Financial Stability Review (FSR) released by the State Bank on 7th July 2017 for the CY2016 shows that Pakistan's banking system remains, in general, in a stable and sound condition. However, some emerging risks in short- to medium-term need attention and were closely monitored by the central bank. The growth momentum of advances picked up further during CY16 with private sector as the main beneficiary while asset quality improved with a decline in infection ratio. Gross advances increased by 12.81 percent during CY16 compared to the growth of 8.12 percent a year earlier and the ratio of non-performing loans to total loans came down to a decade low level of 10.01 percent. Banks' profitability, nonetheless, moderated after seeing an expectationally high growth in the last four years. The return on assets and equity stood at 2.1 percent and 23.8 percent as compared to 2.5 percent and 25.8 percent, respectively, at the end of previous year. The liquidity position remained comfortable and CAR was high at 16.2 percent at the close of CY16. In line with the international best practices, the Review also assessed the resilience of the banking sector to adverse scenarios by macro-stress testing and found that the banking system was able to withstand adverse shocks. The Financial Market Infrastructure (FMI) of Pakistan continued to function smoothly and efficiently. Large value payments continued their growth momentum, e-banking was fast replacing the paper-based modes and the downtime of ATMs significantly improved.
The outlook of the financial sector in CY17 largely remains positive but some risks are appearing on the horizon. Although high provision coverage ratio provides reasons for some comfort, the banks need to enhance their credit evaluation and monitoring standards to minimise risk of future defaults and adverse impact on profitability. Exposure of banks to public sector advances and off-balance sheet items remains significant. This not only challenges the financial intermediation function of banks and some non-banks but is also susceptible to changes in government policy. The widespread use of technology, though useful for the end consumer, puts an additional burden on the institutions to protect their vital systems and information technology infrastructure. Higher exposure to equities is vulnerable to correction in asset prices. CAR of the banking system, though substantially above the prescribed limit at present, needs further attention in view of enhanced regulatory requirements in the coming years, moderation of profits and expected increase in their risk profile as exposure to the private sector increases.
The FSR presents a very good analytical assessment of Pakistan's financial sector along with all the associated risks which are likely to appear on the scene in short- to medium-term. It is of course very encouraging to see that major indicators of the banking sector are in good shape and the financial sector, as a whole, has the necessary resilience to absorb shocks arising from some unforeseen circumstances. A very significant and positive development was the increasing credit to the private sector which was generally held back in the previous years due to higher investments of the financial sector in government securities which yielded high returns without any risk. The redirection of credit to the private sector would boost growth impulses in the economy and improve financial intermediation of the sector. One could argue that the higher private advances may be due to better macroeconomic conditions like higher growth in LSM, lower inflation, stability in exchange rate, better law and order situation and improved energy supplies but the development augurs well both for the economy as well as the financial sector. It is also good to note that the CAR continues to remain at a comfortable level and there is no immediate threat of insolvency to the financial sector. The SBP has also carried out a macro-stress testing and found the system stable and in good health. The moderation in profitability, however, is a reflection of lower interest rate environment and not of a great concern so far as the banking industry's profits are comparable to other sectors for the economy. The risks on the horizon as pointed out by the SBP, however, merit a great deal of consideration. Exposure of banks to public debt is still quite high and needs to be reduced. This, of course, is difficult to do when the budget deficit is widening and the reliance of the government on banks for budgetary support is quite high. Increased use of technology, establishment of Asset Management Companies and Alternate Payment Delivery Systems, though necessary, calls for more vigilance by the SBP. The SBP also needs to be more vigilant about the role of non-banking financial sector. Toxic elements in the NBFIs like excessive leverage and illiquid investments need to be particularly watched. We are sure that the central bank is fully cognizant of the emerging risks in the financial sector and prepared to strengthen its regulatory and monitoring framework in order to improve the efficiency and security of the financial system, enhance consumer protection and enforce good governance regime. This is necessary because the financial sector of a country plays a vital role in the development and modernisation of the economy by mobilising financial resources and placing them at the disposal of entrepreneurs.
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