Emerging risks hamper growth of banking sector

This comes amid contraction in industries’ growth, slowdown in economy

KARACHI: Banks in Pakistan have remained resilient; however, now, money laundering, terror-financing, and cyber security are challenging their growth. This comes at a time when major credit seeking clients of banks – the industries – have reported contraction for the first time in 10 years and their capacity to pay-off previous loans has become weaker. On the other hand, the domestic economy is also experiencing an overall slowdown in activities.

“Going forward, credit, market and other emerging risks such as anti-money laundering (AML)/combating the financing of terrorism and cyber security may pose significant challenges for the banking sector, though. The banks may also encounter funding constraints if the deceleration in deposit growth prolongs,” the State Bank of Pakistan (SBP) said in its annual Financial System Review 2018, released last week.

The mitigating measures against the risks such as compliance with AML/CFT related laws and regulations, fortifying systems against cyber-attacks, enhanced due diligence to ward-off fake/benami (fictitious) accounts ,seeking legal remedies to manage challenges in overseas operations, etc are all costly, the report added.

To recall, the law enforcement and investigating agencies have found dozens of benami accounts in banks that were allegedly used for money laundering worth billions of rupees. Several bankers have been brought to justice in this regard.

The central bank has imposed penalties worth Rs773 million on nine banks, including big ones, during the month of August 2019 for compromising rules and regulations related to anti-money laundering, combating financing of terrorism, foreign currency exchange operations. Similarly, it put penalty of Rs185 million on four banks for almost similar failures during the prior month of July 2019.

Pakistan remained confident that the actions taken on money laundering and terror-financing would help it in exiting the Financial Action Task Force’s (FATF) grey-list next month; October 2019. The report said that law enforcement agencies are investigating the widest range of terrorism financing activity and that the country will be successful in implementing the action plan agreed with the FATF.

“Pakistan is working to implement the action plan by September 2019 to negotiate an exit from the ‘grey-list’,” it said. Besides, a couple of banks have also faced cyber-attacks and lost consumers data in the aftermath of skimming at ATMs nationwide. The events caused heavy damages on banks’ balance sheet. According to an accountability agency, banks have lost around Rs1 billion in the events so far.

Banks have started upgrading infrastructure protect themselves against such bad events. However, it remained a costly task.

Positive side

The only, but a strong and easy, option available to banks to ensure sustainability in these challenging times is high interest rate regime. They may aggressively lend to the cash-strapped federal and provincial governments at significantly high interest rate since the International Monetary Fund (IMF) has conditioned the governments to overcome budgetary requirement through borrowing from commercial banks instead of the central bank.

The central bank has aggressively increased the benchmark interest rate by 7.5 percentage points since January 2018 to an eight-year high at 13.25% at present.

“The banks’ investment behaviour in government securities and the interest earned there against are largely dependent on interest rate dynamics,” the report said.

Future outlook

The banking outlook depends a lot on the future economic prospects and the corresponding policy responses. The monetary tightening towards the end of the year ended December 2018 and first half (January-July) of current year 2019 may lead to re-pricing of loans, according to SBP Financial System Review 2018.

“This may improve the net interest income and, thus, profitability and solvency of the banking sector. On the other hand, it may dent the repayment capacity of the borrowers, thus, escalating the credit risk. Further, considering the contraction in large scale manufacturing (LSM) sector during July-March FY19 reflecting the dwindling performance of non-financial corporate sector, suggest that the odds of defaults are increasing. Further, any downgrade of a sizeable portion of non-performing loans (NPLs) parked under ‘doubtful’ and ‘substandard’ categories could raise the provisioning expense for the banks. Thus, the credit risk remains paramount going forward,” the report said.

Besides implications arising from the realisation of credit risk, the profitability of the banking sector depends upon the costs associated with mitigating the emerging operational risks and the interest rate dynamics.

Moreover, fiscal measures (such as super tax) have implications for the bank’s after-tax returns and solvency. “In order to meet the growing financing demand of public and private sector, banks need to renew their focus on deposit mobilisation,” the central bank said in the annual report.

The writer is a staff correspondent.

Published in The Express Tribune, September 9^th, 2019.

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