Banking sector resilient to adverse economic shocks: SBP

KARACHI: Pakistan’s banking sector has adequate resilience to withstand the severe economic shocks, as its capital adequacy ratio remains significantly higher than both domestic and global benchmarks of solvency in the medium term, the State Bank of Pakistan (SBP) said on Tuesday.

“Stress test results show the banking sector is expected to maintain a reasonable resilience against various hypothetical adverse economic shocks over the projection period of three years,” said the SBP in its Financial Stability Review (FSR) for 2021.

The hostile macroeconomic conditions are associated with severe pressures on the global commodity prices, recurrence of extreme weather conditions such as floods and droughts, and any assumed disruptions to the IMF programme.

“Reassuringly, the domestic systemically important banks particularly show stronger capital buffers, and the banking sector, in general, is likely to continue supporting the economy by lending even during periods of economic stress,” it added. The SBP regularly conducts scenario analysis (macro stress testing) to chart out the probable outlook of banks’ credit risk and solvency against the multiple domestic and global stress factors for informing its policy interventions.

The capital adequacy ratio of banks stood at 16.7 percent and stayed well above the minimum domestic regulatory benchmark of 11.5 percent and the international benchmark of 10.5 percent.

The SBP said the risks to financial stability are contingent upon the strength of external buffers, policy continuity, and overall macroeconomic conditions in the context of developments on the geopolitical front in Europe and global financial conditions.

A rising trend in the global commodity prices and a slowdown in the world economic growth may influence the country’s external account dynamics.

“A further increase in oil prices may exacerbate the current account deficit that may have adverse implications for financial markets and the real economy. On the other hand, continued monetary tightening by the US Federal Reserve, for instance, may push up the external funding cost and add to pressures on the exchange rate, impacting foreign trade and portfolio investments,” it said.

On the domestic front, preserving external sector stability, implementation of agreed reforms under the IMF programme —including fiscal discipline — and political stability will play a pivotal role in keeping the confidence in

financial markets, maintaining financial system stability, and addressing the emerging risks to macroeconomics, it noted.

The SBP expects delinquency rates in banks’ lending portfolios to remain in check owing to improved debt servicing capacity of the corporate sector, decent recoveries on rescheduled /restructured loans under the debt relief scheme, and continuing demand for bank credit due to higher input prices.

“The consumer portfolio of banks may also face some strain due to both rate rise and general inflation levels,” it said and added, “[Given] the contained exposure of banks to this sub-sector, and risk management capabilities that banks have developed over the years for retail exposures, and the prudential requirement of making general provisions against consumer portfolio, it is expected that the banks may not face any significant strain on asset quality and earnings”.

The recent increase in interest rates will improve the banks’ margins on growing earning assets, according to the SBP.

The fiscal needs of the government are seen keeping the level of banks’ investments in government securities elevated. However, the mobilisation of deposits and generation of adequate liquidity is likely to remain a key challenge for banks to finance the increased demand for bank credit from the public and private sectors.

The implementation of IFRS-9 may result in a slight increase in provisioning expenses in respect of prospective losses; however, it has been observed that the banking industry, in general, has already raised the level of general provisions over the last few years.

The financial sector’s asset base expanded by 15.6 percent in 2021, while financial markets observed relatively contained volatility compared to last year.

The banking sector posted strong growth of 19.6 percent, compared with 14.2 percent in the previous year. The growth was particularly aided by a surge in private sector advances.

The expansion was well supported by healthy deposit growth of 17.3 percent, while banks also increased reliance on borrowing from the banking system. Encouragingly, the credit risk of the banking sector remained contained as the gross non-performing loans (NPLs) ratio declined by 130 basis points (bps) to 7.9 percent, while the provisions coverage ratio improved by 291 bps to 91.2 percent. Accordingly, the net NPLs ratio declined to 0.7 percent, indicating lower residual risk to the solvency from delinquent loans. On the performance front, the earning indicators observed improvement as return on assets stood at 1.0 percent and return on equity improved to 14.1 percent, the FSR noted.

The Islamic banking segment also posted strong performance with a 30.6 percent increase in its asset base in 2021, extending their share by 160 bps to 18.6 percent in the banking sector.

Microfinance banks, which exhibited a reasonable growth, observed an uptick in infection rate and deterioration in earning indicators.