Dec 12 - 18, 20

The assets of Pakistan's banking system soared eight per cent or Rs577 billion to Rs7.7 trillion during the first half of calendar year 2011 (January-June, 2011).

The financial stability review (FSR) by the State Bank of Pakistan said that this surge in banks' total assets, both in absolute and growth terms, was the most significant since 2007.

Deposits rose 9.4 per cent registering the highest half-yearly growth during the last four years, it said, adding that net investments, with an increase of 22.4 per cent during the first half of 2011, markedly outpaced the anemic growth of 1.04 per cent in net advances.

The review said that banks' profits before tax were up by 31 per cent during the first half of 2011 to reach Rs77 billion, with return on assets (ROA) of 2.1 per cent (1.8 per cent in June-10) and return on equity (ROE) of 21.9 per cent (17.7 per cent in June-10).

During Jan-June 2011, banks remained liquid on the back of growing share of investments in government papers, it said, adding that further, banks' capital adequacy ratio also observed improvement, reaching 14.1 per cent by June-2011.

The concentration in profits of the five big banks also dropped from 95 per cent in Dec-10 to 78 per cent in June-2011, ensuring that even smaller banks have a share, albeit marginal, in industry profits. Further, growing profits also helped reduce the number of loss making banks, from 17 in June-10 to eight in June-11,' it said.

However, the review cautioned that source of profits is shifting away from interest income through advances to investments in government papers. Specifically, returns from investments in government papers now account for almost 30 per cent of banks' interest income, up from 24 per cent in June-2010, it added.

This suggests that growth in government borrowings has shored up banks' earnings, the review said and added that this trend is neither desirable nor sustainable, first because it compromises intermediation function and second as any sharp cut in discount rate can discernibly affect banks' profits.

The review stressed that there has been growing evidence of banks' flight towards quality as net investments, mainly in government securities, now constitute around 34 per cent of banks' assets compared with 28 per cent in June 2010.

'The share of net advances witnessed a concomitant drop, from 47.6 to 43.9 per cent during the same period,' it said and added that unsurprisingly, advances-to-deposits ratio further dropped from 63 per cent in June, 2010 to 56.7 per cent by June 2011.

According to the review, while government's reliance on the banking sector heightens the concerns about private sector crowding out, poor credit off-take by the private sector has other causes as well that include severe energy crises and challenging economic environment.

Credit risk remained a major challenge as banks accumulated Rs31 billion of fresh non-performing loans, pushing infection ratio from 14.7 per cent to 15.3 per cent, the review said and added that public sector commercial banks and mid-sized local private banks appear more vulnerable to higher credit risk. However, going forward, the results of the stress tests showed that the banking system is resilient to shocks emanating from a challenging macroeconomic and business environment, it observed.

Islamic banking institutions (IBIs) registered 17.5 per cent growth during H1CY11, with bulk of incremental assets channeled into government securities. Islamic banks appear more liquid, solvent, and profitable when compared with rest of the banking sector but face unique risks like reputational risk and displaced commercial risk.

Referring to other components of the financial system, the review said that domestic financial markets remained stable during the half year under review, despite some bouts of mild strain. External inflows kept the value of domestic currency almost stable, as PKR depreciated by a marginal (0.35 per cent) against the dollar. The capital market managed to post a growth of four per cent during the half year under review.

During the period under review, the asset base of the development finance institutions (DFIs) managed to grow marginally by four per cent primarily on account of stronger growth in investments. 'Share of advances in total assets remained intact (around 35 per cent), though at significantly lower level than what DFIs' nature of business would warrant,' it added.

However, the trading volumes and activities in the corporate debt market largely remained low. The derivatives market, on the other hand, shrank further as insipid credit to private sector coupled with stable exchange rate and interest rate environment dampened the demand for new derivative contracts.

In contrast, the mutual funds industry witnessed its revival as the money market investments improved the net assets of the industry by 24 per cent in H1CY11.

'The insurance industry witnessed a growth of 16.6 per cent in its asset base with the life business experienced a much strong growth (24 per cent).

The payment systems functioned smoothly, with amount transacted through retail payment system growing by 14 per cent (YoY) against 11.6 per cent in the corresponding period last year.

In terms of volume, share of e-banking transactions gained momentum, reaching 42 per cent by June-11.

In the area of branchless banking, Pakistan is experiencing a rapid expansion, with four banks offering services through various operational setups. As more banks are planning to enter this growing segment, there is strong potential to significantly improve financial inclusion in the years ahead.

While discussing the future outlook, the FSR said that a mild pickup in private sector credit is likely as the borrowing cycle of some key industries resumes, though receding commodity prices would keep the growth in check.

Further, the challenging business environment in general and banks' risk aversion amid high credit risk would limit the possibility of a perceptible reversal in asset mix away from the government papers, it said.

'The current monetary policy stance would make banks' asset selection challenging in the months ahead; banks will either have to live with lower returns on their investments (a key contribution to profits in recent times) or to aim for greater private sector credit, which in a difficult economic environment, would truly test their ability to adroitly manage an already high credit risk,' the review added.