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Financial institutions under the pandemic : a brief review

Collectively, financial sector’s risk indicators have significantly strengthened since the last financial crisis of 2008. In terms of capitalization, the industry boasts of a CAR of 18.7% , ADR of 46.3% and about 53% of the asset base is liquid as of June 2020. These ratios are indicative of strong loss absorption buffers while the excess liquidity available with the banks should allow them to sail through the crises. Private sector lending, which is expected to be most affected during pandemic stood at Rs. 5.8 trillion as of June 2020 out of which 8.1% was outstanding against the SME sector. In contrast to deposits, private sector lending constitutes roughly a third.

State Bank of Pakistan (SBP), in an effort to promote financial stability, ensure continuous credit supply to the economy and maintain confidence in banking system, has taken a few measures which include the following:

  • Banks were allowed to defer principal payments for up to one year.
  • The policy rate had been reduced by 625 basis points to 7% (Dec-19: 13.25%).
  • Capital conservation buffer has been waived by 100 bps to 1.5%.
  • For SMEs, the regulatory limit for extension of credit has been increased from Rs. 180 million.
  • Debt burden ratio for consumer loans has been enhanced from 50% to 60%.

By end June 2020, the quantu0m of deferment requests stood at Rs. 593 billion which is roughly 7% of the industry advances. The SBP mandated relaxations are expected to delay the impact of non-performance from reflecting on the asset impairment ratios. Accordingly, the asset impairment ratios of the industry are expected to broadly remain intact in short term. The uptick in impairment ratios is likely to materialize as and when SBP relief period matures i.e. June 2021. In the short term, the deferment of principal and markup payments and further requirement of short term financing for the industry will require channelization of liquid assets towards lending. Nevertheless, industry liquidity is considered to be strong.

The industry profitability is expected to weaken going forward on account of the following:

So far, the interest rates have already dropped by 625 bps, this sharp drop in interest rates and narrowing of the interest rate corridor is expected to negatively affect banking spread. A review of historical banking spread in low interest regime indicates that spread shrinkage is likely going to be approx. 50 bps. However, in the near term, spreads may post short term improvement as a result of faster re-pricing on liabilities vis-à-vis assets. This short term spread improvement will likely keep the spreads intact for the ongoing year. The adverse credit risk movement is expected to translate in increased provisioning burden on account of pandemic outbreak. In view of the reduced economic activity and trade volumes, fee related income and overall ancillary income will reduce with most banks expecting a 10% reduction. This, along with projected spread shrinkage in 2021, will have an adverse impact on efficiency ratios across the industry.

It is evident that the banking industry is expected to go through a stressed phase with profitability concerns and increased loan loss expectations particularly in 2021. While these projections are expected to test the asset quality of the sector, capitalization buffers are expected to reinforce over the past decade to provide adequate cushion to absorb these loan losses.

Rs. In billions Dec-18 Jun-19 Dec-19 Jun-20
Total Assets 19,682 20,718 21,991 23,705
Net Investments 7,914 7,968 8,939 10,979
Net Advances 7,955 8,104 8,249 8,065
Borrowings 3,001 2,620 2,932 2,971
Deposits 14,254 15,227 15,953 17,404
Equity 1,406 1,488 1,658 1,814
Profit After Tax 149 83 171 126
Provisioning charges 36 26 68 57
Non-Performing loans 680 768 761 847
Net NPLs 110 166 141 156
CAR 16.2 16.1 17.0 18.7
Gross Infections 8.0 8.8 8.6 9.7
Net infections 1.4 2.1 1.7 1.9
ROA 1.3 1.6 1.5 1.9
ROE 17.4 21.3 20.1 25.2
ADR 55.8 53.2 51.7 46.3

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