The profitability of Pakistan’s banking sector decelerated significantly in the first half of 2024, with after-tax profit growing by just 1.1% to Rs. 287 billion, according to the State Bank of Pakistan’s (SBP) Mid-Year Performance Review of the Banking Sector.
This slowdown was driven by reduced growth in advances and declining returns on earning assets as market interest rates adjusted to lower inflation. The report also highlighted a contraction in the sector’s net interest margin (NIM), as net interest income (NII) in H1 2024 was 13.2% lower than in the second half of 2023.
A detailed analysis showed that changes in interest rates negatively impacted earnings from advances on a year-on-year basis. However, investments benefitted from both rate changes and an increase in volume. On the other hand, interest expenses on deposits rose due to increased rates and deposit mobilization, while borrowing expenses were affected by lower rates, though higher volumes pushed costs up.
Key profitability indicators such as return on assets (ROA) and return on equity (ROE) also fell. The after-tax ROA and ROE of the sector dropped to 1.2% and 20.4% in H1 2024, respectively, compared to 1.5% and 26.0% in H1 2023.
Outlook for H2 2024
The SBP’s review suggests that the sector’s performance in the second half of 2024 will depend on the broader operating environment and evolving policy measures. Positive signs include the revival of economic activity, receding inflation, and a narrowing current account deficit. Additionally, the SBP has reduced the policy rate by 450 basis points, and a stable exchange rate is expected to ease financial conditions.
The banking sector’s expansion is expected to be driven by increased investments, mainly to meet the government’s borrowing needs. Advances are projected to gain momentum in the fourth quarter of 2024 due to seasonal factors, economic recovery, and improved financial conditions.
The SBP report also notes that a continued economic recovery may enhance both credit demand and borrowers’ repayment capacity, potentially improving banks’ credit risk profiles. The recent upgrade in Pakistan’s sovereign credit rating is seen as a positive development, though the timely implementation of a new IMF program will be critical in reviving financial inflows.
Challenges Ahead
Despite these improvements, the report warns that the banking sector’s exposure to the government is expected to remain high in H2 2024. It calls for the government to take serious measures to reduce its reliance on the banking sector for fiscal needs.
However, the SBP stressed that the sector remains resilient, with sufficient capital buffers to withstand potential shocks. Results from macro stress tests indicate that the banking sector, particularly the large systemically important banks, is well-positioned to endure severe economic shocks over the next two years.
Expansion of the Balance Sheet
The banking sector’s balance sheet expanded by 11.5% in H1 2024, driven mainly by investments in government securities. Despite this, advances to the private sector remained subdued due to net retirements, although long-term financing for SMEs showed some revival. The decline in private sector advances was notably lower than in H2 2023.
On the funding side, deposits increased by 11.7%, driven by growth in saving and current accounts. However, the higher pace of asset growth required additional funding, leading to continued reliance on borrowing.
Asset Quality and Solvency
The asset quality of the sector remained stable, with a subdued increase in gross non-performing loans (NPLs). Total provisioning coverage against NPLs improved to 105.3% by the end of June 2024, aided by the adoption of IFRS-9, which led to general loan loss provisions for performing loans.
Non-interest income, including fee income and trading gains on government securities, helped support profitability. Despite a decline in key profitability metrics, the sector’s solvency position remains strong. The Capital Adequacy Ratio (CAR) improved to 20.0%, up from 17.8% in June 2023, well above regulatory requirements.
In conclusion, the SBP’s review highlights that, despite the challenges faced by the banking sector in H1 2024, the gradual improvement in macroeconomic conditions and resilience of the sector are expected to drive steady performance in the second half of the year.
