State Bank of Pakistan (SBP) has cautioned that banks’ source of profits were shifting away from interest income through advances to investment in the risk-free government securities, a trend central bank dubbed as neither ‘desirable’ nor ‘sustainable’. And this risk-averse behaviour of commercial banks took their assets to Rs7.7 trillion, registering a growth of eight per cent or Rs577 billion, during the first half of calendar year 2011 (January-June 2011).
Bad debts on the rise
On the other hand, banks’ advances-to-deposits ratio was moving downwards, having further dropped to 56.7 per cent by June 2011, against 63.0 per cent of last year. Banks, however, can hardly be blamed for their current anti-growth attitude given their ever-increasing bad debts which, SBP said, had mounted to Rs31 billion, pushing the infection ratio from 14.7 per cent to 15.3 per cent. SBP noted that public sector commercial banks and mid-sized local private banks appeared more vulnerable to higher credit risk. The regulator, however, is upbeat that in months ahead its current monetary policy stance of keeping interest rate at 12 per cent would make asset selection challenging for the banks. “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 a difficult economic environment, would truly test their ability to adroitly manage an already high credit risk,” SBP said in its Financial Stability Review (FSR) on Friday.
Safer shores of investment
In its future outlook for the country’s troubled economy, State Bank said a “mild” pick-up in the so-far-muted private sector credit was likely as the borrowing cycle of some key industries was resuming. The bank, however, is concerned over receding commodity prices that it said would keep economic growth in check during current fiscal year.
“The challenging business environment in general and banks’ risk aversion amid high credit risk would limit the possibility of a perceptible reversal in asset mix away from the government papers,” it said. About banks’ tilt towards government papers, the regulator said the returns from investments in government securities now accounted for almost 30 per cent of the banks’ interest income, up from 24 per cent 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.” SBP stressed that there had been growing evidence of banks’ flight towards quality as net investments, mainly in government securities, now constituted around 34 per cent of the banks’ assets, compared with 28 per cent in June 2010.
Crowding out private sector
“The share of net advances has witnessed a concomitant drop, from 47.6 to 43.9 per cent during the same period,” it said. According to State Bank, while the cash-strapped government’s reliance on banking sector heightened concerns about private sector crowding out, poor credit off-take by private sector had other causes as well that include severe energy crises and challenging economic environment.
However, going forward, results of stress tests showed that banking system was resilient to shocks emanating from a challenging macroeconomic and business environment, the regulator observed. About surge in banks’ assets SBP said it was in both absolute and growth terms and was the most significant since 2007.
The banks’ deposits increased by 9.4 per cent, registering the highest half yearly growth during last four years, it said; adding that net investments, with an increase of 22.4 per cent during July-Dec 2011, markedly outpaced the anemic growth of 1.04 per cent in net advances.
profits before tax up 31pc
The first-half yearly review shows that the banks’ profits before tax were up by 31 per cent during the first half to reach Rs77 billion, with Return On Assets (ROA) of 2.1 per cent (1.8 per cent in June-10) and Return On Equity (ROE) of 21.9 per cent (17.7 per cent in June-10). During Jan-June 2011, the banks remained fairly liquid on the back of growing share of investments in government papers, it said, adding that banks’ capital adequacy ratio also observed improvement, reaching 14.1 per cent by June-2011.
SBP said concentration in profits had dropped (share of top five banks down from 95 per cent in Dec-10 to 78 per cent in June-11), ensuring that even smaller banks had a share, albeit marginal, in industry profits. “Further, growing profits have also helped reduce the number of loss-making banks, from 17 in June-10 to 8 in June-11,” the regulator observed.
Islamic banks grow by 17.5pc
About Islamic Banking Institutions (IBIs) it said Sharia-compliant banking had grown 17.5 per cent during H1-CY11, with bulk of incremental assets channeled into government securities. Islamic banks appeared more liquid, solvent and profitable when compared with rest of the banking sector but were facing unique risks of “reputational” and “displaced commercial” nature, it said. Referring to other components of financial system, SBP reviewed that domestic financial markets remained stable during the period under review, despite some bouts of mild strain. External inflows kept value of domestic currency almost stable, as Pak rupee depreciated by a marginal (0.35 per cent) against US dollar. Capital market managed to post a growth of four per cent during the half year under review. Bank said during the review period, asset base of Development Finance Institutions (DFIs) managed to grow marginally by four per cent, primarily on account of stronger growth in investments. “Share of advances in total assets remained intact (around 35 per cent), though at significantly lower level than what DFIs’ nature of business would warrant.” However, SBP said trading volumes and activities in corporate debt market largely remained low. Derivatives market, on the other hand, shrank further as insipid credit to private sector coupled with stable exchange rate and interest rate environment dampened demand for new derivative contracts.
money market investments
In contrast, State Bank said, mutual funds industry witnessed its revival as money market investments improved net assets of industry by 24 per cent in H1-CY11. “The insurance industry witnessed a growth of 16.6 per cent in its asset base with the life business experiencing a much strong growth (24 per cent),” it added. Payment systems had functioned smoothly, with amount transacted through retail payment system growing by 14 per cent (YoY) against 11.6 per cent in the corresponding period last year. In terms of volume, the share of e-banking transactions had gained momentum, reaching 42 per cent by June-11, the bank said. It said branchless banking was experiencing a rapid expansion in the country and more banks were planning to enter this growing segment.
With inflation raging , at least, at 12 percent and directly and indirectly Governments,Federal and Provincials and their corporations other entities and circular debt sucking all fresh liquidity, our banks are doomed in the long run.
Their executives, directors and auditors are out to make fast buck while their demise is not very far.
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