ii

Acknowledgements
The FSR team is highly indebted to Mr. Ashraf Mahmood Wathra, Governor, State Bank of Pakistan (SBP)
for his encouragement and guidance. The team is also grateful to Mr. Riaz Riazuddin, Deputy Governor
(Policy) and members of Publications Review Committee (PRC) for providing invaluable feedback on the
report. We are also thankful to Mr. Jameel Ahmad, Executive Director, Banking Supervision Group, for his
continuous support and supervision in the preparation of this report.

The team would also like to thank data support from various departments of SBP, especially Banking Policy
and Regulations Department (BPRD), Domestic Markets and Monetary Management Department
(DMMD) , Islamic Banking Department (IBD), Monetary Policy Department (MPD), Payment Systems
Department (PSD) and Statistics and Data Warehouse Department (S&DWHD).

We are also grateful to the Securities & Exchange Commission of Pakistan (SECP) for providing relevant
data and technical information on Insurance sector and Non-Bank Financial Institutions (NBFIs).

iii
 Financial Stability and State Bank of Pakistan
Financial stability is defined as a situation in which the function of efficient financial intermediation and
payment services continues without disruptions despite internal and external shocks, and financial risks are
monitored and managed so well that the possibility of systemic crisis is minimized. The SBP sees financial
stability as an evolving process, as the financial sector adapts itself to the needs of the economy and financial
globalization.

Efficient financial intermediation and access to financial services across all segments of the population is the
ideal situation in which economic growth can thrive. The significance of the financial sector is even more
crucial given its inter-linkages with the real sector. SBP being the leading regulator of the financial sector
strives to play a facilitating role in the growth of the sector. The confidence of economic agents in the
financial sector’s ability to meet their financial needs in a convenient and secure manner is also important
for maintaining and promoting financial stability. The SBP works closely with the Securities and Exchange
Commission of Pakistan (SECP), Pakistan Banks’ Association (PBA), the Federal Government, and other
regulatory bodies in achieving this goal.

Ensuring financial stability also complements another important SBP’s objective of securing monetary
stability. It is hard to imagine monetary stability in absence of financial stability. Financial Stability Review
(FSR) provides an assessment of financial stability issues and pitches input for policy initiatives. The report
gives an independent perspective and commentary on the state of financial stability by providing an
objective view on the developments in the financial sector, and giving an in-depth analysis of issues relevant
to the financial institutions and markets. It also endeavors to promote informed public debate on various
aspects of the financial system.

The FSR was used to be published as a biannual document. The last published FSR covered the period of 1 st
Half, 2013. The current installment of FSR, a yearly document, focuses on the year 2015. To bridge the gap
between the two publications, however, an attempt has been made to discuss important developments in the
financial sector over the years 2013 and 2014, as well. From now onwards, FSR will be published as an
annual document.

State Bank of Pakistan welcomes feedback and comments on the FSR.

iv
Data Convention and Coverage
The Financial Stability Review (FSR) uses two terminologies; CY for Calendar Year and FY for Financial
Year (except otherwise mentioned) in case of Non-Bank Financial Institutions (NBFIs).

The review is, generally, based on the data reported in the audited or unaudited accounts of financial
institutions for different components as follows:

 Banks (conventional or Islamic), Development Finance Institutions (DFIs), Microfinance Banks,

Financial Markets and Payment System are based on un-audited financial statements reported to
SBP through Quarterly Reporting Chart of Accounts (RCOA) and various other returns .
 Data on NBFIs (excluding DFIs) is based on audited annual accounts for the relevant financial year
which ends in June.
 The financial close for Insurers is December of the corresponding year.

v
 Contents

 Overview 01

Section A: Banking Sector

 Chapter 1: Process of Financial Intermediation 13

 Chapter 2: Risk Analysis of the Banking Sector 23

 Chapter 3: Profitability, Soundness, and Resilience 43

 Chapter 4: Islamic Banking 59

Section B: Non-Banking Financial Sector

 Chapter 5: Non-Bank Financial Institutions 69

 Chapter 6: Insurance Sector 91

Section C: Financial Markets & Infrastructure

 Chapter 7: Financial Markets 101

 Chapter 8: Financial Market Infrastructure 113

 Technical Appendix 129

 Acronyms 131

 Annexures 133

vi
List of Boxes

 Box A: Regulatory Developments – Perspective of growth and stability of financial sector……….07

 Box 2.1: Banking exposure on Textile Sector – a stability perspective……………………………. 34

 Box 2.2: Sugar Sector and Banking Sector Stability …………………………………………….....39

 Box 3.1: Key Technical Assumptions ………………………………………………………….....55

 Box 3.2: A framework for the assessment of bank’s earnings ………………………………….… 57

 Box 5.1: Revamped Regulatory Framework for NBFCs …………………………………………. 87

 Box 5.2: Real Estate Investment Trusts (REITs) in Pakistan …………………………………….. 88

 Box 8.1: CPMI & IOSCO Supervisory & Oversight Principles for FMIs ………………………..125

vii
 FSR Team
Team Leaders
Mr. Muhammad Javaid Ismail, Director, FSD [email protected]
Dr. Asif Ali [email protected]

Team Members
Ms. Ghulam Khadija Chapter 3, Chapter 5, Box 3.1 [email protected]
Mr. Manzoor Ahmad Chapter 4 [email protected]
Mr. Muhammad Sadiq Ansari Overview, Chapter 1, Chapter 7, Box [email protected]
A, Box 2.1, Technical Appendix
Ms. Sarwat Amir Chapter 3, Technical Appendix [email protected]
Mr. Imran Sadaf Chapter 8, Box 8.1 [email protected]
Ms. Kashifa Nosheen Chapter 2, Box 2.2 [email protected]
Mr. Muhammad Inaam Ashraf Overview, Chapter 2, Chapter 6, [email protected]
Technical Appendix
Mr. Faraz Karim Chapter 6 faraz.karim @sbp.org.pk
Ms. Rabia Zulfiqar Chapter 5, Box 5.1, Box 5.2 rabia.zulfiqar @sbp.org.pk

Publication Review Committee

Mr. Riaz Riazuddin (Chairman) Mr. Muhammad Ali Malik
Mr. Jameel Ahmad Mr. M. Farooq Arby
Mr. Qasim Nawaz Dr. M. Nadeem Hanif
Mr. Syed Irfan Ali Dr. Farooq Pasha
Mr. Syed Samar Husnain Dr. Jameel Ahmed
Dr. Saeed Ahmed

viii
ix
 Overview

The financial system remains in a stable and sound debt to GDP ratio, capital outflows and fragility in
state at the end of CY15. Assets base of the financial equity markets, depreciation in currencies etc. have
sector has expanded at a decent pace of 15.1 percent kept the global financial stability under stress. The
in CY15 (12.6 percent, on average, during CY13- slowdown in China and the resulting stock market
CY15). As a result, the financial depth1, measured by correction had rippled effects throughout emerging
financial assets to GDP, has increased from 56.4 and advanced economies in later half of 2015
percent in CY13 to 59.4 percent in CY14 and 68.4 particularly after August.
percent in CY15 (Table 1).
The weak economic recovery in European Union
Table 1 (EU) coupled with higher political risks due to
Assets Composition of the Financial Sector Greek financial assistance have put the European
CY12 CY13 CY14 CY15 banks, already suffering from low profitability,
Assets (PKR Billion) 13,120.1 14,146.6 16,261.2 18,718.0
under renewed stress. Higher sovereign and private
Growth rate (Percent) 18.7 7.8 14.9 15.1
Percent of Total Assets
sector debt have been identified by the European
MFBs 0.3 0.4 0.4 0.5 Central Bank as one of the potential systemic risks
NBFIs* 4.6 4.2 4.1 3.9 for its financial sector.2 As the EU, one of the
Insurance* 4.3 4.5 4.7 4.3
biggest trading partners of Pakistan struggled with
CDNS 16.4 16.5 16.4 15.6
Banks 74.4 74.5 74.4 75.6
nominal growth prospects amid low interest rates
Assets as Percent of GDP and quantitative easing, Pakistan’s exports to EU
MFBs 0.2 0.2 0.3 0.4 declined3.
NBFIs 2.7 2.3 2.4 2.7
Insurance 2.5 2.5 2.8 3.0 The continued slump in commodity prices added to
CDNS 9.6 9.3 9.7 10.7 the fiscal burden of commodity rich countries,
Banks 43.6 42.0 44.2 51.6
mainly Gulf Cooperation Council (GCC) countries,
Overall assets 58.6 56.4 59.4 68.4
and slackened the pace of remittances flow to
* All numbers of NBFIs and insurance for CY15 are as of end June.
Source: Unaudited/audited financial statements of banks, MFBs, NBFIs and
emerging economies. Moreover, cross border
insurance companies. SECP & SBP. investments have also reduced4.

