TARIQ AHMED SAEEDI (tariqsaeedi@hotmail.com)
June 8 - 14, 2009

On all public forums, Governor State Bank of Pakistan Salim Raza used to reiterate potentials of Pakistan banking sector and flagged resilience of the sector in the face of flurry of activities in the global financial system for substantiating his claim. Not so wrong he has been for despite freefall in growth rate of international banking system, Pakistan continued to witness growing albeit slowly bank assets. That whether or not this forward move would persist depends on the positive macroeconomic fundamentals. The economic slowdown and domestic security issues may dampen the growth of the banking system in coming quarters, according to quarterly performance review of banking system for March 2009.

It sees continuation of high credit risk and more shift of assets mix towards government papers due to low demand of banks' advances. It however expects profitable banking business but this would variable for different banks. The review warns that banks have to enhance deposits that remained insignificant during the quarter. Liquidity profile of banking system in this period was strong because of the low disbursal of advances. Reversal is however not in store even with 2.5 or 3 percent or below growth envisaged for the next fiscal year. Under the growth forecast by the central bank for this financial year that is 2-3 percent assets of banks grew upward though economic recession decreased the pace of the banking sector.

By 1.6 percent or Rs 91 billion, assets of banking sector grew during the third quarter ended March this fiscal year as against 1.3 percent in the comparable period last fiscal year. Due to mounting non-performing loans and subsequent credit risks, banks kept loans portfolio low-key and increased exposure to investments in government securities. NPLs increased by 21 percent over the quarter. However, the rate of increase was not similar for all banks, and indeed some of them posted heightened NPLs. This might have underpinned the growth of assets. Additionally, this shift reduced the value of risk-weighted assets and elevated capital adequacy ratio to 12.9 percent in contrast to 12.2 percent in end 08.

Highlighting the reasons of escape of banks' earning from high infection ratio, the review said earning of banking system was unaffected because additional provisioning requirements were recognized in retained earnings through audited accounts for calendar year 08. Besides, most of the NPLs were recorded in doubtful category that requires partial provisioning coverage. The banks earned a staggering profit before tax of Rs26.2 billion during the quarter while it posted in the account only Rs10.5 billion in preceding quarter ended December 08.

Even foreign banks that witnessed profits downturn in CY08 saw takeoff in profitability. High interest and non-interest earnings and rationalization of administrative expenditures helped banks to enjoy profits despite constraining factors, illustrated the analysis of the banking system. More than dividend a significant increase in net interest income was recorded over the quarter, it underscored. Extraordinary widening of gap (spread) in lending and deposit rates of 7.24 percent offset the impact of diminishing advances.

During the period under review, deposits base of banks expanded with a diminutive percentage point. Deposits registered insignificant increase of Rs1 billion during the quarter, reaching to Rs4,218 billion. According to the report, the slowdown was caused by investors' inclination towards high return instruments of national saving. Investment in CDNS jumped up by 11 percent to Rs124 billion in the quarter.

In this quarter, while advances growth declined by 5.6 percent, yet investment in government papers increased by 20 percent (Rs216 billion) as against 6.8 percent in the corresponding period. The share of advances in total assets decreased to 52.6 percent as compared to 56.6 percent in December 08 and that of investment increased to 22.6 percent over 19.1 percent. The review noted that this decline was a result of banks' realignment of their risk profile.

During the quarter under review lending to both public and private sector dropped. All sectors that include corporate, SMEs, agriculture, consumer, agriculture, and commodity operations reduced borrowings from banks. Working capital finance-largest shareholder of advances and loans-contributed substantially in the decline. Following a declining trend since the last quarter of CY07, investment set off in the last quarter when it inched up by 5.2 percent. The investment portfolio-second largest component of assets base-gained size further in the wake of credit risks.

Equity investments of banks increased by 20.7 percent (Rs9.6 billion) in this quarter. Only five large banks grab major chunks of market share. These banks hold over 51 percent of total banking assets. After the arrival of medium and small sized banks, redistribution of market shares occurred. However, good liquidity profiles of large banks maintain their dominant positions in the market. The review underlines the urgency for banks to design operational risk management framework based on the key risk indicators. Variable in business line, complications in technology, openness of banking system to external environment, increasing risks of forgery and frauds, and global financial meltdown require the system to develop protective shield to withstand risks of deteriorating assets quality that poses serious threat to solvency of the system.

At the end of the quarter under review, growth of assets of Islamic banks stayed at 0.7 percent to Rs278 billion. Islamic banking industry witnessed slowdown in its growth rate in comparison to its previous performance. The industry depicted an average annual growth rate of 37 percent since 2002. Noticeably, deposits remained the domineering component of funding structure of Islamic banking. Gradually growing, deposits peaked by 2.3 percent to Rs206.2 billion during the quarter. Like conventional system, financing of IBs decreased and investments increased. Overall banking system continues to face challenges of mobilizing deposits, heightened credit risks, and managing quality of assets in coming quarters, but outlook for earning is still bright, the review says.



The inclusion of Pakistan stock market in the Dow Jones is certainly an interesting development to hold symbolic significance as it marks another step towards Pakistan re-emergence on the international financial scene.

The Karachi Stock Exchange would now be appearing in international indices launched by Dow Jones and the Federation of Euro-Asian Stock Exchanges which is likely to brighten the atmosphere by attracting foreign funds in the days to come.

The Dow Jones Index and the Federation of Euro-Asian Stock Exchanges (FEAS) plan are ready to be launched by the Dow Jones-FEAS Composite Index (Friday) on 5th June.

It is believed that Pakistan would be the fourth largest market in the index with 70 stocks and combined weight of 9.27%, however the top 10 stocks in the index do not include any Pakistan stock.

It may be recalled that Pakistan markets had experienced a phase of obscurity due to the floor imposition in Aug-08, following which Pakistan was excluded from MSCI Emerging Markets Index in the Dec-08. Consequently, there was a net outflow of funds estimated at US$286million which, however, can be attributed to removal of the floor on Dec 15th and, selling pressure or exclusion from MSCI EM.

However Pakistan has staged a gradual comeback on the international front when it was included in the MSCI Frontier Markets Index, since then the gross inflow numbers of foreign funds have raised in April and May.

Though the real impact of the DJ-FEAS index on the KSE, in terms of foreign flows, will take time to materialize, it will pave the way for foreign inflows as the DJ-FEAS Composite is a hybrid of emerging and frontier markets, while in the backdrop of the shift in global investment trends during last 12 months, frontier markets as an asset class remain less in vogue when compared to emerging markets. Hence the real upside case for foreign flows is inclusion of Pakistan in indices.