Financial Stability Review

According to the Financial Stability Review (FSR) released by the State Bank on 27th June, 2016, financial system of Pakistan remains in a good shape but is also beset with certain challenges at the same time. The asset base of the financial sector has increased at a decent pace of 15.1 percent during CY15 as against the average of 12.6 percent in CY13-14. Consequently, financial depth has improved as financial assets to GDP ratio has increased to 68.4 percent in CY15 from 59.4 percent in CY14 and 56.4 percent in CY13. Advances grew at a modest pace of 8.1 percent while investments - mostly in government securities - increased sharply by 30 percent. This asset expansion was financed mainly by growth in deposits to the tune of 12.6 percent followed by financial borrowings. Asset quality improved with a reduction in infection ratio from 13.3 percent in CY13 to 11.4 percent in CY15 and a rise in provision coverage from 77.1 percent to 84.9 percent in the same period. However, banks do face a challenge in reducing the high stock of NPLs and SBP is working on various legal and regulatory measures in this regard. Operating performance improved considerably as banking sector posted record after tax profit of Rs 199 billion during CY15, ROA (after-tax) increased to 1.5 percent in CY15 from 1.1 percent in CY13 and ROE rose to 15.6 percent from 12.4 percent in CY13. The solvency also remained robust with high Capital Adequacy Ratio at 17.4 percent in CY15 compared to 14.9 percent in CY13.
Challenges identified by the FSR include a low level of credit to the private sector. This could be attributed to both the demand and supply side factors. Private sector is facing a challenging economic and business environment due to various structural issues such as power shortages. Consequently, banks have increased their exposure towards risk-free investments in government securities loaded with PIBs and MTBs. On the funding side, deposit growth in past couple of years has remained short of meeting asset growth requirements of both the public and private sectors. FSR has also noted that global uncertainties could impact the economy as well as the financial sector of Pakistan through trade and financial linkages with Asia, and the EU. Low commodity prices could also impact revenues of export-oriented sectors, including textile sector which may impact the repayment capacity of borrowers of these sectors, stressing the asset quality of banks.
We feel that FSR is a very good statement on the current health of the financial sector of Pakistan. It has not only taken a balanced view of the prevailing situation but also identified the challenges confronting the financial sector of the country. A noted achievement of the country's financial sector has been that it has continued to flourish despite challenges in the global environment which had a very negative impact on banking sector in some other countries. In fact, performance of the banking sector in Pakistan has improved over the last few years on the back of excessive earnings and high CARs; these factors have contributed towards enhancing the overall resilience of the sector. A reasonable growth in assets and a modest revival of private sector credit are also good omens for the banking sector. Improvement in these indicators may be due to signs of some improvement in the economy. Inflation is low, foreign exchange reserves are building up, exchange rate is stable, fiscal consolidation continues and LSM has picked up some pace along with credit to the private sector.
The biggest challenge, rather problem, of the banking sector in the country is, however, excessive investment in government securities and lower exposure to the private sector credit. Such a strategy may be more profitable for the financial sector for the time being but could be risky for the long-term and undermine the growth prospects of the economy due to a depressed business activity in the private sector. It is not difficult to see that aggressive funding to public sector may create some bouts of liquidity shortages. Also, easing off in fiscal reliance on banking funds leading to massive unwinding of the public investment portfolio might be a challenge because it will be very testing for the banks to deploy the released funds in alternative avenues which could generate decent income stream. Besides, banks need to intensify their efforts for deposit mobilisation to minimise the risk of maturity mismatch. This could partly be done by the banks to share their increasing profits with depositors (by raising deposit rates). The imposition of higher withholding tax on non-filers for cash withdrawals could, nonetheless, adversely affect the deposit mobilisation efforts of banks. Although such measures may be considered justified for fiscal reasons, but would certainly have an impact on the behaviour of depositors. Hopefully, the SBP and banks would try together to ensure that the present problems of the banking sector are resolved and financial resources of the country are employed optimally towards the development of the country.