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September 6, 2019

Financial sector faces risks from economic vulnerabilities


September 6, 2019

KARACHI: Economic slowdown may further impede the financial sector’s growth that moderated last year, but IMF-backed reforms program is expected to help introduce stabilisation in the economy, the central bank said on Thursday.

Also read: IMF to send SOS mission to Pakistan on 16th

“The external account imbalances and related uncertainties are likely to have repercussions for the financial markets,” the State Bank of Pakistan (SBP) said in its financial stability review for 2018. “The financial sector performance and stability will largely hinge on the improvement in macroeconomic conditions.”

The SBP, however, said the successful implementation of the International Monetary Fund program (IMF) is expected to foster macroeconomic and financial sector stability in the country.

“The necessary stabilisation measures may further slow down the pace of economic activity.” The SBP further said the monetary tightening may affect the debt repayment capacity of the borrowers with some lag.

“Under the challenging macroeconomic environment, the corporate sector, which is already showing signs of slackness in its performance, may perform below its full potential,” it added.

The SBP said last year was challenging for the financial sector of Pakistan with the sector’s growth having moderated to 7.5 percent last year, while the financial depth, as measured by financial assets to GDP ratio, subsided to 73 percent from 74.5 percent a year earlier. “The financial markets, particularly, the forex and equity markets have trended downwards with increased volatility.”

The SBP, however, said the financial institutions and financial market infrastructure have largely remained resilient and performed steadily during the year under review.

The SBP said the deceleration in deposit growth is a key challenge to banking sector despite all its resilience and that “may pose funding risk for asset expansion”. “However, the resilience analysis indicates that the banking sector has the capacity to absorb adverse domestic and global stress in the medium-term,” it added.

The SBP said the financial intermediation has improved with a rise in advances to deposit ratio to 55.8 percent, highest in the last eight years.

“Growing advances have helped reduce the gross loans to NPLs (non-performing loans) ratio, but other asset quality indicators have slightly deteriorated due to rise in the quantum of NPLs during last year.”

The SBP said banks have posted reasonable profits. “However, higher provisioning expense along with rise in administrative cost and one-off extra ordinary expense has kept the profitability slightly below the last year’s level,” it added. “Encouragingly, increase in the share of interest income from financing activity has improved the net interest margin, which has been falling for the last 3 years.”

The SBP said the concentration of banks’ exposure to public sector, though reduced due to net retirement in Pakistan Investment Bonds in 2018, “remains significant”. “Further, the risks related to anti-money laundering and combating the financing of terrorism and cyber security need continuous attention for mitigation,” it added.

The State Bank further said the Islamic banking institutions (IBIs) have maintained fast growth trajectory and now constitute 13.5 percent of the total banking sector assets. “This growth is, primarily, driven by broad based financing activity to various economic sectors, with majority of financing extended under profit and loss sharing modes of Musharika and diminishing Musharika,” it added. “While financial health of IBIs remains sound, they continue to face dearth of shariah-compliant investment avenues that limit their ability to effectively manage their liquidity as well as mobilise deposits.”

The SBP said risk averseness in equity market linked non-bank financial institutions (NBFIs), like mutual funds, has increased due to higher volatility in the financial markets, “that has led to contraction in assets under management and flight to safer money market instruments”.

“Nevertheless, to allow the NBFIs to facilitate financial deepening, FSR 2018 suggests that issues like the small size and limited outreach of the capital market, difficulty NBFIs face in mobilising low cost funds and attracting quality human resources need to be addressed through development of an industry level strategy,” it said.

The SBP also advised concerted efforts for mobilisation of affordable long-term financing from development finance institutions as their role in long-term funding remains less than encouraging.

On insurance industry, the central bank said it witnessed higher asset growth due to reasonable increase in gross premium, though its profitability indicators have slid down owing to increase in net-claims. “The insurance penetration remains quite low, indicating sufficient room for expansion in this sector.”

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