Banking system assets grow by 8 percent to Rs 7.7 trillion in Jan-June 2011: State Bank

Karachi: The assets of Pakistan’s banking system soared by 8% or Rs 577 billion to Rs. 7.7 trillion during first half of calendar year 2011 (January- June, 2011). This surge in banks’ total assets, both in absolute and growth terms, was the “most significant” since 2007, says State Bank of Pakistan’s Financial Stability Review FSR released on Friday.

Deposits increased by 9.4%, registering highest half yearly growth during last four years. Net investments, with an increase of 22.4% during first half of 2011, markedly outpaced anaemic growth of 1.04% in net advances. The first-half yearly Review said banks’ profits before tax were up by 31% during first half of 2011 to reach Rs. 77 billion, with Return On Assets (ROA) of 2.1% (1.8% in June-10) & Return On Equity (ROE) of 21.9% (17.7% in June-10). During Jan-June 2011, banks remained fairly liquid on back of growing share of investments in government papers. Further, banks’ capital adequacy ratio also observed improvement, reaching 14.1% by June-2011.

It said concentration in profits dropped (share of top 5 banks down from 95% in Dec-10 to 78% in June-11), ensuring that even smaller banks have a share, albeit marginal, in industry profits. Further, growing profits also helped reduce number of loss making banks, from 17 in June-10 to 8 in June-11. However, Review cautioned that source of profits is shifting away from interest income through advances to investments in government papers. Specifically, returns from investments in government papers now accounts for almost 30% of banks’ interest income, up from 24% in June-2010.

This suggests that growth in government borrowings has shored up banks’ earnings. This trend is neither desirable nor sustainable, first because it compromises intermediation function and second as any sharp cut in discount rate can discernibly affect banks’ profits.

There has been growing evidence of banks’ flight towards quality as net investments, mainly in government securities, now constitute around 34% of banks’ assets compared with 28% in June, 2010. The share of net advances witnessed concomitant drop, from 47.6 to 43.9% during same period’, it said and added that unsurprisingly, Advances-to-Deposits ratio has further dropped from 63.0% in June, 2010 to 56.7% by June, 2011.

While government’s reliance on banking sector heightens concerns about private sector crowding out, poor credit off-take by private sector has other causes as well that include severe energy crises and challenging economic environment. Credit risk remained a major challenge as banks accumulated Rs. 31 billion of fresh Non-Performing Loans, pushing infection ratio from 14.7% to 15.3%, Review said. Public sector commercial banks and mid-sized local private banks appear more vulnerable to higher credit risk. However, going forward, results of stress tests showed that banking system is resilient to shocks emanating from a challenging macroeconomic and business environment.

Islamic banking institutions IBIs registered 17.5% growth during H1-CY11, with bulk of incremental assets channelled into government securities. Islamic banks appear more liquid, solvent and profitable when compared with rest of banking sector but face unique risks like reputational risk and displaced commercial risk.

On other components of financial system, it said domestic financial markets remained stable during half year under review, despite some bouts of mild strain. External inflows kept value of domestic currency almost stable, as PKR depreciated by a marginal (0.35%) against dollar. Capital market managed to post growth of 4% during half year under review. Asset base of Development Finance Institutions DFIs managed to grow marginally by 4%, primarily on account of stronger growth in investments. Share of advances in total assets remained intact (around 35%), though at significantly lower level than what DFIs’ nature of business would warrant.

However, trading volumes and activities in corporate debt market largely remained low. Derivatives market, on other hand, shrank further as insipid credit to private sector coupled with stable exchange rate and interest rate environment dampened the demand for new derivative contracts. Review said in contrast, mutual funds industry witnessed its revival as money market investments improved net assets of industry by 24% in H1-CY11. Insurance industry witnessed growth of 16.6% in its asset base with life business experienced much strong growth (24 %).

The payment systems functioned smoothly, with amount transacted through retail payment system growing by 14% (YoY) against 11.6% in corresponding period last year. In terms of volume, share of e-banking transactions gained momentum, reaching 42% by June-11. In branchless banking, Pakistan is experiencing rapid expansion, with four banks offering services through various operational setups.

As more banks are planning to enter this growing segment, there is strong potential to significantly improve financial inclusion in years ahead. FSR said a mild pick-up in private sector credit is likely as borrowing cycle of some key industries resumes, though receding commodity prices would keep growth in check. Further, challenging business environment in general and banks’ risk aversion amid high credit risk would limit possibility of a perceptible reversal in asset mix away from government papers. Current monetary policy stance would make banks’ asset selection challenging in months ahead; banks will either have to live with lower returns on their investments (a key contribution to profits in recent times) or to aim for greater private sector credit, which in difficult economic environment, would truly test their ability to adroitly manage an already high credit risk.

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