The State Bank of Pakistan (SBP) has reported a significant expansion in the country’s banking sector during the first half of 2024, with an 11.5% growth in the balance sheet footing. This growth has been largely fueled by investments in government securities, which remain in high demand as the government continues to require substantial credit from the banking system.
In its Mid-Year Performance Review for 2024, the SBP provided an in-depth analysis of the banking sector’s performance, including insights into financial markets and potential risks to financial stability as perceived by independent experts through the Systemic Risk Survey (SRS). Here, we’ll break down the key findings of the SBP’s review, examining the sector’s advances, asset quality, earnings, and the major risks highlighted for the rest of the year.
Key Growth Drivers: Government Securities
A standout point from the SBP’s review is that government securities played a crucial role in the sector’s 11.5% growth. With the government’s demand for credit remaining strong, banks have ramped up their investments in these securities. This shift allowed banks to grow their asset bases, despite only modest advances to the private sector.
The government’s borrowing needs have been a long-standing feature of Pakistan’s banking environment, where private sector lending has often taken a backseat to the state’s requirements. However, in the first half of 2024, private sector advances did experience some improvement, particularly with long-term financing to small and medium enterprises (SMEs) showing signs of revival. Although private sector retirements slowed overall growth, the decline in advances was significantly less severe than in the first half of 2023.
Funding Side: Rise in Deposits
On the funding side, the SBP report reveals that deposits increased by 11.7% in the first half of the year, with savings and current deposits contributing the most to this growth. This surge in deposits is a positive indicator of the public’s trust in the banking system, but it also came with its own challenges.
As assets grew rapidly, banks had to find additional funding to maintain liquidity. This led to a continued reliance on borrowing, indicating that while the deposit base expanded, it wasn’t sufficient to fully meet the funding needs of the banks.
Asset Quality and Non-Performing Loans
The overall asset quality of the sector remained stable during this period. Non-performing loans (NPLs) saw only a modest increase, signaling that despite some economic challenges, borrowers are still largely able to service their debts. Importantly, provisioning coverage against NPLs improved to 105.3% by the end of June 2024, providing a stronger buffer for banks against any potential losses.
A noteworthy development in this regard is the implementation of IFRS-9, which led banks to create general loan loss allowances even for performing loans. This conservative approach to risk management ensures that the banking sector is well-prepared to absorb future losses, further enhancing its resilience.
Earnings and Profitability
Despite positive growth in assets and deposits, the earnings of the banking sector took a hit during the first half of 2024. This decline was primarily due to a reduction in return on advances and a contraction in net interest margins (NIMs), which traditionally form a major portion of bank profits.
However, non-interest income helped offset some of the losses. This income came from various sources, including fees and commissions, as well as trading gains from government securities. These revenue streams allowed banks to maintain profitability, even if the overall return on assets (ROA) and return on equity (ROE) decreased compared to the previous year. By the end of June 2024, ROA had declined to 1.2%, down from 1.5% in June 2023, while ROE dropped to 20.4% from 26.0% during the same period.
Strong Solvency and Capital Adequacy
Despite the challenges in earnings, the solvency position of the banking sector remained robust. The Capital Adequacy Ratio (CAR), a key measure of a bank’s capital strength, improved to 20.0% by June 2024, up from 17.8% in the same period last year. This was well above the minimum regulatory requirement, reflecting the sector’s strong capital buffers.
The improved CAR demonstrates that banks are well-capitalized, which not only supports their growth ambitions but also ensures they can withstand any future financial shocks.
Financial Markets and Macroeconomic Outlook
The review also highlights an improvement in domestic financial markets, driven by gradual improvements in Pakistan’s macroeconomic conditions. While the country has faced significant economic headwinds in recent years, the SBP noted that stress in the financial markets was relatively lower during the first half of 2024. This suggests a degree of stabilization, even as the broader economy continues to navigate challenges such as inflation and fiscal deficits.
Systemic Risk Survey (SRS): Key Concerns
The SBP’s review includes insights from the 14th wave of the Systemic Risk Survey (SRS), conducted in July 2024. Independent experts participating in the survey identified three key risks to the financial system:
- Energy Crisis: Rising energy costs and supply disruptions remain the top concern, as they could severely impact industrial production and economic stability.
- Commodity Price Volatility: The fluctuations in global commodity prices, particularly oil and food, present risks to inflation and balance-of-payments stability.
- Foreign Exchange Risk: With the Pakistani rupee continuing to face pressure, foreign exchange volatility was another prominent concern among experts.
Despite these concerns, the participants expressed confidence in the stability of the financial system and praised the SBP’s regulatory oversight. They believe that Pakistan’s financial institutions remain resilient and capable of navigating the risks ahead.
Conclusion: A Strong but Cautious Outlook
The State Bank of Pakistan’s Mid-Year Performance Review paints a picture of a banking sector that is growing, resilient, and well-capitalized. Investments in government securities, rising deposits, and improved provisioning coverage have all contributed to this stability. However, challenges remain, particularly in the form of declining earnings and macroeconomic risks like the energy crisis and exchange rate volatility.
As the sector moves into the second half of 2024, the focus will likely remain on maintaining asset quality, improving earnings, and navigating external risks. If these challenges are successfully managed, Pakistan’s banking sector could continue on its growth trajectory, playing a vital role in the country’s broader economic recovery.
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