KARACHI: The slowdown in profitability may hamper the banks’ ability to plough back profits and support the capital base, which can put downward pressure on their capital adequacy ratio (CAR), said the State Bank of Pakistan (SBP) in its third quarterly report (July-September) issued on Wednesday.

The report said the spread between lending and deposit rates is shrinking in the wake of easy monetary conditions.

This, along with a falling yield on treasury investments, is already taking a toll on the sector’s profitability.

For the last couple of quarters, earnings of the banking sector have shrunk due to declining interest rates and lower non-markup income. The after-tax profit of the banking sector has dropped 6.3 per cent year-on-year to Rs138.9 billion in nine months of 2016.

It is expected that the decelerating profitability may further push banks towards their core – and higher yielding – business of lending, said the report.

The report said the performance of the banking sector remained steady during the third quarter despite seasonal effects and a shift in the government’s borrowing pattern.

“The seasonal net retirement in major sectors has resulted in 2.3pc decline in gross advances in the third quarter compared to 0.2pc fall in the corresponding quarter of last year,” said the report, adding that investments have fallen 2.5pc due to the shifting of the government’s borrowing from commercial banks to the central bank. This has resulted in shrinking the asset base of the banking sector by 1.6pc during the quarter compared to 2.1pc growth in the corresponding period a year ago. On the funding side, deposits inched up 0.6pc per cent in the third quarter due to a lower decline in current deposits and higher growth in savings and fixed deposits.

According to the SBP report, post Eidul Azha reversals, government borrowing from the central bank – which may partially remain parked at banks – and the reported slowdown in the real-estate activity might have resisted deposit withdrawals.

“The year-to-date profitability (before tax) of the banking sector has narrowed by 7.3pc due to lower interest margins and lower non-markup income,” said the SBP.

The asset quality – gauged by the non-performing loans (NPLs)-to-advances ratio – slightly deteriorated mainly on account of a seasonal decline in advances.

Apart from the seasonal uptick in the fourth quarter, the private sector credit is expected to take a boost from improving demand conditions as implied by growth in the manufacturing sector, better energy supplies, especially to the manufacturing sector, growing momentum of CPEC-related activities and the lagged impact of easy monetary policy, said the report.

The SBP said the government reliance for budgetary borrowing away from the banking sector (and towards the central bank) may also induce banks to go for the alternative investment avenue of the private-sector lending.

On the funding side, borrowings from financial institutions – mostly from the SBP – have seen 12.7pc decline while deposits have observed nominal growth of 0.6pc.

Segment-wise data shows an overall decline in working capital advances, which is commensurate with the seasonal fall in financing. However, net retirements in the trade finance segment (6.9pc) during the quarter were in contrast with positive flows during the third quarter in the preceding three years.

Declining exports – predominantly of the textile sector – appears to have taken its toll on trade finance demand, which is reflected in the reduced banks’ borrowing from the SBP for export refinance.

Published in Dawn, December 8th, 2016