In the midst of economic challenges, why is the banking sector thriving? 

KARACHI: In the midst of rising inflation, economic uncertainty and falling business confidence the country’s banking sector has continued to post skyrocketing profits. The first half of this fiscal year saw banks double profits from Rs 126.2 billion in the same period last year to an impressive Rs 284.5 billion.

The asset base of the banking sector also experienced significant growth, expanding by 14 percent from January to June 2023, compared to a 16 percent increase during the same period in the previous year, ultimately reaching an astonishing Rs 40.8 trillion. The driving force behind this growth was primarily investments, constituting 52.7 percent of the asset base, while advances, or loans to the private sector, remained subdued.

There has also been a marked slowdown in domestic private sector advances during H1CY23, which contracted by 7 percent, in stark contrast to the 6.8 percent growth observed in the corresponding period last year.

What is up with the increasing investments? 

A significant contributing factor to the increase in investments was the increasing reliance on government securities within banks’ investment portfolios. By the end of June 2023, government securities and total investments accounted for 49.6 percent and 52.7 percent, respectively.

Despite a challenging economic landscape, banks also witnessed a notable increase in their deposits, rising by 14.2 percent during H1CY23 to reach Rs 26.8 trillion by the end of June 2023. This influx of deposits, coupled with a slower pace of lending, led to a decline in the Advances to Deposits Ratio (ADR) from 50.4 percent in December 2022 to 45.0 percent.

The remarkable surge in profits can largely be attributed to higher net interest income, driven by rising interest rates. The SBP policy rate saw a cumulative increase of 600 basis points during H1CY23. While interest income doubled to Rs 2723.1 billion in H1CY23 compared to the same period in the previous year, interest expenses also more than doubled to Rs 1882.1 billion.

While the increase in interest rates played a significant role in boosting banks’ income from advances and investments, the expansion in the volume of these assets also contributed to the growth in interest income. However, non-interest expenses increased by 31.9 percent during H1CY23, surpassing last year’s figures.

Outlook for next half of 2023

As the banking sector looks to the second half of 2023, its performance will be contingent on the operating environment and evolving policy stance. Furthermore, the results of the latest stress tests indicate that the banking sector is expected to display resilience in the face of severe macroeconomic shocks over the next two years. Expectations for the banking sector in the coming months include continued steady performance, driven by investments to meet the government’s borrowing needs. Advances are also anticipated to rise in the final quarter of CY23, especially in sectors like textiles and sugar, which could boost credit demand.

While the banking sector is likely to maintain its operating performance, the impact of higher interest rates may pose challenges in terms of high-interest expenses. Nevertheless, steady earnings are expected to support solvency and improve capital adequacy ratios. Though aggregate demand containment and stressed financial conditions may raise credit risk concerns, the sector’s exposure to corporate borrowers with robust creditworthiness is expected to safeguard asset quality. However, reducing the banking sector’s reliance on government borrowing remains a pressing need to ensure long-term fiscal stability.