Financial Stability Review 2006

The Financial Stability Review (FSR), released by the State Bank of Pakistan on 17th December, 2007, gives a candid perspective and provides an in-depth and exhaustive overview of the financial institutions and markets. Discussing the global markets, it says that in the recent past world economy has enjoyed good economic growth and increasing depth in financial markets, accompanied by significant financial innovation.
This growth was accompanied by favourable economic indicators and relatively benign inflation under the watchful eyes of more independent central banks around the world. However, low risk premia, an easy access to finance, rising oil and commodity prices and continuing global imbalances remained significant risk factors for the sustainability of economic growth. The first signs of current market turmoil appeared in February-March, 2007 and assumed serious proportions from mid-July, 2007 onward when the impact of credit squeeze on financial markets was felt by the central banks and market participants around the world.
Pakistan's progressive and dynamic financial sector, according to the FSR, has witnessed a tremendous growth due mainly to the reform process undertaken by the authorities. Its overall size grew by 32 percent or almost Rs 900 billion to reach a new peak of Rs 6.9 trillion by June, 2007. Banks with a share of 72 percent in total assets continue to dominate the asset base of the financial sector.
Some 17 percent yearly increase in assets pushed up the overall size of the banking sector to Rs 4.3 trillion by the end of 2006, which further increased to Rs 5 trillion by the close of June, 2007. The reform process is paving the way for a more diversified financial sector, equipped to facilitate the economic growth of the country. The outreach of the financial sector, albeit slow, continues to gain ground with the expanding network of commercial banks, microfinance institutions and Islamic banks in all parts of the country.
Banks have also made inroads into the previously under-served segments which is evident in the rise in the credit shares of SMEs, agriculture and consumer finance. In addition, the process of gradual shift towards fixed deposits has already started, as evidenced by the narrowing of banking spreads.
However, the State Bank is not oblivious to the weaknesses still existing in the system. The FSR emphasises that since Pakistan continues to be categorised among low savers of the world, the financial system now needs to focus on providing innovative liability products to give the investors and savers more options to choose from according to their risk/return preferences.
In this context, the role of Private Pension Schemes is particularly important as an incentive to smooth out consumption patterns over the life-cycle, by providing a forced saving mechanism aimed at overall social security. The FSR also shows concern about the rising level of non-performing loans (NPLs). Banking sector wrote off loans worth Rs 42.5 billion during 2006 as compared to Rs 17.1 billion during 2005. There was a fresh inflow of Rs 49 billion of NPLs in the first six months of 2007, the highest level since 2004.
Spread over 184 pages, the FSR gives a detailed account of the financial sector of the country, with particular reference to the recent developments which have taken place in response to the changes on the domestic and international financial horizon. After going through the document, one certainly feels satisfied about the progress of Pakistan's financial sector which has improved a lot in terms of coverage, sophistication and product development during the recent years.
In our view, such a healthy outcome was not possible without granting autonomy to the State Bank. The autonomous status certainly enabled it to initiate a major reform process under which the SBP liberalised the financial sector and restructured its own organisation to meet the new challenges. Fortunately, our financial sector has also remained immune to the crisis emanating from sub-prime lending almost all over the world due probably to the difference in the nature of collaterals for the security of loans. A vibrant and healthy financial sector definitely adds to the saving and investment potential of the country which spurs industrial activity and growth.
The observations of the SBP suggest that it is not very much satisfied with the current status in this regard and would like to devise more innovative ways to mobilise a higher level of savings to be channelised into productive investment. The State Bank is also concerned about the present high level of NPLs and the writing-off of loans. These are certainly some of the weaknesses which need to be addressed.
However, we would like to remind the State Bank that while the developments in the financial sector seem to in the desired direction and certain weak areas need to be improved, the major focus of the monetary authorities should always be on the maintenance of price stability. As the recent inflation data suggest, the State Bank must continue to work hard in this area, despite the heavy odds which, of course, are many.