In contrast to weak economic fundamentals

The consistent performance of the financial sector is
throughout Asia (China, Japan, Gulf countries etc.)
quite encouraging, considering that the global
and Europe, the US economy showed signs of
developments have been challenging. The
moderate expansion. Recognizing the improvements
vulnerabilities in emerging markets owing to high

2 European Central Bank, “Financial Stability Review”, November

1 For explanation of financial depth and its measurement, please see 2015.
the background section of “Global Financial Development Report 3 State Bank of Pakistan, “The State of Pakistan’s Economy”, Second

2015/2016” of the World Bank. Quarterly Report, 2015-2016.

http://www.worldbank.org/en/publication/gfdr/background/financ 4 State Bank of Pakistan, “The State of Pakistan’s Economy”, Second

ial-depth Quarterly Report, 2015-2016.

1
 in some key fundamentals of the economy (such as (Figure 1). Particularly, performance of the banking
household spending, business fixed investments, sector improved on the back of record earnings and
labor market recovery etc.), the US Federal Reserve high capital adequacy ratio. Strong assets growth
and revival of private sector credit, along with
(Fed) raised the interest rates in December 20155.
gradual improvement in the asset quality further
However, the credit risk in US has risen – with strengthened the overall financial position.
surge in nonfinancial business debt – owing to Figure 1
highly accommodative credit and underwriting Despite growth, banking sector remains stable
standards. The high corporate leverage coupled with Banking Sector Stability Map
macroeconomic challenges has dampened the debt CY13
Capital
repayment capacity of the borrowers6. Moreover, Adequacy CY14

the long anticipated rate rise by the Fed suppressed Instability CY15

further the risk appetite of the investors and stock Liquidity

Asset
Quality
markets throughout emerging economies suffered.

Domestically, the economy of Pakistan fared better

in CY15. Inflation remained subdued; foreign Stability
Exposure to
exchange (FX) buffers continued to rise; exchange Earnings Public
Sector
rate remained stable; current account deficit reduced
despite fall in exports; large scale manufacturing
grew and investor sentiments remained at the Interconnect
edness
Residual
Growth
elevated levels.7
Source: Financial Stability Department (FSD), SBP
Enabling macroeconomic environment brought
about by prudent management policy consistency,
Over the last three years (CY13-CY15), asset base
falling global commodity prices and relatively better
observed average growth of 13.2 percent year-on-
energy situation allowed the economy and the
year (YoY), with a healthy growth of 16.8 percent in
financial sector to flourish.
CY15. During the same period, advances grew at a
Banking sector remains in a comfortable state, if modest pace of 8.7 percent (YoY) lead by corporate,
viewed through various dimensions of growth and agriculture and consumer finance, while
soundness as seen in the Banking Stability Map8 investments, mostly in government securities,
increased by 20.1 percent.
5 Federal Open Market Committee (FOMC) of US Federal Reserve,
“Monetary Policy Statement”, December 2015
http://www.federalreserve.gov/monetarypolicy/files/monetary20151 The asset expansion has been financed by deposits
216a1.pdf (average YoY growth of 12.5 percent) and
6 Office of Financial Research, “Financial Stability Report”, 2015,

United States Department of Treasury. borrowings (average YoY growth of 28.2 percent).
7 State Bank of Pakistan, “The State of Pakistan’s Economy”, Second
As such substantial portion of the excess growth
Quarterly Report, 2015-2016.
8 The Banking Stability Map represents a comprehensive picture of (residual growth) in assets has been financed by the
stability in seven different dimensions. Risks in each dimension are non-core liabilities (borrowings). Though most of it
measured by a weighted combination of key indicators. The percentile
is short term and secured in nature, unsecured
rank of each indicator gives the degree of stability relative to its level
in the past (since 1996). For details please see Technical Appendix. portion has also seen considerable growth,
For methodology please see Dattels, P., McCaughrin, R., Miyajima,
K., & Puig, J. (2010). “Can you map global financial stability?” IMF
Working Papers, 1-42.

2
particularly during CY15, indicating higher level of has moderated from 13.3 percent in CY13 to 11.4
interconnectedness among the banks. percent in CY15; while, at the same time, provision
coverage ratio has increased from 77.1 percent to
Over the last few years, public sector exposure on 84.9 percent.
the banks’ balance sheets, primarily, in the form of
investments in sovereign papers has increased While infection ratios have improved and flow of
significantly. The share of such investments to total fresh NPLs has subsided, reducing high stock of
assets has risen from 36.7 percent in CY13 to 44.7 NPLs10 remains the key challenge for banks. To
percent in CY15. If the banks’ advances to PSEs are address the issue, SBP on its part is endeavoring to
also included, the share of public sector exposure in provide conducive environment through legal and
total asset increases 53 percent in CY15. regulatory measures for recovery of NPLs and
improving flow of credit to private sector(see Box
With rising investments in government securities, A for details). Banks, on the other hand, need to
however, the funding liquidity9 of the banking sector make concerted recovery efforts to reduce quantum
has remained quite comfortable during CY13 to of NPLs.
CY15; average liquid assets represent 50 percent of
the total assets and 66 percent of the deposits. Earnings performance of the banking sector, have
consistently improved over the last three years,
Although banking sector’s exposure to government largely on the back of growing share of income
has strengthened the liquidity position, from investment in government securities. From
concentration of these assets do carry certain risks. PKR 165 billion in CY13, the profit (before tax) has
The holding of sovereign papers (particularly of increased to PKR 329 billion in CY15. Key
longer-term maturity) exposes banks to market risk profitability ratios such as return on assets (ROA)
due to interest rate movements. Higher demand of and return on equity (ROE) have also improved
funds for fiscal needs also creates some pressure on from 1.6 percent and 17.9 percent in CY13 to 2.5
short term liquidity, particularly in the period of percent and 28.5 percent in CY15, respectively.
private sector credit demand. Moreover, in case of
any easing-off in fiscal reliance on banking funds, an Capital position of the banking sector continues to
orderly unwinding of the huge investment portfolio strengthen as Capital Adequacy Ratio (CAR)stayed
will be testing for banks. In the latter scenario, well above the local and international benchmarks.
banks would face challenge in deploying excess The CAR has improved from 14.9 percent in CY13
funds into alternative avenues that could generate to 17.3 percent in CY15. Tier 1 CAR is also
decent income stream within their risk appetite. comfortably placed at 14.4 percent in CY15 as
compared to 12.6 percent in CY13.
Asset quality of the banking sector has improved
with the decline in gross non-performing loan ratio High level of CAR has improved the overall
(GNPLR) and rise in provisions coverage. GNPLR resilience of the sector under various hypothetical
stress scenarios considered in Chapter 3. However,
9 Funding liquidity means the ease with which market participants can if private sector credit demand further picks up in
obtain funds; while market liquidity implies ease with which assets
(e.g. bonds) could be traded in the market. For details please see
the wake of favorable monetary conditions and
Brunnermeier, Markus K., and Lasse Heje Pedersen. "Market liquidity
and funding liquidity." Review of Financial studies 22.6 (2009): 2201-
10
2238. NPLs have been hovering around PKR 600 billion since
CY12

