Fitch Ratings on Thursday said that the Pakistani banking system has, over the last decade, gradually evolved from a weak state-owned system to a slightly healthier and active private sector driven system.
The agency notes in an upcoming special report that the private sector controls nearly 80 percent of the system assets, as opposed to the early 1990s when 90 percent of the system assets were controlled by the government.
The Pakistani banking system is made of 53 banks, which includes 30 commercial banks, four specialised banks, six Islamic banks, seven development financial institutions and six micro-finance banks.
The four largest commercial banks account for 44.2 percent of system assets, while eight second-tier banks account for a further 35 percent indicating moderate concentration.
The system grew at a compounded annual growth rate (CAGR) of 17.8 percent between FYE 01 and FYE 06, supported by relatively strong growth in the domestic economy, with the underlying liability growth driven by both an influx of private and institutional capital, as well as inter-governmental receipts.
Loans too grew at a strong CAGR of 24.2 percent during the same period, before slowing down to only 2 percent. During the first nine months of 2007 (9M07) there was greater political uncertainty, which in turn affected economic sentiment. Fitch notes that Pakistan's banks have historically enjoyed low cost of funds as a result of their large low cost deposit base resulting in some banks enjoying interest spreads of around 7.5 percent -8.5 percent.
Asset quality which constrained banks' performance in the 1990s has since improved with the reported gross NPL ratio declining to 7.7 percent at end-9M07, from a staggering 23.5 percent at FYE00. Capitalisation as measured by the reported equity to total assets ratio improved sharply to 10.2 percent at end-9M07 from 4.5 percent at FYE00 due to greater earnings retention and new equity infusions.
This in Fitch's opinion is a more satisfactory level of capitalisation considering the inherent risks embedded in the Pakistani economy. The larger banks have all undergone restructuring exercises from time to time, which included loan book clean-ups, strengthening of risk management functions, equity infusions, and streamlining of operations.
The beneficial impact of all these is evident in the ROAs, which in 9M07 stood at 2.0 percent compared to a dismal negative 1.2 percent in FY97. Implementation of the standardised approach of Basel II commenced in January 2008 and the State Bank of Pakistan, based on its computations, expects this to lower the banking system capital adequacy ratios (CAR) by about 200bps. At end-9M07 the total CAR of the commercial banking system was 14.2 percent, above the regulatory minimum of 8 percent.
Fitch further notes that the 1-iberalised environment of the past few years drove M&A activity in the banking sector, resulting in 36 transactions between FY01-FY07. Such M&A activity may continue provided there is political stability. Likely players would include foreign banks seeking a footprint in Pakistan or a consolidation among smaller local banks, where the process may be shareholder driven.
The bigger banks are unlikely to pursue an aggressive deposit/asset growth strategy, especially in the backdrop of the current political environment. They are more likely to focus on consolidating their existing position and enjoying the high interest spreads, which the agency believes could prevail at least in the short term. Fitch notes that the resolution of the current volatile political environment and its likely impact on the economy would be a key driver that determines the fortunes of the Pakistan banking system.
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