LAHORE, Oct 31: The major challenge faced by the banking sector is efficient deployment of funds into earning assets in an “increasingly competitive environment and less than robust growth in credit demand,” a Pakistan Credit Rating Agency (Pacra) report on private commercial banks says.

In its review of performance of private banks during the first half of the current year issued on Friday, Pacra said most banks, however, had managed to maintain their position and their overall credit-to-deposit ratio also remained almost static.

It said private banks maintained deposit-led growth during the current year. Benefiting from the continuing consolidation in the nationalized banks and the cautious stance of most foreign banks, private banks managed to marginally increase their system share.

“This is largely due to improvement in service quality and the expanding geographical outreach,” the review said.

“For majority of these banks, considering their focus on trade finance, the growth in imports/exports business provided required impetus for expansion and the trend is likely to continue,” added the report.

Meanwhile, the Pacra review said increasing focus on consumer financing would emerge as a major catalyst in the volume growth. Housing finance is yet another area that is being targeted for credit expansion. A few of the banks have already launched their housing finance products, while some others are in the development stage. The impact towards credit expansion is expected to be more pronounced in the short-term, the prospects of which with prevailing low interest rates appear promising. However, at this stage it is difficult to forecast the extent of the success of these initiatives,” the review said.

Pacra said the banking sector, particularly the medium-sized private banks which in fact witnessed a slight improvement in spreads during the first half of the current year, managed to resist the pressure on spreads contrary to expectations. “This was made possible through lowering of deposit rates. Although with the re-pricing of assets the benefit would progressively decline, a moderate increase in return on government securities — expected to be in narrow range with an overall stable outlook — is expected to somewhat help in spread management. While the increase in interest revenue is not likely to sustain profitability, the increasing contribution of non-interest income is expected to lead to higher profitability levels by the year-end. However, a major portion of non-interest income — gain on securities — is not likely to be sustainable in the long run.”

The review said asset quality of the loan portfolio of most banks had remained almost unchanged with risk of potential loss marginally declining through additional provisioning. Most banks largely maintained their equity to assets position.

However, for certain individual banks, this was made possible through realization of substantial capital gains to support their weakening equity against continued growth in their total assets.

“On the other hand, banks, which continue to carry large unrealized surplus on their balance sheets, may not be able to maintain this level owing to erosion in market value of listed securities subsequent to June 30 and likely inching up of interest rates on government securities.

This in turn could impact negatively on the risk absorption capacity. Going forward, entering into relatively new credit avenues requires further strengthening of risk management systems for ensuring that credit quality is not undermined by the pursuit of volume growth.”

The Pacra review said individual banks would face a critical testing time and some might find it difficult to replicate past performance due to the current sluggish economic

environment and particularly limited growth in the private sector credit demand despite improving trends in recent months.

Nonetheless in the short-term, the traditional trade finance business is expected to provide volumes for credit expansion, particularly in the textile sector that is making substantial investment in anticipation of emerging opportunities as a consequence of the liberalized WTO trade regime.

Meanwhile, the review said, the recent increase in cotton price would help banks increase the level of financing for meeting seasonal working capital requirements.