3
 developments on other fronts such as China Pakistan auto, cement etc.). Smooth functioning of markets
Economic Corridor (CPEC), it will attract higher indicates reduced risks to the stability of the
capital charge and may shrink the capital buffers financial system.
presently available with the banks. In the meantime,
banks also have to strengthen their capital to meet Apart from banks, Non-Bank Financial Institutions
the gradual increase in the minimum capital (NBFIs) with varying business models and focused
requirements. Banks, therefore, need to closely clientele have performed reasonably in FY15.
evaluate the situation and plan for capital generation Mutual Funds have fared well followed by leasing
for matching the expected increase in credit and Modarabas. The profitability of Development
requirements and enhancing their resilience. Finance Institutions (DFIs) has dwindled a bit in
FY15; while Investment Finance Companies (IFCs)
Within the banking sector, Islamic Banking have suffered losses. The business of IFCs is facing
Institutions (IBIs) have continued to increase their stagnancy and some are even non-compliant under
share in overall assets (9.6 percent in CY13 to and NBFC regulations issued by SECP. Moreover, the
11.4 percent in CY15) which is in line with SBP’s funding risk remains prominent for some of the
Strategic Plan for the Islamic Banking Industry NBFIs. Also, the diversification of clientele
2014-2018. With healthy growth in financing suggested in the business models of NBFIs has yet
portfolio, financing to deposit ratio has reached to to be achieved. NBFIs are serving similar market
46.9 percent against the conventional banks’ average segments as the banks, in which they do not possess
of 46.3 percent. Earnings of IBIs have moderated competitive advantage.
during CY15; ROA (before tax) of 1.2 percent in
CY15 compared to 1.5 percent in CY14. Insurance sector performance remained steady with
considerable improvement in profitability of all its
Given the better performance of the economy and segments. Continuing growth in gross premiums
the banking sector, the markets (Money, FX and have not only increased the asset base of life
Equity) have also performed smoothly during CY15; insurers but also the improved the insurance
though some volatility was witnessed in equity and penetration rate (from 0.5 percent in CY13 to 0.8
FX markets in second half of the year (post Yuan percent in CY15). The non-life sector is growing
devaluation and expected rise in interest rates in the steadily; while Shariah based insurance (Takaful) is
US) when majority of the emerging economies also gaining traction. The concentration risk remains
observed capital flight and came under stress. the main concern for life insurance due to high
market share of a single public owned insurer.
Structural changes in SBP’s interest rate corridor Further, penetration rate is low by international
and effective implementation of monetary easing standards and efforts are needed for improving the
stabilized the money market. Improved Balance of outreach of the insurance service.
Payment (BoP) position, accumulation of reserves
and consecutive successful IMF reviews has helped The current stable position of the financial sector,
calm the FX market. Despite spillover of global especially the banking sector, could not have been
financial stress to domestic markets, local equity possible without the enabling regulatory
markets remained relatively stable due to positive environment. SBP, over the past few years, has
developments on domestic front and better taken several measures to strengthen and guide the
performance of few corporate sectors (fertilizer, banking sector towards better performance with

4
stability. The measures adopted pertain to a wide of both private and public sectors. Consequently,
spectrum of bank’s operations such as Capital banks’ repo borrowing from SBP rose sharply
Adequacy, Payment Systems, Anti-Money during CY15. With the expected rise in private
Laundering (AML) and Countering the Financing credit and given the trend in government
for Terrorism (CFT), Large Exposures and borrowings, it will be quite challenging for banks to
Concentration Risks, Banking supervision (On-site match the credit demand from core liabilities. Only
& off-site monitoring), Priority Financing (Export opportunity for banks is to intensify deposit
Refinance, Long Term Financing) and serving the mobilization efforts not only to match the expected
underserved/unbanked areas (Financial Inclusion increase in credit but also to reduce reliance on non-
Agenda). SBP “Vision 2020” has also set the core sources of funds.
direction for further strengthening the financial
stability and improving efficiency, fairness and Third, credit risk is higher for Public Sector
effectiveness of the banking sector (See Box A for Commercial Banks (PSCBs) and medium-sized
further details). banks (mostly privately owned). PSCBs carry the
highest GNPLR and it has been increasing since
Notwithstanding the overall position of the financial CY13. GNPLR of medium sized banks is quite high
sector and risks highlighted earlier, following areas with low provisions coverage ratio. This advocates
may pose challenges to stability of the financial that some of these banks are unable to either
sector. identify (adverse selection) or attract quality
borrowers; legacy debts persist on their balance
First of all, there has been a noticeable decline in the sheets and there are inherent weaknesses in their
prime risk taking activity (i.e. lending) by the credit risk management system. Therefore, these
banking sector. Advances to Deposit Ratio (ADR) banks need to strengthen credit standards, accelerate
of the banking system has consistently been falling recovery efforts and improve credit risk
since long and as of end CY15 stands at 46.4 management practices..
percent; down from 75.9 percent as of end CY08
and 48.6 percent as of end CY13. This could partly Fourth, the degree of complexity and sophistication
be due to weak demand from the private sector of technology based payment systems, though
(textile and sugar sectors are under pressure due to beneficial, could expose the payment system to
idiosyncratic and structural issues) and partly due to external risks (such as cyber attacks, equipment
bank’s inclination towards easier options. failure etc.).As the financial market infrastructure is
Government’s fiscal needs have compelled it to tap spread across various participants who are not
liquidity from the banking sector. This has given an operating under one regulatory umbrella, risk
opportunity to the banks to bet on the inevitable originated in payment system (settlement risk,
and earn risk free returns. The banks’ balance sheets liquidity risk, operational risk etc.) spreads out in no
are now sensitive to market risk, re-investment risk, time and with large magnitude. Therefore, the
banks’ own treasury operations and the changes in overarching and collaborated efforts for oversight
government’s liquidity and debt management have become a must in current era to ensure
policies. undisrupted and secured functioning of financial
market infrastructure of the country. SBP is working
Second, deposit growth, though higher than last in the same direction based on international best
year, has been insufficient to meet the funding needs practices with material progress.

5
 Finally, global environment is a key risk factor for
the economy, in general, and the banking sector, in
particular. The continuous slowdown in China and
emerging economies, the ongoing negotiations on
Greek assistance program and referendum in UK to
decide its future in the EU are the sources of
uncertainty in CY16 and beyond due to our trade
and financial links with Asia, EU and UK. These
global challenges may impact the exports,
particularly already under pressure textile sector; the
largest borrower of financial sector. The trade
activity, if squeezed, will also impact the non
interest income (fee, commission etc) of the banking
sector. Further, global uncertainty may possibly
trigger volatility in the equity market as well.

Moreover, falling commodity prices, though

beneficial for import dependent economies like
Pakistan, could also dent the revenue of export
oriented sectors. Given the dependence of the
country’s exports on a few major sectors (e.g.
textiles) and commodities (e.g. rice), falling
international prices may hurt the repayment capacity
of borrowers of these sectors, which may posemild
risk to the asset quality of the banking sector.Any
sustained stagnancy in low oil prices may further
add to the fiscal burden of GCC countries, which
may depress the outflow of workers to these
countries and worker remittances, already
decelerating, may further slowdown that may impact
the flow of funds to the banks.

