BANKING SECTOR REFORMS VITAL FOR SUSTAINABLE GROWTH

SUMAIR SIRAJ
(feedback@pgeconomist.com)

Jan 16 - 22, 20
12

According to the State Bank of Pakistan's recently published 10-year strategy paper for banking sector reforms, a growing and dynamic banking sector is essential for economic growth in Pakistan, as affordable and easy access to credit would encourage a greater level of private sector investment and consumption, which in turn, would boost economic activity and lead to a greater level of employment creation.

BANK DEPOSITS, ADVANCES AND NET PROFIT

YEAR DEPOSITS (RS. BLN) ADVANCES (RS. BLN) NET PROFIT (RS. BLN)
2005 2,832 1,991 63.3
2006 3,255 2,428 81.9
2007 3,854 2,688 73.1
2008 4,217 3,183 43.3
2009 4,786 3,240 54.4
Source:Economic Survey of Pakistan,2010-11;Financial Stability Review, 2009-10

Indeed, without a progressive and dynamic banking sector, availability and access to affordable credit would not be possible due to which consumers and businesses would not be able to finance their monetary needs. This would lead to a spiraling effect in the opposite direction, resulting in spending levels declining, a reduction in economic output, and an increase in unemployment levels.

Is the banking sector dynamic and growing? Pakistan's banking sector growth in recent years, in terms of deposit creation, lending, and profitability, has been impressive. During the period 2005-09, deposits grew at an annual average rate of 14 per cent, from Rs2,832 billion in CY'05 to Rs4,786 in CY'09 (CY: calendar year). Advances increased from Rs1,991 billion in CY'05 to Rs3,240 billion in CY'09 with an annual average growth rate of 13 per cent. The banking sector profit-after-tax as of CY'09 was Rs54 billion.

FINANCIAL SECTOR AND BANKING SECTOR ASSETS

YEAR FINANCIAL SECTOR ASSETS (RS. BLN) BANK ASSETS (RS. BLN) BANK ASSETS AS A % OF FINANCIAL ASSETS
2001 3,042.7 1,941.2 63.8
2002 3,417.7 2,221.5 65
2003 3,943.7 2,543.7 64.5
2004 4,518.3 3,040.8 67.3
2005 5,201.5 3,661.9 70.4
2006 5,957.5 4,283.4 71.9
2007 7,115.2 5,172.8 72.7
2008 7,646.6 5,627.0 72.1
2009 7,125.8 6,515.0 91.4
Source: Financial Stability Review 2007-08

Improvements in banking sector profitability are also reflected in trading activity of banking sector shares in the stock market. The trading volume of banking companies' shares at the Karachi Stock Exchange (KSE) grew at an average of 34 per cent during the period FY'00 to FY'10, with the highest trading volume of 161 million shares in FY'07 (FY: fiscal year).

The contribution of the banking sector in total trading volume increased from three per cent in FY'00 to an impressive 46 per cent in FY'10. On average, 25 per cent of the total trading activity, during the FY'00 to FY'10 period was generated through trading in shares of banking companies.

The bank assets-to-financial assets ratio shows the contribution of banks to overall financial sector services and is an indicator of the banks' capacity to mobilize funds and create credit.

The bank assets-to-financial assets ratio grew from 64 per cent in 2001 to 91 per cent in 2009, indicating that banks have played a greater role in mobilizing savings in Pakistan in recent years.

Although the banking sector has grown, with improvements in the deposit base and profitability, the banking sector's financial depth has remained stagnant, which signifies that the rate of financial sector development in the country is very slow.

Financial depth shows the extent of penetration of banks in the economic system. It is a ratio of bank assets-to-total GDP, and a measure of the banks' ability to provide credit and financial services to the private sector.

CONTRIBUTION TO GDP (%)

YEAR FINANCIAL SECTOR ASSETS BANK ASSETS
2001 70.2 44.8
2002 73.3 47.7
2003 75 48.3
2004 74.4 50.1
2005 73.7 51.8
2006 72.9 52.4
2007 74.1 53.9
2008 73.3 52.6
2009 72.0 47.4
Source: Financial Stability Review 2007-08 and 2009-10

A lower level of financial depth means that the banks do not have the capacity to lend to all potential borrowers in need of financing. Inadequate levels of credit availability result in businesses forgoing investments in the form of plant expansions and purchases of machinery, equipment, and inventory, eventually leading to a loss of economic output. Bank assets as a percentage of GDP declined from 54 per cent in CY'07 to 47 per cent in CY'09, indicating that financial deepening has slowed down in recent years.

In conclusion, Pakistan's banking sector has grown in recent years but lacks depth. Improvements in banking sector profitability and a wider deposit base cannot ensure sustainable economic growth without an adequate level of financial deepening in the banking system. Apart from financial depth, the State Bank of Pakistan's strategy paper has also identified the need for financial safety nets, proper supervision of banks, and greater financial access.

Since the banking sector plays a vital role in stimulating economic activity, far-sighted and meaningful reforms, intended at improving the availability of and access to financial credit, need to be taken to ensure sustainable economic growth in years to come. The State Bank of Pakistan's 10-year strategy paper on the banking sector identifies such reforms.

The writer teaches Economics and Finance at SZABIST.