Banking system continues to show resilience against major risk factors

Pakistan’s banking industry continued to show the resilience against major risk factors through improved solvency position, though the heightened credit risk remained a major source of concern for banks.
Banking system witnessed some let up in the impacts of macroeconomic pressures that have been affecting its asset quality and growth for last few quarters, though overall macroeconomic outlook with slight improvements remained stressful.
IMF’s latest estimates predict that world Gross Domestic Product (GDP) would decline by 1.0 percent in 2009 followed by a modest 3.0 percent growth in 2012. Pakistan‘s economy also grew by 2.0 percent during FY09 – the lowest for current decade – while the projection of 3.3 percent for FY10 also remains low, says State Bank of Pakistan’s latest Quarterly Performance Review of the Banking System.
The growth in non-performing loans (NPLs) pacified and deposit after showing some stagnancy witnessed strong growth of 8.2 percent during the quarter.
Major stress from weakened economic conditions i.e. flow of additional Non performing Loans (NPLs) that was pronounced in last couple of quarter, pacified to some extent as NPLs grew at slower pace. Nevertheless, the system continues to face a considerably heightened credit risk, which has built up since later half of CY08.
The system‘s asset and deposit base witnessed noticeable increase as compared to recent trends. Due to enhanced loan loss provisioning and decline in banks’ risk appetite, reflecting in enhanced risk based capital adequacy position, the baseline solvency indicators registered some improvement. Accordingly, the system continued to show strong resilience towards unusual shocks in major risk factors.
The asset base of the banking system grew by 6.0 percent. The deposits, which had been showing stagnancy since Jun-08, registered an appreciable growth of 8.2 percent during the quarter under review. The advances grew by 5.0 percent; however, this increase occurred in lending to public sector for its Commodity Operations and to Public Sector Enterprises (PSEs). Due to risk aversion of banks and slackened demand from private sector, lending to private sector shed by 1.8 percent. Further, banks’ investments in Government papers also significantly grew by 12.9 percent during the quarter under review. Accordingly, asset mix further shifted from loans and advances to investments in government papers.
Banks posted pre-tax profit of Rs28.6 billion during the first six months of the year 2009 while risk-based capital adequacy ratio (CAR) for banks improved to 13.5 percent in April-June, 2009 (12.9 percent in Jan-Mar, 2009).
This improvement in CAR was caused by growth in equity as well as reduction in Risk Weighted Assets as the banks shifted their asset mix from private sector credit to less riskier lending to public sector and government papers, the Report pointed out.
The asset base of the banking system grew by 6.0 percent over the quarter to reach Rs6,087 billion. The asset mix, however, witnessed significant change as banks continued to focus on government papers and lending to public sector. A 5.0 percent growth in advances was mainly contributed by lending to public sector for commodity operations and Public Sector Enterprises (PSEs). However, due to heightened credit risk as well as private sector’s low demand for credit, banks’ lending to private sector declined by 1.8 percent.
NPLs grew by 4.9 percent over the quarter and infection ratio stayed at 11.5 percent. However, due to increased loan loss provisions, net infection ratio decreased to 3.7 percent in June, 2009 (3.9 percent in Mar09) and provisions covered 70 percent of the NPLs. The higher loan loss provisioning during the quarter nonetheless affected the earnings. Pre-tax Return on Assets of 1.7 percent though lower than the levels of corresponding periods of last couple of years, was higher than the entire year results of CY08.
The increased macroeconomic vulnerabilities and constrained repayment capacity of borrowers have resulted in significant increase in NPLs of the banking system during last two quarters. The quarter under review, however, witnessed slowdown in infection rate as the NPLs accumulated at relatively passive rate of 4.9 percent to Rs398 billion (Rs379 billion in Mar-09, and Rs359 billion in Dec-08). Due to a matching growth in loan portfolio, the infection ratio remained at the last quarter level. This increase in NPLs occurred in Doubtful and Loss categories and banks almost fully provided for additional NPLs. Accordingly, net infection and capital impairment ratios slightly receded, and NPLs coverage after deteriorating over the last few quarters improved to 70.2 percent.
The significant increase in loans loss provisioning moderated the earnings of the system: year to date Profit before Tax (PBT) of Rs47.8 billion in Jun-09 as compared to Rs61.4 billion for corresponding period of CY08. The baseline indicators of Return on Asset (ROA) and Return on Equity (ROE) remained significantly lower than the level for corresponding period of last year, though still higher than entire year results of CY08. Satisfactory earnings, however, were not widely shared by market players and were skewed towards large and medium-sized banks as most of the small sized banks’ earnings remained in red.
Accumulation in year to date earnings led to reasonable increase in equity base of the system. This growth was also augmented by improvement in revaluation surpluses on both Available for Sale (AFS) equity investments and fixed income securities due to favorable movements in market prices. The net worth to total asset ratio slightly came off. However, improvement in eligible capital and reduction in Risk Weighted Assets (RWA) as the banks continued to shift their asset mix from private sector credit to investments in government papers and lending to PSEs, improved the risk based Capital Adequacy Ratio (CAR) to 13.5 percent (14.0 percent for commercial banks).
The deposits after showing stagnancy for the last few quarters, witnessed a significant increase which surpassed growth in advances, and a larger share of fresh deposits was invested in liquid assets. Resultantly, the liquidity profile of the system further improved during the quarter. Advances to deposits ratio (ADR) came off to 69.6 percent and liquid assets to total assets ratio improved to 31.2 percent. Similarly, the market risk of the system with some moderation remained subdued. Strong recovery by the capital market made for the substantial part of revaluation losses, which accumulated during later half of CY08. Interest rate risk was also low as the interest rates gradually declined during the quarter, appreciating the value of fixed income securities while re-pricing mismatches remained within acceptable ranges.
Economic slowdown and domestic security issues are likely to dampen the growth of the banking system. Low demand for banks’ credit from private sector, increased risk aversion on the part of banks, and public sector demand for bank credit will further shift asset mix away from advances to government papers and lending to PSEs. Given the slackened economic activities and constrained repayment capacity of borrowers, credit risk continues to remain the foremost concern for the system. However, stress test results indicate that banks are well placed to withstand any unusual shocks in credit risk factors. Banks have though shown strong performance in attracting deposits during the quarter under review. However, future growth in earnings assets and lending to private sector for supporting the accelerated economic activities during Oct-Dec quarter will largely depend upon banks’ ability to mobilize fresh deposits. Therefore, they will have to step up their efforts for mobilizing deposits, which are again showing some stagnancy in latest post quarter statistics. Keeping in view some improvements in key economic indicators, State Bank of Pakistan (SBP) has been following the policy of discreetly easing off monetary policy for providing impetus to sustainable recovery. Accordingly, the interest rates are likely to remain relatively low compared to CY08 levels. The system, on aggregate basis, is expected to post satisfactory earnings, though the individual banks would experience mixed results, depending upon their size and earning capacities.