Profitability of the banking sector may come under stress in 2HCY20: SBP

November 17, 2020 (MLN): The profitability of the banking sector may come under stress in the next half of the year, mainly, from prevailing low interest rate environment.

However, revaluation gains on government securities, if realized,may offset the impact to a certain extent and the rise in zero risk weighted Government securities will likely strengthen Capital Adequacy Ratio of the banking sector, said State Bank of Pakistan (SBP) in its Mid-Year Performance Review of the banking sector.

During 1HCY20, the profitability of the banking system rose significantly with profit after tax at Rs.125.8 billion, marking a rise of 52 percent over the same period last year.

According to the performance review report, this was the highest level of earnings ever recorded in any H1 since the availability of data from H1CY04.

The earnings was supported by the favorable interest rate environment which facilitated higher net interest income (NII) and larger gains on sale of government securities. In addition, SBP’s measures to contain credit risk also strengthened the earnings of the sector.

Out of the YoY growth of 52 percent, conventional contributed 37 percent points, indicating that it remained the dominated contributor compared to the same period of last year when  Islamic Banking Institutions (IBIs) primarily contributed in the YoY growth in after-tax profit.

The earning indicators such as Return on Assets (ROA) and Return on Equity (ROE), which were almost stagnant for the past two quarters, recorded notable improvement during H1CY20, the report said.

After-tax ROA rose to 1.1 percent in 1HCY20, from 0.8 percent in 1HCY19. Likewise, after tax ROE increased to 14.6 percent in 1HCY20 from 11.4 percent in the same period last year. Moreover, the Net Interest Margin (NIM) observed a considerable improvement. Though the average earning assets grew at an accelerated pace of 10.3 percent in 1HCY20 compared to 3.7 percent in 1HCY19), the net interest income was much higher at Rs 424.7 billion in 1HCY20 against Rs 330.6 billion in 1HCY19. Besides the increase in volume of investments, the favorable interest rate environment also facilitated in improving the NIM., the report underlined.

Among the contributing factors, earnings on investments boosted the overall interest income. The share of earning on investment is rising and exceeded earnings from customer advances during H1CY20. The earnings on advances, however, recorded deceleration in H1CY20.Although the interest rates remained in double digits until March 2020, the emergence of COVID-19 related lockdowns plummeted the demand for advances.

The non-interest income also contributed in profitability during 1HCY20 where gains from sale of securities was the major factor. Banks made Rs.34.6 billion gains from the sale of securities during H1CY20; mostly from dealing in MTBs and PIBs. Moreover, due to the revival of equity market during Q2CY20, the benefit from trading in shares also contributed marginally.

In line with lockdown measures and abrupt fall in economic activities, the fee, commission and brokerage income consisting of around 65 percent share in non-interest income, fell sharply by 11.3 percent YoY to Rs. 54.8 billion in 1HCY20. However, its impact was compensated by the rise in gains from sale of securities during 1HCY20, the report underscored.

The report also higlihgted the outook of the banking sector for 2HFY21, as per which the performance of the banking sector in 2HCY20 depends upon the trajectory of COVID-19, economic recovery, and the evolving policy environment. While financial conditions in the form of interest rates and asset prices remain supportive.

Furthermore, the recent uptrend in virus infections presents a challenging scenario domestically as well as globally. In this backdrop, the outlook for the private sector advances presents a mixed picture. However, a seasonal uptick  LSM index in 2HCY20 may stimulate demand. To note during Jul-Aug 2020, LSM index has grown by 3.66 percent YoY.

Similarly, looming uncertainty about the timing of recovery in the foreign markets could subdue demand from export oriented sectors such as Textiles. Besides demand for credit, in case of crystallization of downside risks, the re-payment capacity of the borrowers could weaken that may lead to furtherrise in NPLs, the report cited.

On the other hand, Banks’ investments are likely to remain strong during the second half of CY20. The pandemic related uncertainties would take time to subside, hence banks’ risk averse behavior may keep lending flows subdued. Consequently, government securities may remain a preferable alternative, the report added.

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Posted on: 2020-11-17T18:47:00+05:00