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Performance review of the banking system.

It is a matter of satisfaction that banking industry of Pakistan has remained relatively unaffected by the recent global financial crisis. According to the "Quarterly Performance Review of the Banking System" for the quarter ended 31st March, 2009 released by the State Bank, the country's banking industry was able to maintain its resilience, and snowed improvement in key solvency indicators, despite current economic situation in the country. The heightened credit risk due to deterioration in macroeconomic indicators, however, would remain a fundamental area of concern for the banking system in the near future. The State Bank also projected that the financial system was expected to remain profitable, though the levels as well as the pervasiveness of earnings among different market players would remain constrained as 'Compared to previous years' results. It was also indicated that in line with SBP monetary policy, the interest rates were likely to remain relatively low in future.

Reverting to the developments during the quarter under review, the heightened credit risk transpired in significant increase in non-performing loans (NPLs) of the banking system which rose to Rs. 379 billion from Rs.313 billion in December, 2008, signifying an infection ratio of 11.5 percent compared to 9.1 percent a quarter earlier. Accordingly, the capital impairment ratio i.e. NPLs-to-capital went up to 17,9 percent for commercial banks, indicating that banks' inability to recover NPLs and further deterioration in their credit quality could impinge on their solvency. However, even in the face of constraining factors, the banking system earned profit before tax of Rs.26.2 billion during January-March, 2009 quarter compared with Rs 10,5 billion in the previous quarter and pre-tax Return on Assets (ROA), a baseline indicator of profitability, registered a slight improvement from 1.7 percent to 1.8 percent. The increased loan provisions in absolute amount, nonetheless, depressed aftertax Return on Assets to 1.1 percent from 1.2 percent in the first quarter of 2008 and 1,5 percent in Q1-2007. Asset base of the banking system grew by 1.6 percent over the quarter to reach Rs 5,744 billion. The asset mix, however, witnessed a significant shift from advances to investment in government paper and government guaranteed debt securities that are relatively risk-free and liquid. Banks' efforts for deposit mobilisation remained largely muted by the Central Directorate of National Savings (CDNS) products which offered higher returns and greater security. The Capital Adequacy Ratio (CAR) under Basel-It framework improved to 13.8 percent for banks and DFIs due to reduction in risk-weighted assets, and in ranital market leading to appreciation in the value of available-for-sale investments and satisfactory earnings.

A clear message from the State Bank through the quarterly performance review that fundamentals of the financial system are still strong and it has at least so far weathered the storm with relative ease is a good news for the country. There is absolutely no doubt that a sharp deterioration in the performance of banking industry as witnessed in most of the developed countries and the resultant insolvency problems would have compounded our economic difficulties further and made the task of recovery much harder. This is so because a vibrant financial system plays a pivotal role in improving the health of the economy by increasing the level of investment through concerted efforts at deposit mobilisation and weakening of this link could be damaging for the economy. The fact that Pakistan's banking industry has remained relatively unscathed could be attributed to several factors. Firstly, recession in Pakistan was less severe than most of the other countries and, therefore, quality of assets did not suffer extensively. Secondly, the exposure of banking industry to more risk-prone assets like housing finance was relatively much lower in Pakistan. Thirdly, banking industry in Pakistan is still guided by a conservative approach and innovations like derivatives and other new products were not very common. And finally, State Bank of Pakistan in the last few years had improved its regulatory and supervisory framework which did not allow the banks to act in a very care-free manner. However, while our financial system is still deemed to be resilient and reasonably solvent and performing its functions, there is an urgent need to keep an eye on the emerging weaknesses. The increase in NPLs by as much as 21.09 percent in a single quarter is definitely a cause of concern. The continuation of such a trend could obviously harm the banking industry and retard economic development of the country. Of course, recession in industrial activity could be a dominant factor for a steep increase in NPLs but the banks must also have to improve their credit appraisal standards to keep this ugly development under control. It is also sad that in order to avoid the increasing level of NPLs, banks have started investing increasingly in government paper which would reduce credit flows to the private sector. The reduction in private sector credit could dampen overall economic activity further and deepen the recession. Besides, the banks need to launch rigorous deposit mobilisation campaigns in order to compete with the CDNS and expand their businesses. Such an effort would also enhance saving rate in the economy which is so vital for economic development of the country.
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Publication:Economic Review
Geographic Code:9PAKI
Date:Jun 1, 2009
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