The State Bank of Pakistan (SBP) issued a Mid-Year Performance Review (The Review) of the Banking Sector, shedding light on the challenging macroeconomic environment prevailing in the second half of the calendar year. This adversity stems primarily from subdued economic activity and elevated inflation levels.

Covering the period from January to June 2023 (H1CY23), The Review not only evaluates the performance and robustness of Pakistan’s banking sector but also briefly delves into the financial markets and Systemic Risk Survey results, which represent expert insights on potential risks to financial stability.

During the first half of CY23, the banking sector demonstrated commendable performance and resilience. However, the trajectory of the sector’s performance in the latter half of CY23 hinges on the operational landscape. The macroeconomic environment remains challenging, primarily due to sluggish economic activity and persistent inflation. Furthermore, domestic financial conditions have tightened significantly due to stabilization measures.

Despite these hurdles, SBP anticipates that business confidence may experience a revival following the recent IMF Stand-By Arrangement (SBA). In this context, the banking sector is expected to sustain its steady performance in the foreseeable future.

The Review underlines that while economic stabilization policies to curb aggregate demand and address financial stress may raise credit risk concerns for banks, their asset quality is likely to remain robust. This is attributed to their significant lending focus on corporate borrowers, who typically possess better creditworthiness and resilience to economic shocks.

However, the Review points out that the banking sector’s high exposure to the government necessitates earnest measures to reduce reliance on banks for fiscal requirements.

Looking ahead, the major expansion of the balance sheet is expected to be fueled by investments, driven by the government’s borrowing needs. Additionally, advances are projected to experience a seasonal uptick toward the end of CY23, with increased credit demand from sectors such as textiles and sugar in Q4.

The SBP highlights that the banking sector’s operating performance is likely to remain solid as the impact of rising interest rates continues to translate into returns on earning assets in the coming months. However, elevated interest expenses may temper earnings growth, but the steady earnings are expected to bolster solvency positions and improve capital adequacy ratios.

The Review also underscores the resilience of the banking sector, particularly the large systemically important banks, in the face of assumed severe macroeconomic shocks over a two-year period, as revealed by macro stress tests.

Despite these challenges, the banking sector’s balance sheet expanded by 14.0 percent during H1CY23, primarily driven by investments in government securities. Alongside robust deposit inflows, banks continued to rely on borrowings.

Advances of the banking sector registered muted growth during H1CY23, with private sector advances contracting while the public sector sought additional financing, primarily for commodity finance operations. Encouragingly, asset quality indicators improved, with the net non-performing loans (NPLs) to loans ratio decreasing to 0.45 percent by the end of June-23.

Profitability indicators also showed marked improvement, with return on assets (ROA) rising to 1.5 percent in H1CY23. This enhanced earnings, in turn, contributed to a strengthened Capital Adequacy Ratio (CAR) for the banking sector, reaching 17.8 percent by the end of June-2023.

Finally, The Review delves into the results of the 12th wave of the Systemic Risk Survey (SRS) conducted in July-23. The key potential risks identified for the financial system include foreign exchange risk, rising domestic inflation, and political uncertainty. However, respondents expressed confidence in the stability of the financial system and the regulatory authorities’ ability to manage potential challenges effectively.

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