6
Box A: Regulatory Developments11 – Perspective of amendments to meet international standards and to bring
growth and stability of financial sector consistency and clarity in the enforcement provisions.
In order to align the existing regulatory framework with
the fast changing business environment and the best
One of the prime responsibilities of SBP is to ensure that
international practices, Prudential Regulations (PRs) for
the financial system, particularly the banking system, is
the Corporate and Commercial banking were revised in
sound and remains on its potential growth trajectory
June 201415. Key objective of the amended regulations is
without jeopardizing the financial stability. SBP – within
to help the banks and DFIs to address their unique risk
its regulatory domain – continuously endeavors to bring
factors and dynamic environment in a better way by
in improvement in the regulatory structure which could
allowing them more discretion in business decisions.
address the unique spectrum of domestic risk profile and
align it with best international practices. Consequently,
Further, in its revised PRs, SBP more comprehensively
the financial landscape of the Pakistan is equipped with
addressed concentration risk and related party exposure
well structured, effective, and robust regulatory
issues. SBP defined the large exposure and aligned such
framework.
exposures with overall gross advances and investment of
banks. Such regulatory steps will be of great help to
The capital is the main line of defence against risks to the
implement system-wide Macro Prudential Regulations in
financial stability. In August 2013, SBP issued Basel III
Pakistan.
instructions for implementation in Pakistan in the light
of Basel III reform package introduced by the Basel
Regulations without effective and timely
Committee on Banking Supervision (BCBS)12. Besides,
supervision/monitoring and necessary enforcement
SBP introduced disclosure templates released by BCBS
action may dilute the effectiveness of even a strong
for capital adequacy purposes to enhance consistency
regulatory structure. Knowing this fact, both of SBP’s
and comparability of banks’ capital related disclosures13.
supervisory legs (off-site and on-site) play a pivotal role
Lately, SBP has issued instruction for implementation of
and ensure that banks perform under the compliance of
Basel-III Liquidity standards,
regulatory ambit, identify key risk areas threatening the
stability of institutions/system, and identify the potential
SBP has been initiating measures to prevent the use of
areas to promote growth and efficiency.
banking channels for the purposes of money laundering/
terrorist financing. In this regard, SBP developed
The concept of thematic inspection was introduced
comprehensive Anti Money Laundering (AML)
recently, with a view to identify issues that are common
regulations which were strengthened from time to time14
across the industry and work on proactive policy
and aligned with the Financial Action Task Force
responses to address potential risk and vulnerabilities to
(FATF) recommendations/ international norms.
Moreover, SBP had major contribution in drafting and the financial system. In this regard, industry-wide
finalization of the AML law/Act and its subsequent thematic inspections were conducted which not only
facilitated assessment of compliance with the regulatory
requirements but also identified areas requiring
11 There is a wide range of regulatory initiatives SBP has been improvements in various regulatory policies.
persuading on related to areas e.g. financial inclusion, customer
protection, legal and regulatory structure, financial infrastructure, Further on the supervisory front, SBP successfully and
foreign exchange and monetary policy, banking services etc. However,
emphasis here is put on those regulatory measures which have helped effectively employed the resolution regime for one of ex-
bringing in stability and promotes growth in the banking sector. problem bank. Effective resolution strategy, efficient
12 Banking Policy and Regulations Department (BPRD) Circular No.6

of 2013 communication with the general public, media and

13 BPRD Circular No.11 of 2014
14
BPRD Circular Letters No.13 of 2015, No. 6 &7 of 2014, No.22 of
2013, and BPRD Circular No.2 of 2012 15 BPRD Circular No.6 of 2014

7
 bank’s depositors and prompt resolution of issues refinance scheme, Islamic export refinance scheme
prevented emergence of any panic or contagion like and Long term financing facilities;
situation in the overall banking sector. SBP’s
enforcement actions against the problem bank c) SBP in consultation with banks has proposed
established its regulatory writ and financially weak banks amendments in the Financial Institutions (Recovery
got the message and paced up their efforts to address the of Finances) Ordinance 2001 (FIRO), including
regulatory issues. alternative provisions for dealing with foreclosure
matters in a more transparent manner. Once
With privatization of the public sector banks and entry promulgated, these amendments will not only
of private players in the market, majority of the banking facilitate recovery of NPLs but also expansion of
sector in Pakistan is now private sector owned. mortgage and infrastructure financing;
Accordingly a need was felt for instituting explicit
deposit protection scheme, which is considered integral d) SBP has prepared and submitted Financial
safety-net tool to ensure the soundness of the banking Institutions (Secured Transactions) Bill, 2015 for
system and protect small depositors of a bank in case of initiating approval process from the Parliament. The
failure. SBP, therefore, in consultation with various implementation of the project will enable lenders to
stakeholders developed draft of Deposit Protection create charge on the movable assets of the borrowers
Corporation (DPC) Act in the light of Core Principles that will consequently facilitate flow of financing to
for Effective Deposit Insurance Systems as propounded private sector, particularly, the SME sector;
by International Association of Deposit Insurers (IADI).
The bill is presently in the parliament and is expected to e) SBP is actively pursuing financial inclusion agenda
be enacted shortly.. through its different work streams including Islamic
finance, SME finance, Microfinance etc. In order to
To bring credit demand to its potential growth path and enhance the outreach of financial access across the
increase credit to GDP ratio, concerted efforts of all country, SBP is pursuing Financial Inclusion
stakeholders are required. SBP – in its capacity - has Program (FIP). Furthermore, SBP in collaboration
taken various measures to enhance private sector credit. with SECP is trying to build a vibrant capital market
Some of the key measures are given below: so that large corporates may fulfill their funding
requirements from issuance of papers in the
a) SBP, in the prevailing state of the financial markets, secondary markets. This would enable banks to cater
can only impact demand indirectly through giving the needs to SMEs, housing and agriculture sector.
price incentive. To spur demand, SBP has
significantly cut its policy rate in the recent past. The f) SBP is working for promotion of green banking &
monetary easing triggered by SBP actions has finance in the country, which broadly includes
transmitted to the retail interest rates as WALR has concepts like renewable energy/ energy efficiency
declined from 11.3 percent in Dec-12 to 7.7 percent financing, resource efficiency & sustainable
in Dec-1516. Also, the results of consumer finance development. To this end, SBP has held consultations
survey conducted in June 2015 showed that the cost with various stakeholders to design and implement
of auto financing has reduced by 300bps over the policies and initiatives on green banking in the
last one year; country and encourage local banks to extend credit to
this sector. Further, SBP issued the scheme for
b) SBP has introduced priority financing schemes to Financing Power Plants using Renewable Energy(RE)
enhance private sector credit which include Export to help in provision of concessional lending to
banks/DFIs for onward lending to the RE projects
and promote climate friendly investments. The
16 http://www.sbp.org.pk/ecodata

8
 scheme has been recently revised to make it more standardization of financial articles such as cheques, pay-
attractive for borrowers and participating banks. orders, demand draft etc22 (c) issuance of several
rules/guidelines to facilitate or direct financial participant
Protecting depositors’ interest is one of the key priorities to improve the quality and safety of transactions etc.
of SBP. To ensure that depositors get their due share,
SBP enhanced minimum saving rate to 6 percent (p.a.) in SBP regulatory efforts are forward looking and deeply
May 201217 followed by advising banks to calculate MSR synchronized with the economic interconnectedness. In
on monthly average balance18 in March 2013. In order to August 2015, SBP issued its “SBP Vision 202023” after
rationalize the cost of deposit with changing monetary developing it through a participative and consultative
policy stance, in September 201319, SBP linked MSR with process. The plan embodies strong emphasis on
monetary policy through aligning it with SBP repo rate. organizational efficiency and effectiveness. The SBP
In June 2014, SBP lifted up MSR condition on fixed Vision 2020 revolved its six strategic goals i.e.
deposits20.
1) Enhance the effectiveness of monetary policy
SBP over the last few years has revitalized its consumer 2) Strengthen the financial system stability regime
protection mandate to “Conduct Supervision” to ensure 3) Improve the efficiency, effectiveness, and
that the consumers are treated in a fair, transparent and fairness of the banking system
efficient manner, and banks grow sustainably in a 4) Increase financial inclusion
responsible manner. To promote fair banking practices, 5) Develop modern and robust payments systems
SBP has issued various set of instructions and guidelines 6) Strengthen SBP’s organizational efficiency and
including Fair Treatment of Consumers(FTC) effectiveness
framework, Consumer Grievance Handling Mechanism,
Product Disclosure Requirement, guiding principles for Under the strategic goal – 2, a special focus has been put
Fairness of Service Charges, Standards of Banking on to ensure financial stability. For that purpose, a
Conduct, Banking facilities for visually impaired persons, separate department i.e. “Financial Stability Department
Fair sales practices for third party products etc. These (FSD)” has been formed. Apart from consolidating
regulatory initiatives will also help customers make financial stability issues in FSD, SBP has also initiated
informed decisions through better understanding of working in several new areas aiming to address financial
services provided by the banks. Further, SBP is working stability concerns. Some of the important areas on which
on Conduct Assessment Framework which will allow the FSD is working on include: (a) Designing of financial
banks to assess their business conduct and identify areas system stability framework, (b) crises management
requiring improvement. framework, (c) review and update of consolidated
supervision framework, and (d) framework for
SBP has made concerted efforts to ensure safety, identification and supervision of D-SIBs 24 in Pakistan.
integrity, efficiency and reliability in the designated
payment system. Such endeavors remained well It is expected that SBP initiatives will strengthen the
complemented with huge banks’ investment in IT and stability of the financial system enabling it to better
core banking solutions. Following the international best withstand any contingent situations. It will further bolster
practices, SBP has taken numerous initiatives to enhance the process of financial intermediation in short to
efficiency, security, and standardization including (a) medium term.
international bank account number (IBAN)21, (b)

