Macroeconomic imbalances impact financial sector: SBP

KARACHI: State Bank of Pakistan (SBP), in its flagship annual publication titled "Financial Stability Review calendar year 2018" issued here on Thursday, said the macroeconomic imbalances impacted some segments of financial sector.

The review presents performance and risk assessment of various segments of the financial sector including banking, non-banking financial institutions, financial markets, exchange companies, non-financial corporate and financial market infrastructure.

In addition, it discussed the possible implications of the appraised risks to the overall stability of the financial sector.

It suggested that the calendar year 2018 had been a challenging year for the financial sector of Pakistan. The macroeconomic vulnerabilities emerging from twin deficits and elevated inflation level had necessitated the stabilization measures that had slowed down the pace of economic growth.

The financial markets, particularly, the forex and equity markets had trended downwards with increased volatility. Accordingly, the growth of the financial sector had moderated to 7.5 percent in the calendar year.

Similarly, the financial depth, as measured by financial assets to Gross Domestic Product, had subsided to 73 percent in calendar year 2018 from 74.5 percent a year earlier. However, the financial institutions and financial market infrastructure had largely remained resilient and performed steadily during the year under review.

Among the financial institutions, banking sector had remained resilient, with strong capital adequacy ratio of 16.2 percent—well above the minimum regulatory level of 11.9 percent and high fund-based liquidity. Among various factors, rise in rating culture in the corporate sector had facilitated enhancement in CAR.

The financial intermediation had improved with a rise in advances to deposit ratio to 55.8 percent, highest in the last eight years. Growing advances had helped reduce the gross loans to non-performing loans ratio, but other asset quality indicators had slightly deteriorated due to rise in the quantum of NPLs during calendar year 2018.

The banks had posted reasonable profits. However, higher provisioning expense along with rise in administrative cost and one-off extra ordinary expense had kept the profitability slightly below the last year's level.

Encouragingly, increase in the share of interest income from financing activity had improved the net interest margin , which had been falling for the last 3 years.

The FSR had also highlighted few challenges facing the banking sector. The deceleration in deposit growth that was continuing over the last few years might pose funding risk for asset expansion. The concentration of banks' exposure to public sector, though reduced due to net retirement in Pakistan Investment Bonds in calendar year 2018 remains significant.

Further, the risks related to anti-money laundering and combating the financing of terrorism (AML/CFT) and cyber security need continuous attention for mitigation. Encouragingly, resilience analysis indicated that the banking sector had the capacity to absorb adverse domestic and global stress in the medium-term.

The Islamic banking Institutions had maintained fast growth trajectory and now constituted 13.5 percent of the total banking sector assets. This growth was, primarily, driven by broad based financing activity to various economic sectors, with majority of financing extended under profit and loss sharing modes of Musharika and Diminishing Musharika.

While financial health of Islamic Banking Institutions remains sound, they continued to face dearth of Shariah compliant investment avenues that limit their ability to effectively manage their liquidity as well as mobilize deposits.

Due to higher volatility in the financial markets, risk averseness in equity market linked Non-Banking Financial Institutions  like Mutual Funds, had increased. It had led to contraction in assets under management and flight to safer money market instruments. On the other hand, financing based NBFIs, had observed growth and exhibited relatively better performance.

Nevertheless, to allow the NBFIs to facilitate financial deepening, FSR 2018 suggests that issues like the small size and limited outreach of the capital market, difficulty NBFIs face in mobilizing low cost funds and attracting quality human resources need to be addressed through development of an industry level strategy.

Similarly, the role of Development Finance Institutions in long-term project financing remains less than encouraging and progress on this front requires concerted efforts for mobilization of affordable long-term funding.

Insurance industry had witnessed higher asset growth due to reasonable increase in gross premium, though its profitability indicators have slid down owing to increase in net-claims. Moreover, the insurance penetration remains quite low, indicating sufficient room for expansion in this sector.

The review highlights that the Financial Market Infrastructures remained resilient and continue to perform efficiently without any major disruption.

Both large value and retail payments had registered an uptrend in volume and value of transactions. The increasing adoption of electronic modes for payment indicates growing consumer trust. Wider use of digital financial services is also facilitating in furthering the objective of Financial Inclusion, which was one of the key priority areas for SBP.

Particularly,  the branchless banking and m-wallet accounts have enabled access of financial services to the underserved areas of the country.

However, with an upsurge in technology-based financial services, cyber security threat had emerged as the key risk for FMIs. During calendar year 2018, the supervisory authorities have enhanced focus on this category of risk and have fortified the mitigation measures jointly in collaboration with the market players.

Commenting on the outlook of the financial sector, the Review highlights that the necessary stabilization measures may further slowdown the pace of economic activity. The external account imbalances and related uncertainties are likely to have repercussions for the financial markets.

The monetary tightening may affect the debt repayment capacity of the borrowers with some lag. Under the challenging macroeconomic environment, the corporate sector, which was already showing signs of slackness in its performance, may perform below its full potential. Therefore, the financial sector performance and stability will largely hinge on the improvement in macroeconomic conditions.

The successful implementation of IMF program was expected to foster macroeconomic and financial sector stability in the country.

The review highlights that SBP was aware of the emerging challenges to the financial sector and has taken appropriate steps, for its regulatees, to strengthen risk management practices and enhance stability.

Moreover, SBP, in line with its strategic goal of "strengthening the financial stability regime" was working in collaboration with other stakeholders for formulating and implementing a comprehensive and well-structured Macro-prudential Policy Framework to ensure the stability of the entire financial sector.