Banking sector developments

A stable and sound banking sector is the cornerstone of a vibrant economy. Thankfully, its performance continues to be satisfactory in Pakistan. According to the latest quarterly report released by the State Bank on 7th December, 2016, solvency profile of the banking sector strengthened further during the third quarter (July-September) of CY16 as Capital Adequacy Ratio (CAR) improved to 16.8 percent at the end of September, 2016 from 16.1 percent as of end-June, 2016, which was well above the minimum requirement of 10.25 percent in Pakistan and international benchmark of 8.625 percent. Asset quality of the sector, nonetheless, deteriorated slightly and assets of banks declined by 1.6 percent to Rs 15.134 trillion during the quarter July-September, 2016 compared to a rise of 2.1 percent in the corresponding quarter last year. The dip in assets was driven by a decline in advances to the private sector and a reduction in banks' investments in government securities. On the funding side, while deposits grew nominally by 0.6 percent, borrowings from financial institutions, mostly from the SBP, witnessed a decline of 12.7 percent. The fall in advances was due to net retirement on account of commodity operations and private sector, especially textile, sugar, cement, agribusiness and chemical and pharmaceutical sectors. Investments fell by 2.5 percent to Rs 7.625 trillion due to shifting of government borrowings from commercial banks to SBP. The investments to deposit ratio stood at 69.2 percent as of end September, 2016 compared with 71.4 percent a year earlier.
As expected, profitability of the banking sector continued to deteriorate due to a depressed interest rate structure. Profit after tax of banks stood at Rs 139 billion during the first nine months of CY16 as compared to Rs 148 billion in the corresponding period of 2015. Return on assets of banking sector also shrank to 2.1 percent during July-September, 2016 compared to 2.2 percent in the previous quarter and 2.6 percent in January-September, 2015. The ratio of NPLs to gross advances inched up by 20 basis points (bps) to 11.3 percent but the coverage ratio improved by 30 bps to 82.7 percent at the close of September, 2016.
The latest quarterly report on the banking sector is a clear manifestation of the fact that though some of the indicators like a rise in advances to PSEs, government's increasing deficit financing by resort to SBP, a slower private sector credit growth and depressed deposit rates may not be to our liking due to their likely negative impact on economy but the overall health of the banking sector continues to be strong. CAR of the banking system is much higher than the minimum limit prescribed by the SBP or international benchmark while NPLs, coverage ratio and provision for NPLs remain within satisfactory limits. This clearly shows that there is no threat of insolvency and saving units of the country could deposit their savings with the banks with full confidence. Such an unassailable position of banks would help maximise the channelization of financial resources through the formal financial system for investment and growth. Although the level of NPLs has increased slightly, it is still very much within manageable limits as coverage ratio of NPLs is quite satisfactory. The stagnation of assets and liabilities during the quarter July-September, 2016 reflects the seasonal behaviour of deposits and advances rather than some other problem in economy or the banking sector. Return on assets has declined somewhat but is still at a level which would continue to attract savers, entrepreneurs and top managers in the sector. Overall, the latest quarterly report indicates very clearly that stability and resilience of the banking system remains comfortable and its solvency profile is quite strong. However, the slowdown in profitability could impact certain areas negatively. Obviously, it could hamper banks' ability to plough back profits and support the capital base, putting a downward pressure on the banks' CAR. Besides, the spread between lending and deposit rates is shrinking in the wake of easy monetary conditions. Deposit rates for the savers are also on the decline. These factors may affect the behaviour of banks, their depositors and borrowers but cannot pose a serious threat to the solvency and management of the banks. The SBP has increased the CAR for banks to 10.65 percent with effect from the last day of the current calendar year. Given the strong solvency position of the banking sector, such a change is not going to make much difference insofar as the health of financial institutions is concerned.