Banking sector fares well

Measured by most indicators, banks continue to do exceptionally well in Pakistan. According to the Quarterly Performance Review of the banking system for October-December, 2014, released by the State Bank on 16th April, 2015, banking industry’s pre-tax profits surged by as much as 52 percent (YoY basis) to reach an all-time high of Rs 247 billion in 2014, thanks largely to their huge investments in government securities. Net Interest Margin (NIM) and ROA (before tax) increased from 3.9 percent and 1.6 percent in CY13 to 4.4 percent and 2.2 percent, respectively, during 2014 while Capital Adequacy Ratio (CAR) has also improved by 1.6 percentage points to reach 17.1 percent, which is well above the benchmark of minimum 10 percent. Asset base of the banking sector soared by Rs 977 billion or 8.8 percent during the quarter ended December, 2014 to reach Rs 12.1 trillion. On the funding side, deposit growth of 5.6 percent during the quarter over the previous quarter and 11 percent over the corresponding period of 2013 supported the overall growth in the balance sheet of banks. Quality of assets also continued to improve as infection ratio receded further by 70 bps to reach 12.3 percent and net NPLs to net loans declined by 50 bps to 2.7 percent during October – December, 2014. At the same time, capital impairment ratio (net NPLs to capital) observed a substantial decline of 350 bps to stand at 10.1 percent, indicating a falling risk to the future earnings and equity of the banking system.

The overall improvement in almost all the indicators of the banking sector would appear to be a highly positive development for the economy because of its enlarged capacity to collect deposits or loanable resources from households spread over all the country and channelise them into productive investment. A weaker banking system could obviously lead to recession, retard country’s growth and promote unemployment. According to the State Bank’s quarterly report, banking system of Pakistan is almost absolutely safe and sound with a strong capital cushion, is earning high profits for its equity holders and its net NPLs to loans are very much manageable. This means that the financial system of the country has no solvency concerns at the moment and is fully equipped to play its due role in the development of the country.

However, while the managers of the banking sector could celebrate their success for earning higher levels of profitability for their shareholders and securing their positions, the overall picture is rather gloomy and much less encouraging than indicated outwardly by the quarterly review. A detailed analysis reveals that the share of investments continues to increase in total assets due to growing stocks of government securities with a quarter-on-quarter rise of 13.8 percent (25 percent Year-on-Year). As a result, banks’ holding of government securities jumped to Rs 4.8 trillion as of end-December, 2014, constituting more than 90 percent share in total investments and 40 percent share in total assets. PIBs’ share in banks’ investment in government securities has risen sharply, reaching 56.6 percent by December 31, 2014, compared to only 19.3 percent a year earlier and most of the investments concentrated in three-year PIBs to manage the market liquidity. Another worrying aspect was that a large part of investment in government securities by the banks was not financed by raising deposits but by liberal lending or injection of high doses of liquidity by the SBP for deficit financing of the government budget. Seen from this perspective, most of the improved indicators of the banking sector are, more or less, a reflection of the government’s poor fiscal policy, State Bank’s haste to accommodate the budgetary requirements and the banks’ greed to make hay while the sun shines. Since private sector off-take is still slow, the economy is not getting the benefit of improved balance sheets of banks in terms of higher investment or better economic activity. In a situation like this, profitability of the banking system would of course be higher and there will be no risk of default – a combination which ideally suits bankers but is less helpful for the economy. Another concern is that depositors are not adequately rewarded which depresses the will to save and increases investment in speculative activities like real estate. The net result of these distorted policies is a poor growth rate of the economy despite a vibrant banking system. Although there are also other factors impeding the growth rate but Pakistan’s economy is only faring better than Afghanistan’s in the whole of South Asia. In short, though the performance of banking sector in Pakistan would appear to be quite robust on paper, it has still to go a long way in making its due contribution to the uplifting of the economy. Hopefully, the government and the State Bank would help nudge the banks to move in the desired direction.