Dec 21 - 27, 2009

Pakistan's banking sector attracted substantial inflows of foreign capital and remained the fastest growing sector until the beginning of global financial meltdown. Since then it has slipped into troubled waters mainly because of piling up of Non Performing Loans (NPLs). The relatively disproportionate contribution of the finance and banking sector to the overall GDP growth was due to 30% yearly growth in the net domestic credit or lending during FY2004-06.

With the monetary tightening the banking sector assets' growth slowed down to only 2-3% in real or inflation-adjusted terms. According to available statistics, deposits of commercial banks increased to Rs 4.162 trillion by end-September, 2009 showing a Y-o-Y growth of 10.0%, better than the growth of 9.15% a year before. But, the growth is comparatively much less than the average growth of 18.5% between 2002 and 2007. But the imminent slowdown in economic activities is continuously hampering the growth rate of the banking system.

As a matter of fact the key asset quality indicators have exhibited a significant deterioration so far during the year 2009. The asset mix has witnessed a significant shift from advances to investments in government papers and government guaranteed debt securities that are relatively risk free and liquid. Resultantly, the liquidity profile has slightly improved.

The heightened credit risk transpired in significant increase in NPLs. However, in the face of constraining factors, the banking system earned before tax profit of Rs 26.2 billion for the Jan-March, 2009 that was higher compared with Rs10.5 billion in previous quarter, though lower than corresponding quarter of 2008.

According to an analysis, average deposit rate of 6.3% in September 2009 has decreased by 150 bps, from 7.8 per cent during the corresponding month of last year. Slow down in economic growth, double digit inflation during last 15 months, and prevailing uncertainty in law and order situation and war on terrorism are additional factors contributing towards slow growth of deposits. It is pertinent to observe that the banks have remained oblivious to increasing deposit rates, despite repeated assertion made by the previous governors of the SBP.

It is interesting to note that whereas average deposit rate during one year period between September, 2008 and 2009 decreased by 150 bps, the lending rate decreased by 0.1% during the same period from 13.8% to 13.7%. Bankers have argued that fall in deposit rates is justified because of cut in interest rates by the SBP by 200 bps during the past nine months.

Consequently, bank spread has increased to 7.4%, near to its previous level of more than 7 %. It is perhaps one of the highest in the world to the great disadvantage of customers. It clearly reflects that the banking sector has acted to make up for its falling incomes.


1- Growing non-performing loans have been translated into a noticeable addition in Net NPLs. The infection ratio of corporate sector, having highest exposure in overall portfolios, is worsening. Imprudent lending practices particularly in the realm of consumer financing have also played havoc in banking sector. The curtailed repayment capacity of the borrower due to static economic conditions, non conducive business climate caused by frequent power outages, deteriorating law and order condition and instability, also resulted in a significant increase in NPLs.

In the wake of increased credit risk due to busted macroeconomic fundamentals and slowdown in economic activities, banks are re-profiling their asset mix away from loans and advances to less riskier investments. The SBP's monetary policy also looks unsuccessful in controlling resurgence of a potential default culture and mounting non performing loans (NPL's).

In six months only (July-Dec-08) net NPL's of commercial banks and DFI's increased by Rs83 billion. The banks booked provisions of Rs 14.8 billion during first quarter 2009 in their profit and loss accounts versus Rs 12.8 billion in the same quarter of last year when FSV benefit was not allowed. This shows how much the situation has deteriorated in the last one year in the banking industry.

2- The growth rate of the banking sector achieved during last few years is not sustainable because high rate was mainly attributable to low rate of returns to depositors, high banking spread and huge loan - loss provisions.

3- Banking sector is facing an intermediate level liquidity crunch since last couple of years. Dire liquidity situation has cropped up because of low growth of deposits and slackness in private sector's credit, owing to high interest rates and stringent credit policies of the banks. Primary reason for reduction in deposits is low interest rates on deposits offered by the banks. Inordinate commercial borrowing by the government to meet its fiscal and energy sector needs has also badly affected the liquidity of banks. Hefty remittances from abroad have also discontinued for an indefinite period. The present rate of domestic savings is just not enough for sustaining the GDP growth rate of even 6%. To increase the rate of savings, the policies of banking sector will have to be restructured which would significantly reduce its profitability.

4- Myopic views of policy makers have also damaged banking sector when banks' main focus has remained on making high profits. The very purpose of financing risk-prone sectors of the economy and to make long-term investments such as development of the country's physical infrastructure, has slightly been touched.

The proportion of advances to SME, agriculture and other development project finance is very meager and inadequate. The structural deficiencies are to be removed in order to reach out to many potential depositors and to expand portfolios in development finance.