17 BPRD Circular No.1 of 2012

18 BPRD Circular No.1 of 2013
19 BPRD Circular No.7 of 2013 22 PSD Circular No.1 of 2014
20 BPRD Circular No.5 of 2014 23 http://www.sbp.org.pk/spd/StrategicPlan-2020-Eng.pdf
21 Payment System Department (PSD) Circular No.2 of 2012 24 D-SIBs stand for Domestic Systemically Important Banks

9
10
Section A: Banking Sector

11
12
 1 Process of Financial Intermediation

The momentum in credit demand from the private sector continues during CY15; though, the surge has not been as sharp as the decline in
weighted average lending rates (WALR). Government papers – being credit risk free instruments – have attracted banking funds resulting
in further rise in investment to deposit ratio. The growth in deposits has not been enough to support the asset side resulting in significant rise
in repo borrowings from SBP. The positive economic outlook, expected developments under the CPEC, and some global recovery are
expected to accelerate the pace of credit demand from private sector in the short to medium term.

The credit demand of the private sector – which started Figure 1.1
to take-off in CY13 after some stagnancy – has Asset growth primarily contributed by investments
continued its growth during CY15. Private sector Asset Composition (Flows during the year)
advances have a major contribution in 8.1 percent (PKR billion) (percent)
growth in overall gross advances; thanks to positive Lending to FIs Investments-net
Advances-net others
economic developments and some easing of structural Asset Growth (RHS)
bottlenecks25. Nonetheless, Government has remained 20

the major user of banking funds due to its fiscal needs26 1,900 18

and shifting of its borrowings from the central bank to 16

commercial banks27, which increased banks investments 1,400

14
12
in government papers by 31.7 percent (Figure 1.1).
10
Consequently, the overall asset base has observed 16.8 900
8
percent growth during CY15 (14.9 percent in CY14).
6
On the funding side, deposits have remained the 400 4
mainstay with 12.6 percent growth28 followed by 2
considerable support from financial borrowings (mainly (100)
CY12 CY13 CY14 CY15
0

through SBP Repo facility) (Figure 1.2). The equity of

Source: FSD, SBP
the banking sector has observed moderate rise on the
back of high profitability, injection of fresh capital in few ADR is consistently declining…
capital deficient banks, and revaluation surplus on
Advances to Deposit ratio (ADR) – which reflects
securities placed in available for sale (AFS) category.
proportion of deposits flowing to serve financing needs -
is considered an important measure to assess the degree
of financial intermediation29.
ADR of the banking system has consistently been falling
since long and as of end December 2015 stood at 46.4
percent; down from 75.9 percent as of end December
25 Such as improvements in law and order, lower energy shortages, 2008 and 48.6 percent as of end December 2013 (Figure
reduced cost of doing business etc.
26 In comparison to previous years FY11-FY13 (7.2 percent on 1.3). The prime reason behind this fall has been the slow
average), the fiscal deficit has come down during FY15 (5.3 percent of
GDP) and FY14 (5.5 percent).
27 Under IMF’s Extended Fund Facility (EFF) program, as one of the

Quantitative Performance Criterion (QPC), government borrowing

from SBP has to be within certain limits. For details
http://www.finance.gov.pk/mefp/eff.pdf 29A very high ADR may indicate liquidity mismatch (both structural
28 This growth was higher than CY14 (11 percent) but lower than and cyclical); while excessively low ADR may hint at compromised
average growth during CY08-15 (13.2 percent). process of financial intermediation.

13
 growth in advances portfolio, relative to deposits30, due might be another challenge. It will be testing for the
to host of factors including structural bottlenecks (such banks to deploy the released funds in alternative avenues
as power shortages, security concerns etc.) and subpar which could generate decent income stream within their
export performance due to global economic slowdown. risk appetite.
Growing credit risk in some key sectors such as textiles
Figure 1.3
and lengthy judicial process for the recovery of NPLs has
ADR falling since 2008
also made banks risk averse in lending to the private
Shift in Asset Mix
sector. On the contrary, deposit base has been steadily (Percent Share)
growing; thus further dropping the ADR. ADR IDR
80
Figure 1.2
Deposits remain the mainstay, borrowings contributed too 70
Liabilities Composition (Flows during the year)
(PKR billion) 60
Deposits Financial Borrowing Equity others
50
2300
40
1800
30

1300
20
Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15
Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

Jun-14

Jun-15
800

Source: FSD, SBP

300
Private sector credit demand reveals some signs of recovery…
-200 Flow of advances to private sector started to gain
CY12 CY13 CY14 CY15
momentum after CY13 owing to improving
Source: FSD, SBP macroeconomic environment, better energy supply and
During this time, fiscal needs, concomitant with limited security conditions, and positive sentiments of both
availability of external funding for government, has made domestic and foreign investors31.
public sector the key user of banking funds. Public sector The growth in gross advances during CY15 (8.1 percent),
exposure has been expanding not only in terms of banks’ though lower than previous year’s growth of 9.4 percent,
investments in sovereign papers but also through lending is still higher than average growth during CY10-13 (6.2
to PSEs. percent). Importantly, CY15 observed decent growth
Although banking sector’s exposure to government, despite outstanding advances of textile sector – the
being domestic in nature, carries no credit risk, yet it has largest borrower of banking sector advances- declining
some inherent issues. The holding of sovereign papers due to subdued external demand from China and Euro
(particularly of longer-term maturity) exposes banks to zone, ongoing structural issues in textiles and low
market risk. Aggressive funding to public sector may also commodity prices (Please see Box 2.1 in Chapter 2).
create some bouts of liquidity shortages. Moreover, in 31 On external front: (i) Moody’s upgraded Pakistan’s foreign currency
case of any easing-off in fiscal reliance on banking funds, bond rating while Standard & Poors upgraded the outlook from
an orderly unwinding of the huge investment portfolio stable to positive, (ii) Business confidence index surveys of CY15
conducted by Overseas Investors Chamber of Commerce and
Industry (OICCI) revealed significant improvement in business
30Average annual growth of advances was 7.7 percent during 2008-15 confidence. On domestic front: (iii) Consumer confidence survey of
(7 years) as against 13.2 percent average annual growth in deposits SBP shows consistent rise in consumer confidence index during
during the same period. CY15.

