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December30,2008Pakistansbankingsectorremarkablyresilientdespite

challengingeconomicenvironment:SBPsFinancialStabilityReviewPakistansbankingsectorhasremainedremarkablystrongandresilient,despitefacing

pressuresemanatingfromweakeningmacroeconomicenvironmentsince late2007,according

totheassessmentoftheStateBankofPakistansFinancialStabilityReview200708 released

today.

TheReportsaidthatgivenitsbankcentricnature,thestabilityofthefinancialsystemis

derivedessentiallyfromthebankingsystem.Anassessmentoftheperformanceofthebanking

sectorfromJanuary2007toJune2008showsthatPakistansbankingsystemhasovertheyears

nurtured itselfsuchthat it isabletowithstandsomeoftheshocks ithasfaced inthe last18

monthsorso.

ThebankingsystemisonstrongfootingandhaslongtermpotentialafeaturewhichhasservedtoattractasubstantialamountofFDIinthesector,withestablishedglobalfinancial

institutionsnowactiveparticipants inthedomesticfinancialsector, itsaidandaddedthat it

has been wellgoverned and being in private hands under professional management, has

witnessedoutstandingfinancialperformanceduringthelastfewyears.

TheReport states thatwith strong regulatoryoversight, therehasbeen a significant

enhancement of capital and riskweighted capital adequacy, supported by high provisioning

requirementswhichweretightenedin2007.Stringentloanprovisioningrequirementhasbuilt

sufficientreservesagainsttheNPLsportfolio. Incontrasttothe liberalizedfinancialsystem in

thewestwhichtookitstollintheformofthecurrentglobalfinancialcrisis,therearestringent

regulations

and

adequate

policies

in

place

to

help

the

banking

system

manage

its

risks.

Itpointedoutthataggregatefinancialsoundness indicatorshave improvedsinceearly

2000, and continue to exhibit strong performance. Tighter provisioning requirements may

havereducedprofits,buthavepositionedbankswell,itsaidandaddedongoingconsolidation

andmergershaveenabledanumberofbankstopositionthemselvesbetter.

Having observed the experiences of the global economy, the way forward for the

financialsectoristomaintainboththesimplicityandtransparencyofproductstructuresanda

gradualpaceoffinancial liberalizationtoenablethe financialsector inexpandingfurther ina

more sound, healthy and efficient manner, the Report said, and added that effective

regulationisthepreferredrouteforcentralbanksresponsibleforsafeguardingbothmonetary

andfinancialstability.

TheReport

said

solvency

profile

has

improved,

and

given

the

pressures

from

the

macroeconomicenvironment,there isan indicationofmarginaldeterioration inassetquality,

whichbanksarewellequipped tohandle.Stress testsconductedon June2008data indicate

thatthe largebanksarerelativelyrobust,withthemediumandsmallsizedbankspositioning

themselvesinnichemarkets,itadded.

Capitaladequacyofthebankingsystem isstrong,12.1percentatendJune2008,well

above the internationallyacceptableminimumrequirementof8.0percent, itsaidandadded

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core capital constitutes about 80.0 percent of the total capital, and Tier 1 to riskweighted

assetsratioofthebankingsystemisat9.7percent.

Thisstrongcapitalbaseisaccompaniedbyadequatereservesonthebackofstringent

provisioning requirements against classified assets the net NPLs to net loans ratio is

reasonablywell

contained

i.e.

at

1.3

percent

in

June

2008,

comparable

to

international

best

standards, the Report pointed out. Profitability of the banking system continues to be

impressive, largely emanating from the persistent growth in highyield earning assets and

expandedbusinessvolumes.BeforetaxReturnOnAssetsofthebankingsystemremainsstrong

at2.3percentinJune2008.Thestrengthsbuiltupovertheyearsarenowcominginhandyin

managingtherecentfinancialstrains.

TheReportmentionedthatthedemand forcreditfromboththegovernmentandthe

privatesectorresultedinliquiditystrainsfacedbysomeindividualbanks,whichalsoemanated

fromthecombinedimpactoftheirweakdepositmobilizationandlowinterestratesofferedon

deposits. TheGovernments and public sector organizations excessive borrowings from the

bankingsystemposedanotherchallengeforthebankingsystem.Notwithstanding,theliquidity

strainsweretemporaryandtheinterbankmarketisnowfunctioningnormally.

Albeitgoingforward,thebankingsectorfacesasignificantchallengeinmaintainingits

depositbaseandinattractingnewdeposits,giventhethreeroundsofincreaseintheratesof

returnonNSS instruments in the first fewmonthsofFY09.Thiswill inaway force them to

enhance the quality and returns on their liability products, and strengthen competition, it

pointedout.

TheReportnoted that the liquiditypositionofbanksalsohadan impacton theNon

BankingFinanceCompanies(NBFCs),whosemainsourceoffundingcontinuestobecreditlines

frombanks. Abroaderassessmentof financialstability indicates that the financialsector is

toobankcentric,and theoutreachandgrowthof theNonBankFinanceCompaniesand the

Insurancesector

have

languished

in

recent

years,

it

said

and

added

NBFCs

face

direct

competitionfrombanksandarenotlikelytogrowsignificantlyuntiltheirfundingsourcesand

costsarestreamlined. Atthesametime,growth inthe insurancesector isweak,andprivate

pensionfundshaveonlyrecentlystartedtogathersomepace. Theinsurancesectorisunlikely

to growunless it gets an infusion of innovation and efficiency. The interest from banks to

associatethemselveswithinsurancecompaniesanddevelopnewproductsforcrosssellingmay

alsorevitalizethesector.Privatepensionfundshaveanenormouspotentialasindicatedbythe

growthofsuch funds inotheremergingmarkets,wheretheyhavebecome importantand in

somecases,principalinstitutionalinvestorsandthemainprovidersoflongtermfunds.

TheReportassertedthatanexcessivedependenceonthebankingsystemtomeetthe

financing

needs

of

the

economy,

as

well

as

other

participants

of

the

financial

sector,

is

quite

stark in comparisonwithother emerging economies,where in general, the growth inother

componentsofthefinancialsector,suchascapitalmarkets,complementsandsupplementsthe

financingcapacityofthebankingsector.

While financial markets (money market and foreign exchange market) remained

resilient to the developments in the macroeconomic environment and functioned well in

maintainingfinancialstability,theimpositionofthefloorof9,144pointsontheKSE100index

in August 2008 has adversely impacted investor sentiments by effectively blocking the exit

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mechanism generally taken for granted in amarket based system. Incidentally, there is no

knownprecedentofplacingaflooronamarketindex,albeittemporarysuspensionoftradingin

equitymarkethasbeenimplementedinsomecasesasanextrememeasure,theReportadded.

TheReportgivesadetailedassessmentofthechannelsoftransmissionofthesecondround

impactof

the

ongoing

global

financial

crisis

on

the

domestic

economy

and

financial

sector.

The

Reportpointsoutthatdespiteseveralachievementsofthefinancialsectorinrecentyears,

financialdepthandpenetrationinPakistancontinuestobelow,andSBPsfinancialinclusion

strategyaswellastherecentlylaunchedstrategicplanfortheIslamicBankingIndustry,are

bothaimedatextendingthenetoffinancialservices.

ThedetailedReportcanbeaccessedatSBPswebsitewww.sbp.org.pk