Mid-Year Performance Review: Macroeconomic environment remains challenging: SBP

KARACHI: The State Bank of Pakistan (SBP) on Monday said that the macroeconomic environment remains challenging during the second half of this calendar year primarily due to subdued economic activity and elevated inflation.

The SBP has issued a Mid-Year Performance Review (The Review) of the Banking Sector. The review covers the performance and soundness of Pakistan’s banking sector for the period January to June 2023 (H1CY23).

It also briefly covers the performance of financial markets as well as the results of the Systemic Risk Survey (which represents views of independent experts about key potential risks to financial stability).

Macroeconomic conditions deteriorated during first half FY23: SBP

According to the Review, the banking sector showed a steady performance and resilience during the first half of CY23, however, the performance of the banking sector in the second half of CY23 depends on the operating environment as the macroeconomic environment will remain challenging because of subdued economic activity and elevated inflation. Moreover, as a result of stabilization measures, domestic financial conditions have considerably tightened.

However, SBP believed that business confidence may revive after the recent IMF’s Stand-By Arrangement (SBA) and in this backdrop, the banking sector is expected to continue its steady performance in the future.

“Overall economic stabilization policy to contain aggregate demand and stressed financial conditions could involve credit risk concerns for banks, however, banks’ asset quality is likely to remain firm, as their major lending is tilted towards corporate borrowers which have better credit worthiness and cushions to withstand economic shocks”, the Review mentioned.

On the other hand, the banking sector’s exposure to the government remains high which demands earnest measures to reduce the reliance on the banking sector for fiscal needs.

The Review also predicted that major expansion in the balance sheet is likely to be driven by investments owing to expected borrowing needs of the government. Advances are also expected to post their seasonal uptick towards the end of CY23, as credit demand from sectors such as textiles and sugar increases in Q4.

The SBP said that operating performance of the banking sector is likely to remain firm as the impact of increase in interest rates will continue to translate onto returns on earning assets in the coming months. However, high interest expenses may keep earnings under check and the steady earnings are expected to support solvency position and improve capital adequacy ratio.

The Review mentioned that the results of the latest macro stress tests also suggest that the banking sector, in general, and the large systemically important banks, in particular, are expected to show resilience to withstand assumed severe macroeconomic shocks over the projected period of two years.

The Review highlights that the macroeconomic environment continued to remain challenging during the first half of CY23. Domestic financial conditions tightened while the operating environment remained under stress due to elevated inflation and prolonged uncertainty.

Nonetheless, the banking sector’s balance sheet expanded by 14.0 percent during H1CY23. The expansion in asset base was mainly driven by investments in government securities. Besides strong inflow of deposits, banks’ reliance on borrowings remained noticeable during the period.

The Review also notes that advances of the banking sector recorded a muted growth during H1CY23; private sector advances contracted while the public sector availed additional financing mainly for commodity finance operations. Encouragingly, asset quality indicators improved: net non-performing loans (NPLs) to loans ratio lowered to 0.45 percent at end June-23 (0.68 percent in June-22) as banks set aside higher provisioning from steady earnings.

Profitability indicators witnessed noticeable improvement as return on assets (ROA) improved to 1.5 percent in H1CY23 (1.0 percent for CY22).

The higher earnings in turn also helped to improve Capital Adequacy Ratio (CAR) of the banking sector to 17.8 percent by end June-2023 (17.0 percent at end Dec-2022). With further improvement in solvency indicators, the ability of the banking sector to withstand a set of severe hypothetical shocks further improved as indicated by latest stress testing results.

Finally, the review also covers the results of 12th wave of SRS (July-23), which suggest that the key potential risks faced by the financial system include foreign exchange risk, increasing domestic inflation and political uncertainty. The respondents, however, expressed confidence in the stability of the financial system and ability of the regulators.

Copyright Business Recorder, 2023