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Banking sector performance: trend, outlook and challenges

Published on 17th Nov, Edition 46, 2014

 

A strong trend in the growth and profitability of banking sector is judged by the stability in the monetary policy, increasing spreads, decrease in nonperforming loans (NPLs) and the selling of stakes by the government in banks to public. The experts see a good trend in banking performance in Pakistan.
The country’s banking sector has four categories including large banks with total assets in excess of Rs500 billion; medium size banks with total assets in excess of Rs100 billion but less than Rs500 billion; small banks with total assets of less than Rs100 billion while the recent growth of Islamic banking in Pakistan will give further boost to the overall performance of the industry. The discount rate has been increased by 100 basis points (bps) and further increase in discount rate will help improving margins for banks. A KASB Securities survey conducted last year among 25 domestic asset managers, banks and corporate entities to gauge their equity market outlook for 2014, 23 percent respondents said the banking sector was expected to outperform the benchmark index in 2014. The Bank Al Habib and Bank Alfalah were two of the five most popular names that the respondents mentioned when asked about their ‘single top pick for 2014′. The country’s per capita investment in the banking sector is one of the highest in the region. Financial industries in India, Bangladesh and Sri Lanka have lower per capita investment than Pakistan. The experts consider it a strong reason for Pakistan to emerge as a least-affected country out of the 2008 financial crisis.

Banking sector earning registered significant growth of 39.2 percent in the nine months of fiscal year 2014. It grew to Rs109.54 billion as against Rs78.69 billion a year ago. The growth in earning witnessed 20.2 percent rise in net interest income, 68 percent decrease in provisions due to lower growth in fresh NPLs and reversals and 16 percent rise in non interest income. However, profitability declined by 2 percent to Rs38.40 billion in third quarter of fiscal year 2014 against Rs39.19 billion in second quarter of fiscal year 2014 due to decline in non funded income owing to limited capital gains. Banking sector net interest income surge by 20.2 percent to Rs269.42 billion against Rs224.17 billion in the nine months of fiscal year 2013 mainly due to change in deposit mix and rise in earning assets. Interest income increased by 16.4 percent to Rs622.96 billion versus Rs535.25 billion in the nine months of fiscal year 2013 mainly due to investments in PIBs.

International credit rating agency Moody’s, however, predicted a negative outlook for Pakistan’s banking system this year. The outlook reflects agency’s expectations of continued challenging operating conditions that will weigh on banks’ business generation and asset quality and banks’ high and increasing exposures to Pakistani government securities, Caa1 negative, tying the system’s solvency to sovereign event risk. Moody’s, however, expects banks to sustain low-cost and stable deposit-funded profiles, partly mitigating these negative pressures. It expects the Pakistani economy will grow in real terms by 2.8 percent in 2013-14 and 3.6 percent in 2014-15, below historical trends, owing to the poor domestic security situation and infrastructure bottlenecks, such as the continuing electricity outages, which weigh on manufacturing output and investment. In the given environment, Moody’s expects subdued credit growth of around 3 percent to 5 percent in 2014, against 10 percent inflation, as the banks continue to devote a substantial portion of their balance sheets to finance the government’s large fiscal deficits, 5.5 percent of GDP in 2013-14.

 

What has been the major source of credit risk is banks’ exposure to government securities because it links banks’ credit profiles directly to the high credit risk of the sovereign. Banks’ exposure to government securities and loans to public-sector companies reached 644 percent of Tier 1 capital as of September 2013 and the rating agency expects this to rise further. The challenging operating conditions are likely to prompt a rise in the level of the banks’ NPLs by the end of 2014 from 14.3 percent as of September 2013. Surge in the NPLs pose a challenge for the banking industry in the country. The NPLs of the banking industry witnessed a rapid increase since calendar year 2007. Commercial banks’ lending to private sector continues to increase. The NPLs compel the banks to adopt cautious approach towards advancing of loans.

A challenging economic and business environment continues to affect the growth of banking industry in Pakistan. The central bank’s tight monetary policy has made the money more costly for the businesses, which ultimately turn into defaults.

Critics say that the government by raising interest rates is creating hurdles in the growth of business environment in the country. Banks generally find it easy to lend money to large corporate sector, while the medium and small size business entities have been paying much higher interest on borrowing. The private sector has been a victim of government’s borrowing from the banking system, which deprived the private sector of using the funds for growth of the economy. The central bank’s tight monetary policy is one of the key reasons behind the private sector’s falling demand for credit. The increased interest rate has made doing business increasingly expensive.

Moreover, Pakistan banking industry faces tough competition unleashed in the global arena. The banking sector still needs to take effective measures for improving and strengthening its competitive position vis-a-vis the foreign banks. The banking industry must be able to meet increasingly complex banking needs if it is to flourish. The country cannot catch up with its Asian neighbors India and China in terms of economic development without making investment in new banking technology. In the Asian economies, the relative wealth increases among the population and a burgeoning middle-class has brought greater demand for banking facilities and investors and business are also looking for more supportive financial services, with a demand for financing solutions, hedge funds, and asset-based securities.

Electronic banking has brought non-traditional channels of delivering services in the banking industry. Information and communication technologies (ICT) have transformed the global economy bringing about a revolutionary change in the financial sector. This revolution finds manifestations today in shape of innovative banking products and services such as Automated Teller Machines (ATMs), internet banking, tele-banking and so on.

Pakistan needs to place ICT on its priority list to keep pace with the advancement in technology and minimize digital divide. The government needs to take measures for creating a conducive environment for technological innovation and its effective use in financial sector. The banks offering mobile banking services need to develop aggressive marketing plans and campaigns to attract customers to visit the agent location for their banking transactions.

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