Banking Sector Profit Grows by 1.1% in H1 2024  

The earnings of the banking sector slowed down, as the after-tax profit grew only by 1.1 percent to Rs. 287 billion in H1 2024, according to State Bank of Pakistan’s (SBP) Mid-Year Performance Review of the Banking Sector.   This slowdown in profitability was due to both a deceleration in the growth of advances as well as falling returns on earning assets as the market interest rates started to factor in the declining inflation.   Accordingly, net interest margin (NIM) of the banking sector also contracted over the reviewed period. The net interest income (NII) of H1 2024 remained 13.2 percent lower than that of the second half of 2023. Detailed analysis to identify the sources of change in interest income and expense reveals that the changes in interest rate negatively contributed to YoY change in earnings from advances; however, in case of investments both a change in rate and an increased volume supported earning. Similarly, in case of deposits both change in rates and increased deposit mobilization contributed in increased interest expenses on deposits.   However, in case of borrowing, the change in rates reduced expenses on borrowing, though volume pushed the expenses up. The key profitability indicators earnings, nonetheless, slowed down owing to declaration in return on advances and contraction in net interest margin.   The after-tax ROA and ROE of the baking sector also declined to 1.2 percent and 20.4 percent in H1 2024 compared to, respectively, 1.5 percent and 26.0 percent in H1CY23 The performance of the banking sector in H2CY24 depends on the operating environment and evolving policy stance. Encouragingly, macroeconomic environment has been improving with revival in economic activity, receding inflationary pressures, and narrowing current account deficit. Moreover, SBP has cut policy rate by 450 bps, so far. Foregoing improvements, coupled with a stable exchange rate, are likely to ease the financial conditions, going forward.   The banking sector is expected to continue on the path of steady performance. The expansion in balance sheet is likely to be driven mainly by investments owing to persistent borrowings needs of the government. Advances are also expected to gain momentum in Q4CY24 due to, inter alia, seasonal factors, the expected recovery in economic activity and easing of financial conditions. Earnings of the banking sector are likely to remain steady on the back of increase in the volume of earning assets and will likely support the solvency position.   A continued economic recovery may enhance both credit need as well as the repayment capacity of the borrowers and further improve the credit risk profiles of the banks. The recent upgrade in sovereign credit rating is a positive development, however, the timely realization of new IMF program will significantly help revive financial inflows. Nonetheless, the banking sector’s exposure to the government is expected to remain high in H2CY24 and it demands earnest measures by the treasury to reduce the reliance on banking sector for fiscal needs.   Nonetheless, the banking sector, due to its capital cushions and buffers, is expected to remain resilient to adverse hypothetical but plausible shocks to key risk factors as well as macroeconomic conditions. For instance, results of the latest macro stress tests also suggest that the banking sector, in general, and the large systemically important banks, in particular, are expected to show resilience and withstand assumed severe macroeconomic shocks over the projected period of two years The Review highlights that the balance sheet footing of the banking sector expanded by 11.5 percent in H1 2024, which was mainly driven by investments in government securities as the government demand for bank credit remained high.   Advances, however, posted a contained growth due to the net retirements by the private sector, although long-term financing to SMEs showed some revival. Nonetheless, the decline in private sector advances was significantly lower as compared to H2 H1 2023.   On funding side, deposits increased by 11.7 percent in H1 0Y24 with a major impetus from saving and current deposits. The higher pace of assets growth, however, necessitated additional funding, which kept banks’ reliance on borrowing intact. The Review notes that the asset quality profile of the sector remained satisfactory, as gross NPLs witnessed subdued increase. Moreover, the total provisioning coverage against NPLs further improved to 105.3 percent by end June-2024, as with the application of IFRS-9, the banks also started to provide general loan loss allowances for performing loans.   Non-interest income such as fee income and trading gains on government securities, however, supported profitability. The performance indicators such as Return on Asset (ROA) and Return on Equity (ROE) thus declined to 1.2 percent (1.5 percent in June-2023) and 20.4 percent (26.0 percent in June-2023), respectively. The solvency position of the banking sector remained strong as Capital Adequacy Ratio improved to 20.0 percent (17.8 percent in June-2023) and was well above the minimum regulatory environment. The Review reveals that in the wake of gradual improvement in macroeconomic conditions, domestic financial markets witnessed relatively lower stress during H1 2024.