14
Further, on the positive side, the credit disbursement is (due to lower inflation) and challenges on domestic and
quite broad based flowing to several sectors including external fronts.
agribusiness32, production and transmission of energy,
Figure 1.4
chemicals and pharmaceuticals and financial sectors
Lending rates fall in response to drop in SBP's policy rate
(Table 1.1). It may be worth highlighting that Strategic
Movement of Lending, Deposit & Policy Rates
Trade Policy Framework (2015-18) has been announced (Percentage)
by Ministry of Commerce, Government of Pakistan WALR WADR Policy Rate
which aims at addressing the important areas such as 14
competitiveness, quality standards, market access of local 12
products etc. This policy initiative, if implemented
10
successfully, is expected to raise exports – including
textile sectors’ - and, consequently, could help generate 8

credit demand. 6

Table 1.1 4

Sector-wise Gross Advances Flows (Public and Private) 2

CY13 CY14 CY15 0
PKR billion

Dec-13

Dec-14

Dec-15
Feb-14

Oct-14

Feb-15

Oct-15
Apr-14

Jun-14

Apr-15

Jun-15
Aug-14

Aug-15
Agribusiness (14.0) 53.5 80.0
Production/transmission of energy 0.3 128.2 60.2 Source: S&DWHD, SBP
Chemical/Pharmaceuticals 0.2 40.1 33.2
Financial 39.3 4.2 22.9 Working capital advances stay unchanged; while fixed investment
Individuals 49.9 49.7 21.8 advances pick up…
Electronic/electrical appliances 1.9 7.0 15.3
(3.7) (9.0) 12.0 Segment-wise information on domestic advances flows
Cement
Sugar 14.7 18.1 6.3 reveals around 75 percent contribution from private
Shoes and leather garments 2.9 (3.6) 2.3 sector – mostly in corporate sector (Table 1.2). Within
Insurance 0.0 0.3 (0.3) working capital financing, repayment from public sector
Automobile/transportation 4.5 11.5 (19.0) entities (PSEs) nullified 13 percent growth by private
Textile 79.5 13.6 (30.5) sector resulting into an overall marginal decline of 0.7
Others 133.8 110.8 196.0 percent in working capital loans. The average working
Total 309.2 424.5 400.2 capital demand declined by 1.0 percent in the last two
Source: FSD, SBP years in sharp contrast to 12 percent average annual
growth during CY10-CY13. This decline may be
Though the recent credit growth is a positive sign, the attributed to demand effects i.e. declining exports and
surge has yet to find the crest considering the recent receding prices of goods used as input in manufacturing
sharp dip in policy rate and weighted average interest process owing to low commodity prices – particularly the
rates (Figure 1.4)33. Besides the time lag involved in oil prices34.
transmission mechanism, the partial resistance may be
due to less than anticipated rise in domestic demand
(lower real GDP growth), still higher real interest rates

32 The partial increase in agribusiness advances during the period is

due to change in reporting methodology for Islamic banks. 34Whole Sale Price (WPI) index showed deflation during entire CY15
33 Weighted average lending rate (WALR) on fresh lending came on YoY basis and average inflation of 1.1 percent during CY14 to
down by 329 bps in CY15 to reach 8.0 percent in Dec- 2015 CY15 against average inflation of 13.2 percent during CY10-CY13 (4
(http://www.sbp.org.pk/ecodata/sir.pdf) years).

15
 Table 1.2 productive capacity; which, surely, hints at expected
Segment-wise Domestic Advances Flow during CY15 future industrial growth. Noticeably, this surge has
Public Sector Private Sector helped in stabilizing the Gross Fixed Capital Formation
(GFCF) to GDP ratio (Figure 1.5).
(PKR billion)
Corporate Sector 23.6 205.2 Figure 1.5
Fixed Investment 108.8 177.8 Gross Fixed Capital stabilizes in relation to GDP
Working Capital (116.6) 113.9 Gross Fixed Capital Formation
(PKR billion) (percent)
Trade Finance 31.4 (86.5)
SMEs 17.2 Gross Fixed Investment GFCF as % of GDP (RHS)

Fixed Investment 33.5 4000 25.0

Working Capital (6.8) 3500
20.0
Trade Finance (9.5) 3000
Agriculture 26.5 2500 15.0
Consumer Finance: 43.0 2000
Credit Cards 1.9 1500 10.0
Auto Loans 24.2
1000
Consumer Durable (0.0) 5.0
500
Mortgage Loan 3.4
0 0.0
Other personal Loans 13.6 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
Commodity Financing 68.1 (22.5)
Source: Statistical Bulletin March 2016, S&DWHD, State Bank of
Staff Loans 9.9 Pakistan
Note: FY here means Fiscal Year
Housing Finance 7.8
Others than housing finance 2.1 Consumer financing gains momentum in a low interest rate
Others (1.7) environment …
Total 91.7 277.6
The consumer financing (CF) – after following high
Source: FSD, SBP
growth path during 2003-0738- observed sharp slowdown
Encouragingly, private sector advances growth has along with rise in infection ratio during 2008-1239
climbed up in fixed investment segment (long term) (Figure 1.6). This fall in CF was in line with the overall
since last couple of years35. The prime users of this long- economic slowdown as well as marginal growth in credit
term financing (over one year) were transport, storage to private sector. However, consumer financing has again
and communication, chemical and chemical products, started to gain momentum in last couple of years (CY15
non-metallic mineral products, construction, textile, and observed growth of 15.3 percent, while CY14 saw 9.2
energy sectors36. The current state of economic affairs percent growth).
[low interest rates37, stable exchange rate and low
commodity prices (including metal and machinery)] has
provided ample opportunity to firms to enhance their

35 CY15 and CY14 observed growth in fixed investment of 19.6

percent and 15.2 percent, respectively, compared to just 3.5 percent
average growth during CY10-CY13 (4 years).
36 Source: http://www.sbp.org.pk/ecodata/By-type-of-finance.pdf 38 Liquidity inflows, low interest rates, banks’ desire to diversify their
37 The capacity building usually requires mega projects of longer term lending portfolio, and overwhelming demand from common public
with huge cost involved. Such projects generally require banks’ helped increase CF at that time.
financing (usually consortium financing) with floating rates. The low 39 The CF after attaining the peak of PKR 371 billion in December,

interest rates may provide a significant cost saving to firms for next 2007 dipped by 40 percent to reach PKR 224 billion as of December
few years. 31, 2011.

16
 Figure 1.6 SME financing grows modestly …
CF grows when NPLs decline
SME financing kept falling during CY08-CY12 and
Annual Flow of CF and NPL Ratio
marginally picked up thereafter. The advances to SME
(PKR billion) (percent)
sector have showed modest growth of 6.0 percent during
Domestic Consumer Loans Consumer Infection Ratio
the reviewed year. In order to encourage banks to
400 25
enhance their exposure to the SME sector, SBP in CY15
350 reemphasized the banks/DFIs to: a) achieve their SME
20
300 financing targets and b) to accomplish some
250 supplementary measures by December-201642. It is
15
200
expected that this policy initiative – complemented by
10 positive economic developments - will play a catalytic
150
role in enhancing growth of SME financing and its share
100
5 in overall advances.
50
The recent surge in consumer financing along with
0 0
increased recovery in SME financing are positive
developments which are also synchronized with SBP’s
Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15
Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

Jun-14

Jun-15

efforts towards financial inclusion. However, banks still

Source: FSD, SBP
have credit concentration in corporate entities, which,
The granular CF data reveals contribution from auto limits banks ability to diversify and venture into
financing followed by personal loans and, to some consumer and SMEs financing.
extent, mortgage financing. Auto financing demand
Pilling stock of wheat financing need to be resolved…
sharply rose in the last three years (34 percent growth in
CY15 and 3-years average of 28 percent during CY13- The financing for the procurement of wheat of PKR 71
15). Besides government sponsored auto schemes, the billion has raised the overall commodity financing during
declining interest rates explain the rise in this segment CY15; while outstanding stock observed pay-offs both in
since most banks have linked auto financing to KIBOR sugar (PKR 2 billion) and urea (PKR 21 billion) (Figure
on floating basis. In parallel, the high growth in auto 1.7). The increase in wheat financing is mainly attributed
manufacturing served the supply-side contribution40. to rise in wheat support price from PKR 1200/40kg to
PKR 1300/40kg in November 201443.
The recently announced auto policy is expected to
increase market competition through bringing in new The public sector outstanding stock of wheat financing –
manufacturers. Lower prices and better choices, as a which is self-liquidating in nature - has remained high
result, might further increase automobile demand and since 2009. On account of unpaid subsidy, government
hence rise in auto financing in coming years. might have to adjust the rising stock through issuance of
debt instruments as it did in the past44. Re-accumulation
Amongst other segments, growth in personal loans –
of these stocks requires devising a mechanism to timely
mostly offered on fixed rate - is contributed by one
retire outstanding commodity financing within the given
major player of the industry41. The slight increase in
cycle.
mortgage financing during the reviewed year is due to the
recent surge in construction activity.

