- Pakistan’s banking sector needs urgent overhauling; can tackle high NPLs and enhance financial inclusion
- Adopting Singapore’s liquidity framework and Canada’s risk management can boost Pakistan’s banking resilience and inclusivity
The banking sector in any country is its spine, allowing it the needed financial mobility and resilience to cope with challenges of all kinds. It’s the epicenter of the country’s upward and downward financial mobility. In addition to it, a robust banking system is the sign of a thronging financial vista,where the circulation of money in different sectors demonstrates people’s trust in their financial management system that keeps countries breathing in modern days.
Pakistan’s banking sector has also undergone significant transformation since its inception, emerging as a robust and resilient industry. The sector comprises about 31 commercial banks, 5 Islamic banks, and 17 microfinance banks, with total assets exceeding PKR 25 trillion (approximately USD 80 billion).
The State Bank of Pakistan (SBP), the central bank, regulates and supervises the industry, implementing policies to ensure stability and growth. Despite challenges, Pakistan’s banking sector has shown remarkable resilience, with improved profitability, enhanced financial inclusion, and adoption of digital banking solutions.
The sector’s growth is driven by increasing demand for financial services, infrastructure development, and government initiatives to promote financial inclusion.
Apart from profitability, and a massive enlargement of the sector, there are problems and hiccups that it needs to overcome to be able to stand and operate strongly in the future with a promising outlook.
Like any other banking sector, Pakistan’s banking sector is also prone to some systematic and internal problems that pose a grave threat to its credibility.
Moreover, Pakistan’s banking sector confronts several challenges, including a high Non-Performing Loans (NPLs) ratio of 9.9% as of 2022, according to the State Bank of Pakistan’s Financial Stability Review (2022). This is higher than the South Asian average, notes the World Bank in its South Asia Economic Focus report (2020).
The sector also faces liquidity risks, with 40% of deposits concentrated in the top five banks, as reported by the Pakistan Credit Rating Agency’s Banking Sector Report (2022). Furthermore, Low financial inclusion, particularly for women and rural populations, remains a concern, highlighted in the World Economic Forum’s Global Gender Gap Report (2021).
Moreover, the banking sector’s exposure to sovereign risk and political instability undermines investor confidence, as noted by Moody’s Investors Service in its Pakistan Banking System Outlook (2022).
Foremost, the biggest bottleneck to a country’s banking sector is the presence of Non_ performing Loans( NPLs) that eat into the lender’s confidence related to borrower. Plus, the failure of the borrower to stand his financial pledges diminishes the confidence of the lender to mine his financial gains. Banks always find these NPLs as a major impediment in their cycle of generating profitability.
The problem lies in the systematic failure on both sides,where Banks lend without proper paperwork in place,and the borrower exploits these flaws to fatten his pockets.
Pakistan’s banking sector is plagued by a persistently high Non-Performing Loans (NPLs) ratio, which stood at 9.9% as of 2022, according to the State Bank of Pakistan’s Financial Stability Review 2022. This is significantly higher than the South Asian average of 6.5% (World Bank, South Asia Economic Focus 2023). The NPLs stock has increased to PKR 1.2 trillion (approximately USD 3.7 billion), with the majority being attributed to the textile, steel, and power sectors (Pakistan Credit Rating Agency, Banking Sector Report 2023).
The high NPLs ratio not only erodes banks’ profitability but also hampers credit growth, as noted by the International Monetary Fund (IMF) in its Country Report No. 2023/047. Furthermore, the Asian Development Bank (ADB) warns that NPLs can exacerbate financial instability and undermine economic growth (ADB, Pakistan Economic Outlook 2023). To address this issue, the State Bank of Pakistan has implemented measures such as the NPL resolution framework and incentivizing banks to provision for bad loans (SBP, Circular No. 02 of 2023).
But NPLs are not the only jammers in the system. Lack of proportional inclusion of the women and rural populace also dwarfs the potential of the Banking system in Pakistan..The data in this regard is all too vivid to be overlooked.
Pakistan’s banking sector struggles with inadequate financial inclusion, particularly in rural areas and among women. According to the World Bank’s 2023 Global Findex Report, only 21% of rural adults and 13% of women have access to formal financial services. This is significantly lower than the South Asian average (World Bank, 2023). The State Bank of Pakistan’s 2023 Financial Inclusion Report notes that 45% of Pakistan’s population resides in rural areas, yet they account for only 22% of bank branches (SBP, 2023). Women’s financial inclusion is also hindered by societal barriers and lack of financial literacy (Pakistan Microfinance Network, 2023).
In contrast, countries like Kenya (63% women’s financial inclusion) and Bangladesh (34%) have made significant strides in women’s financial inclusion (Global Findex Report, 2023). Pakistan’s banking sector also lags behind in digital financial services, with only 12% of adults using mobile banking compared to 73% in Sweden and 64% in South Africa (GSMA, 2023).
Another embedded irritant in Pakistan’s banking sector is the liquidity risk that erodes the fabric of system.
Each banking system must have a sound liquidity Coverage Ratio( LCR) in place that minimizes the fear of the loss of capital. Pakistan’s needs a serious overhaul as the data on the subject shows.
Pakistan’s banking sector faces significant liquidity risk, compromising its stability. As of 2023, the sector’s liquidity coverage ratio (LCR) stands at 164.4%, slightly above the minimum requirement of 160% (State Bank of Pakistan, Financial Stability Review 2023). However, liquid assets-to-total deposits ratio has decreased to 34.6% in 2022 from 40.4% in 2020 (Pakistan Credit Rating Agency, Banking Sector Report 2023). To mitigate this risk, Pakistan can draw lessons from countries like Singapore, which implemented a robust liquidity management framework, resulting in an LCR of 215% (Monetary Authority of Singapore, Annual Report 2023). Canada’s liquidity adequacy test ensures banks maintain sufficient liquid assets (Office of the Superintendent of Financial Institutions Canada, Guideline 2023).
Similarly, Australia’s net stable funding ratio (NSFR) requirement promotes long-term funding (Australian Prudential Regulation Authority, Information Paper 2023). Switzerland’s stringent liquidity risk management framework resulted in an LCR of 230% (Swiss National Bank, Financial Stability Report 2023). Pakistan can adopt measures like enhancing liquidity risk management frameworks, increasing long-term funding sources, and implementing liquidity adequacy tests.
“A well-functioning banking system is critical for economic growth and stability,” according to IMF. Pakistan can do its bit in areas where reforms are overdue for watering the roots of a strong banking system.
To strengthen Pakistan’s banking system, several improvements are crucial.
Firstly, enhancing financial inclusion, particularly in rural areas and among women, is vital.
Secondly, implementing robust risk management frameworks, improving liquidity coverage ratios, and strengthening regulatory oversight are also essential. Additionally, investing in digital banking infrastructure and promoting financial literacy can increase access and efficiency.
Finally, Pakistan can learn from international best practices, such as Singapore’s robust liquidity management framework and Canada’s stringent risk management guidelines. By adopting these measures, Pakistan’s banking sector can become more resilient, efficient, and inclusive.