrow Rs675 billion from banking sector up to March 2012. Though such initiatives will assist the government in managing deficit, banks will participate in such auctions once again as a shift from conventional lending.
Another reason for financial sector stability and resilience of the banking sector is banking is coined as first generation banking, which means that banking carried out today is the banking which was carried out in western markets more than five decades ago.
In terms of financial innovation, Pakistan's banking environment both in terms of treasury, corporate, investment banking and retail product formulation and development has been viewed as follower of practices and products already implemented in western markets.
With low level of interconnectedness as compared to banks with global presence and prudence, Pakistani banks were shielded from investments, which resulted in subprime mortgage crisis.
Banks are conservative with low reliance on financial innovation as compared to westerns markets, though innovation in retail has been witnessed through launching of branchless, internet and mobile banking. Cautious lending and low tolerance to innovation have safeguarded banks from taking on unnecessary risks.
Another reason for high level of resilience in the banking sector is the supervision of SBP through various circulars, guidelines, and prudential regulations.
SBP collects information from banks frequently for reporting of exposures, infected portfolio, compliance, returns on Basel II, portfolio structuring and monitoring.
Banks are encouraged to upgrade their technology and ensure fictitious transactions are flagged to eliminate money laundering. Banks are pushed by SBP to increase geographic reach to remote towns and rural areas across the country extending products and services, specially through branchless banking which is seen as a big challenge since such geographic reach requires strategic planning and high investments in information technology offering remote banking services.
Current banking in Pakistan is not at par with western banks specially when it comes to financial innovation. However, it has many similarities from loan origination to identification and mitigation of risks associated with such lending.
The main challenge is to bank the unbanked so that parallel transactions in the economy can be recorded. Banks are actively striving to increase their geographic reach through alternate channel of distribution where an individual does not need to come to the branch.
Based on current market dynamics, banks are ensured guaranteed returns through investment in T-Bills, which should be discouraged since crowding out results in an increase in lending rate and less residual flow for retail and corporate lending. Financial innovations should be encouraged to provide a wider assortment of products to the borrowers.
No bank is likely to face bankruptcy through mergers and acquisitions, if it continues to meet SBP's requirement of maintaining minimum capital requirement (MCR) for taking on risk. Fixed income markets need to be developed for which the prerequisite is the stability in interest rates and long-term stability in inflation. Banks are expected to continue increasing its liability and asset base, and yield growth through FY12.