42 Islamic SME Financing targets of 15 percent have also been set for
each bank.
40 CY15 witnessed around 44 percent growth in car production in 43 In the second half of CY15, wheat financing reduced significantly

Pakistan (Source: http://www.pama.org.pk/statistical- due to off-loading of wheat by Trade Corporation of Pakistan (TCP).
information/sales-production/monthly-sales-production) 44 In November 2011, government adjusted unpaid subsidy on
41 The outstanding personal loan financing is quite concentrated as commodity finance through issuance of PIBs and MTBs
around 93 percent of financing is being provided by only 3 banks. (http://www.sbp.org.pk/fsr/2011/pdf/2ndhalf/Chap-01.pdf)

17
 Figure 1.7 Figure 1.8
Outstanding stock of wheat financing keeps on rising Relatively more lending by Medium and Small banks
Break-up of Public Sector Commodity Financing Stock Quartile-wise Flow of Advances in CY15
(PKR billion) (PKR billion)
Urea Sugar Wheat
CY14 CY15
600
250
500
200
400
150
300
100
200
50
100
0
Quartile 4 Quartile 3 Quartile 2 Quartile 1
0
CY12 CY13 CY14 CY15 -50
Source: FSD, SBP Source: FSD, SBP

Overall advances flow quite diversified… Investment remained high despite decline in yield…
When analyzed from the perspective of banks’ size45, the Banks have continued to invest in (credit) risk free
lending in CY15 has not been confined to a few large government securities (PKR 1.5 trillion) during CY15
banks, but, rather, it is broad based. Banks in quartile 3 despite decline in yield on government papers of all
(medium sized banks) have had a bigger contribution tenors (Table 1.3). This has lifted up the share of net-
than banks in quartile 4 (large banks) in the advances investment in overall assets to 49 percent as of end
flow during the year. Similarly, banks in quartile 2 (small December 2015 (44 percent as of end December 2014).
banks) also contributed significantly in flow of advances Holding sovereign debt papers has a number of merits –
(Figure 1.8). even at lower rate of return – viz.; risk free interest
income, zero risk weight for calculation of Credit Risk
The recent surge in credit demand is expected to
Weighted Assets (CRWAs) for Capital Adequacy
accelerate further in medium term due to ongoing
purposes and strong fund based liquidity. However,
economic reforms (fiscal consolidation, monetary easing,
inclusion of longer term PIBs has exposed banks to
build up of FX reserves etc), likely resolution of energy
interest rate risk46 (see chapter 2 and 7).
shortfall, developments relating to CPEC) and
strengthening of business confidence. Stable growth remained the salient feature of deposits…
One of the positive aspects in banking has been the
consistent growth in deposits. With growth of 12.6
percent, deposit base has reached to PKR 10.4 trillion as
of end December 2015 (Figure 1.9). Around 72 percent
of the overall deposits of the banking sector are placed in
the core category of CASA (Current Account- Saving
45For this analysis, all banks in each calendar year have been divided Account); exhibiting stability of deposits. The
into quartiles based on their share in total assets. Banks above the 75th
percentile, in terms of total assets, have been classified as large
(quartile 4). Banks between the 75th percentile and 50th percentile have 46Maturity is directly proportional to instrument’s sensitivity to
been categorized as medium (quartile 3) and so on. The methodology interest rate changes which is also termed as high duration or interest
does not account for bank mergers at this point. rate risk.

18
decomposition of data reveals growth in all segments of worker remittances hints at some contribution of
deposits during CY15; non-remunerative current remittances in deposit growth (Figure 1.10). In
deposits (17.7 percent), saving deposits (11.4 percent) addition, the entry of large banks into branchless banking
and fixed deposits (6.9 percent). has augmented the deposit growth (particularly in terms
of number of accounts). It has provided an opportunity
Table 1.3
Flow of Banks' Investment in Govt. Securities to these large banks to explore the untapped avenues of
Flows During CY13 CY14 CY15
the financial system.
PKR billion Figure 1.9
MTBs 171.7 (970.6) 809.6 Decent growth in all segments of deposits
PIBs 108.8 1,977.2 616.1
Annual Flow of Deposits
Others 20.9 0.6 152.7
(PKR billion)
Total investment in Govt.
Securities 280.5 1,006.5 1,425.6 Fixed Saving CA -R CA - NR
Total Investments 301.4 1,007.1 1,578.3
1,100
Investment in Govt. Securities to
Total Investment (Percent) 93% 100% 90% 1,000
900
Outstanding Stock as of end: CY13 CY14 CY15
800
PKR billion
700
MTBs 2,704.1 1,733.5 2,543.0
600
PIBs 736.1 2,713.2 3,329.3
Others 306.7 354.8 452.9 500
Total investment in Govt. 400
Securities 3,746.9 4,801.5 6,325.2 300
Total Investments 4,347.1 5,354.2 6,932.4
200
Source: FSD, SBP
100
The stability in deposit growth may be attributed to 0
CY12 CY13 CY14 CY15
customer’s trust in banking, limited availability of
Source: FSD, SBP
alternate sources and lack of awareness about available
ones, convenience which is further strengthened by Figure 1.10
better use of IT services, banks’ efforts to convey and Deposit flows and worker remittances appear synchronized
convince depositors through aggressive media Workers Remittances & Deposits- Cumulative Flows
campaigns, and recent pick up in advances growth47. (PKR billion) (USD Billion)

Worker remittances and deposits appear to grow together… Deposits Remmittances (RHS)
1,400 25.0
The consistent growth in worker remittances over the
1,200
years48, becoming part of the liquidity of domestic 20.0
financial system, is, perhaps, another factor partially 1,000

supporting the deposit growth. The yearly flow data 800 15.0

exhibiting an upward co-movement in deposits and 600 10.0

400
5.0
47 The analysis reveals that deposits of the banking sector are aligned 200
with cyclical movements in advances. Please see Box-A in the
Quarterly Performance review of the Banking Sector, July-September - -
2015. CY10 CY11 CY12 CY13 CY14 CY15
http://www.sbp.org.pk/publications/q_reviews/2015/q_review_Jul-
Sep_15.pdf Source: SBP
48 Pakistan is the 8th largest recipient of worker remittance

(http://www.worldbank.org/en/topic/migrationremittancesdiasporai
ssues/brief/migration-remittances-data)

19
 SBP made changes in minimum saving rate to safeguard fixed deposits are held in the bucket of shorter term
depositors… maturity (one year or less) and offering rates slightly
above the MSR50.
SBP has been endeavoring to protect the depositors’
interest through its various policy initiatives. To ensure Foreign Currency (FCY) deposit growth subsides…
adequate returns to depositors on their funds placed with
Currency-wise break-up shows 8.0 percent increase in
banks, SBP has been raising and strengthening minimum
FCY deposits – lower than the average growth of around
saving rate (MSR) regime since 2008.
19.4 percent during CY10-CY13 but more than 5.6
Historically, SBP introduced MSR, for the first time, as 5 percent growth in CY14. This could be due to stability in
percent per annum (p.a.) on all saving and term deposit local currency during the first three quarters of the
in May 2008. It then raised MSR to 6 percent (p.a.) in reviewed year. FCY deposits observed rise, mostly, in the
May 2012, advised banks to calculate MSR on monthly last quarter – post Yuan devaluation - owing to
average in March 2014, and linked MSR with lower anticipation of decline in the value of domestic currency
bound of interest rate corridor in September 2014 such (see chapter 7). The FCY deposits, though, remained
that MSR remains 50 bps below the floor of the within the limits prescribed by SBP51.
corridor49.
Retail deposits grow as disposable income rise…
Figure 1.11 The deposit-holder wise distribution shows healthy
Saving deposits grew with changes in MSR
contribution both from institutional depositors
Fixed and Saving Deposits
(governments, NBFIs) and personal/retail depositors52.
(PKR billion)
On the other hand, deposits of private sector businesses
Fixed Deposits Saving Deposits
have decelerated. The growth in retail deposits might be
4,000
driven by higher overall income53 partially supported by
3,500 consistent low oil prices which has increased the
disposable income of various agents in the economy.
3,000
Borrowings rise as growth in deposits fall short of the credit demand
2,500 of private and public sectors …

2,000
The growth in overall deposits has, however, not been
enough to meet the aggregate financing need of both the
1,500 private and public sectors. Consequently, financial
borrowings supported the funding side of the banking
Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15
Apr-11

Apr-12

Apr-13

Apr-14

Apr-15
Aug-11

Aug-12

Aug-13

Aug-14

Aug-15

sector during the reviewed year (Table 1.4).

