The ongoing challenging macroeconomic environment, compounded by torrential rains and flooding, is likely to dent the repayment capacity of banks’ agri and microfinance borrowers in the flood-affected areas, according to the Mid-Year Performance Review of the banking sector issued by the State Bank of Pakistan (SBP).
The torrential rains and flooding in many parts of the country have caused heavy losses to human lives as well as crops, livestock, dwellings, and infrastructure. As a second-round effect, it may impact the financial performance of some agri-based sectors, such as textiles, sugar, fertilizer, etc., as well as the economy in general, the review added.
The review stated that banks as well as microfinance banks need to make prudent assessment of the possible impact on lending portfolios and take the necessary measures for maintaining the asset quality and resilience of the financial strength of their institutions.
The non-performing loans in the agri portfolio may not face a significant increase due to inbuilt flexibility in the regulatory framework, which allows rescheduling in the event of such natural calamities. However, the challenging environment could weaken some of the borrowers of microfinance banks, which typically have low resilience to cope with such natural disasters and macroeconomic shocks.
According to the review, the ongoing economic stabilization measures to contain aggregate demand, coupled with any significant weakening in the output and sales of major borrowing sectors, may affect the demand for private sector credit. However, in line with the seasonal pattern of higher credit demand in the fourth quarter and elevated input prices, this may lead to some increase in advances.
Banks’ interest in government securities is likely to remain intact amid higher government financing needs, particularly in the wake of recent flooding. Banks’ earnings indicators observed some dips in the first half of 2022.
However, with the translation of interest rate changes onto the prices of earning assets during the second half of 2022, the interest margins and corresponding earning indicators are expected to improve.
This, coupled with the expected increase in risk-weighted assets during the last quarter, is likely to keep the capital adequacy position steady. The overall environment may remain challenging in the near term. Nevertheless, the results of SBP’s macro-stress testing show that the overall capital adequacy ratio of the sector, in both business as usual and hypothetically stressed economic conditions, is likely to remain well above the minimum regulatory requirement over the projected period of the next two years.
SBP’s review covers the performance and soundness of the banking sector for the period January to June 2022 (H1CY22).
The review reveals that sustained economic activity during the first half of the calendar year 2022 (H1CY22) supported the expansion of the banking sector balance sheet by 16 percent during H1CY22. The robust increase in the asset base was mainly driven by the flow of private sector advances and an increase in investments, particularly in government securities. Besides the sizable mobilization of deposits, the banks’ reliance on borrowings increased significantly to finance the expanded balance sheet.
The pace of private sector advances growth during H1CY22 was the highest in comparable periods of the previous three years. Improved manufacturing activity, as reflected in double-digit growth in the Large Scale Manufacturing (LSM) index during H1CY22, higher input prices, and the SBP’s refinance schemes, augmented the overall flow of advances.
The review highlights that baseline profitability indicators moderated, despite strong growth in incomes, mainly due to the impact of a sharp increase in tax charges. The Capital Adequacy Ratio (CAR) of the banking sector slightly edged down to 16.1 percent due to faster growth in the asset base and advances. Nevertheless, the ratio remains well above the minimum regulatory requirement (i.e., 11.5 percent), and the banking sector in general has adequate capital buffers and resilience to withstand the impact of severe stress from macroeconomic conditions and shocks to key risk factors.