According to the Mid-Year Performance Review (MPR) of the banking sector released by the State Bank of Pakistan on 21st October, 2019, banking sector maintained its growth trajectory during the first half of 2019 on account of decent increase in deposits, thanks to an amnesty scheme announced by the government. On the liabilities side, deposit growth accelerated to 6.8 percent during January-June, 2019, up from 5.7 percent in the comparable period of last year. A good portion of these deposits was mobilised in June, 2019, leaving a very little time to deploy the funds in higher yielding earning assets. On the assets side, private sector advances witnessed a broad-based slowdown while public sector advances declined due to lower utilisation of commodity financing and retirement of energy sector advances. Resultantly, banks' borrowings declined by 12.7 percent and advances to deposit ratio dipped to 53.2 in June, 2019 compared to 55.8 in December, 2018. Overall, the risk profile of banking sector remained satisfactory and Capital Adequacy Ratio (CAR) at 16.1 percent was well above the local and international benchmark of 11.9 percent and 10.5 percent, respectively. Advances (net) decelerated to 1.9 percent compared to the rise of 12.3 percent in H1CY18 while investments also witnessed a slight increase of 0.7 percent in the first half of 2019 against a contraction of 3.6 percent in the same period of the preceding year.

So far as the second half of 2019 is concerned, the demand of private sector credit is expected to remain subdued due to stabilisation measures initiated by the government and subdued economic activity in the country. Projected slowdown in world economic activity, particularly in the US and the Euro area, is likely to influence exports and demand for advances. Banks may continue to remain risk-averse in their lending behaviour due mainly to a pick-up in NPLs and weakening repayment capacity of firms. The government's commitment to cease its borrowings from State Bank of Pakistan was expected to increase its reliance on commercial banks for financing needs. As such, investments of banks in gold-edged securities is expected to rise further. The rise in Minimum Saving Rate (MSR) is likely to induce depositors to opt for more saving and fixed deposits. Earnings of banking sector are also likely to remain decent in the second half of 2019 due to higher interest earnings and expected pick-up in banks' investment in government securities.

We feel that the latest MPR of the State Bank of Pakistan both for the first and second half of 2019, as usual, is a true reflection of the developments now prevailing in the banking sector and the position likely to emerge in the remaining part of the year. The beauty of the narrative lies in the fact that the banking sector's developments of the year as elaborated in the MPR have been closely related to the situation in other areas of the economy and the monetary policy changes made by the SBP so that ordinary people and the government authorities could have a fairly good idea about the inter-linkages in the economy. To start with, it is good to see that deposits have shown a respectable growth during the year compared to last year and this is mainly due to amnesty scheme offered by the government during the period under review and tightening of monetary policy which seems to have altered the spending behaviour of households in favour of savings. This is probably the biggest gain of higher deposit rates which could accelerate the growth in credit to the private sector as well as provide a source of reliable funding for meeting the budgetary needs of the government.

However, the MPR has also made it clear that higher budgetary requirements of the government sector could also reduce the flow of credit to the private sector which, in turn, could affect the growth rate of the economy. This calls for narrowing the budget deficit which could release more resources for utilisation in the private sector and constrain the banks to serve more as an intermediary between savers and investors in the larger interest of the economy. Advances to deposit ratio has dropped from 55.8 percent in December, 2018 to 53.2 percent in June, 2019 which tells a lot about the risk-averse behaviour of the banking sector and its tendency to invest higher amounts of deposits in government securities during the period under review. In our view, fiscal deficit has to be drastically reduced in order to force a change in the behaviour of banks. A sharp increase of Rs 88.3 billion in NPLs is of course a source of anxiety. This may be due to a slowdown in the business activity in the country and tightening of monetary policy but if NPLs also continue to increase in the second half of 2019, the SBP and commercial banks would need to have a serious look at the situation and take appropriate measures to bring down the amount of NPLs to the previous levels. Fortunately, CAR of banks is still quite high, giving the needed confidence to both the clients of the banks and the regulatory authority about the soundness of the banking system. Banks also need to closely watch the developments in the FATF meetings. This is important due to the repercussions the country and the banking system may have to face if a negative change in country's status is made by the FATF due to the failure of the Pakistani authorities to meet its conditions. The commitment of the authorities to the IMF to make necessary adjustments in the monetary policy of the country would also weigh heavily on the minds of policymakers as well as Bankers.

This article published in Business Recorder on editorial page 25 October 2019.

Copyright Business Recorder, 2019