Source: Statistical Bulletin March 2016. S&DWH D, SBP

After the introduction of MSR, the share of saving

deposit in overall deposits has increased from 32.7
percent as of 31st December, 2008 to 37.2 percent as of 50 Source: Statistical Bulletin, April 2016, SBP
31st December, 2015 (Figure 1.11).
51 As per regulation O-5 of Prudential Regulations, deposits mobilized
under FE 25 scheme, after netting-off the deposits utilized to finance
On the other hand, growth in fixed deposit – after trade related activities such as financing against Import and Export
documents, should not at any point exceed twenty percent of the local
observing deceleration in CY14 – bounced back in currency deposits of the bank.
CY15, likely, due to banks’ effort to balance their 52 In CY15, personal deposits contributed 57 percent in overall

deposit flow (share in outstanding deposit 50 percent) while

funding mix. It may be noted that around 55 percent of institutional deposits added 31 percent (share in outstanding deposits
14 percent)
53 Per capita income in Pakistan reached USD 1,513 in Jun-15; up by
49 SBP also excluded term deposits from MSR policy in June 2014. 9.5 percent from USD 1,384 in Jun-14.

20
 Table 1.4 Figure 1.12
Breakup of Financial Borrowing in CY15 Repo borrowing from SBP dominated overall financial borrowiings
CY13 CY14 CY15 Weekly Flows of Financial Borrowing
PKR million
(PKR trillion)
Secured (406.1) 229.2 678.4
i) Borrowings from Subsidiary Co etc. Repo Borrowing -From SBP Financial Borrowing - Overall
& Directors - - - 3,500
ii) Borrowings From SBP: (491.5) 182.1 681.3
Export Refinance 6.3 7.8 19.4 3,000
Others (Repo borrowing from SBP) (497.8) 174.3 661.9
iii) Repo borrowings (other than SBP) 87.3 41.9 (1.5) 2,500
iv) Others (1.9) 5.3 (1.4)
Unsecured 94.3 48.4 86.3 2,000
i) Call borrowings 58.8 26.9 6.5
ii) Overdrawn nostro accounts 6.0 (2.1) (1.8) 1,500
iii) Others 29.4 23.6 81.6
Total Borrowings (311.8) 277.6 764.7
1,000
Source: FSD, SBP
500
The weekly data54
of outstanding stocks shows that -
banks’ repo borrowing from SBP dominated the overall

Mar-14

Jul-14

Dec-14

Dec-15
Jan-14

Oct-14

Feb-15

Oct-15
May-14

Apr-15
Jun-15
Aug-14

Aug-15
borrowings (Figure 1.12). Particularly, such borrowings
sharply picked up after SBP introduced SBP target rate Source: FSD, SBP
for overnight money market repo rate (ONR)55. In order
to keep ONR closer to SBP target rate, SBP injected Conclusion…
adequate liquidity into the market which addressed the Overall, the flow of deposits and advances advocate that
dual concerns. On the one hand, it contained volatility in small and medium-sized banks have played, relatively, a
overnight rates while, on the other hand, it addressed the better role in financial intermediation during CY15.
liquidity concern of the market enabling it to function Large banks have focused more on investments. They
smoothly (see chapter 7). need to diversify their asset pool, other than investment
Equity observed gradual rise… in government securities, so that any unwinding of fiscal
need in future may not adversely impact their financial
Equity base – one of the most important measures of health, as well as, the financial stability of the entire
banks’ resilience against shocks – reveals a moderate system. The positive economic outlook and expectation
increase of 9.6 percent during CY15. The overall high of gradual recovery on global front provide evidences to
profitability – and retained earnings - and SBP’s expect credit off-take further accelerating in future.
minimum capital adequacy policy that prompted few
capital deficient banks to put in additional equity are the
major reasons behind the rise in equity. Further,
revaluation surplus – primarily on account of mark to
market adjustment on PIBs placed in AFS category - also
supported the equity of the banking sector.

54 Since financial borrowings are transitory in nature, the data of

shorter frequency such as weekly or daily shows a better picture.
55 In May 2015, SBP introduced a ‘Target Rate’ for overnight money

market repo rate, as a new ‘Policy Rate’ to unambiguously signal

SBP’s stance of monetary policy
(http://www.sbp.org.pk/dmmd/2015/C9.htm)

21
22
 2 Risk Analysis of the Banking Sector

The risk profile of the banking sector mainly comprising of Credit, Liquidity and Market risks has remained subdued during the period
under review. Credit risk, as measured by the Non-Performing Loans Ratio (NPLR) or infection ratio, has subsided. NPLR has
declined by 91 bps in CY15 to record 11.4 percent; though stock of NPLs has registered a marginal rise. Textile sector’s infection ratio
has increased making it more vulnerable to credit risk. Whereas, decelerating trend of cash recoveries against NPLs may lead to build up
in stock of NPLs. Despite some growth in non-core liabilities, funding liquidity of the banking sector, by virtue of large holdings of
government securities, remains healthy. Market risk profile of the banking system is well contained, though banks may face revaluation risk
in a rising interest rate scenario.

Credit Risk Figure 2.1

NPLR is declining amid nominal increase in stock of non- Stock of NPLs almost Stagnant
performing loans (NPLs)… Non Performing Loans
(PKR billion) (Percent)
Asset quality of the banking system has observed gradual NPLs
NPLs to Loans (RHS)
Net NPLs
Net NPLs to Net Loans (RHS)
improvement over the last few years, a trend which
700 16
continued during CY15. The NPLR at 11.4 percent, as of
14
end CY15, has come down from a high of 14.5 percent 600

in CY12. NPLR has steadily declined; 12.3 percent in 500

12

CY14 and 13.0 percent in CY13 (Figure 2.1). Besides 400

10

some improvements in domestic macroeconomic 8

300
conditions such as falling interest rates which has led to 6
gradual rise in credit off-take, this decline can also be 200
4
attributed to banks’ recovery efforts and conducive 100 2
regulatory environment.
0 0
CY12 CY13 CY14 CY15
The stock of NPLs has been hovering around PKR 600
billion since CY12 (Figure 2.1). During CY15, NPLs Source: FSD, SBP
inched up slightly by PKR 0.74 billion (or 0.12 percent
YoY) to reach PKR 605.44 billion as compared to PKR The containment of NPLs and improving NPLR are
604.70 billion in CY14. The inflow of new NPLs in 2015 healthy signs for the banking sector’s credit risk.
has almost been offset by cash recoveries (61.8 percent Nevertheless, expected slower cash recoveries in the
of fresh NPLs), write offs (13.7 percent) and future and stagnant stock of NPLs may pose a risk to the
restructuring and upgrade of existing NPLs (23.5 declining trend of infection ratio leading to higher credit
percent). The marginal rise in NPLs is mainly risk.
concentrated in textiles and textile related activities (trade
and commodity finance). Among different categories of banks, Public Sector Commercial
Banks (PSCBs) and Medium-sized banks appear to be vulnerable
With static NPLs, the improvement in infection ratio can to credit risk…
also be attributed to growth in private sector advances.
On YoY basis, gross advances have grown by 7.4 percent In contrast to the overall trend, PSCBs’ infection ratio
in CY13, 9.4 percent in CY14 and 8.1 percent in CY15, has been increasing since CY13 and in CY15 it has
respectively. increased by 50bps to reach 18.3 percent (Table 2.1).
During CY15, stock of NPLs of PSCBs has grown by 4.2

23
 percent (YoY) which again highlights the inherent advances and 3 percent shares in NPLs) and adequate
weaknesses in the credit risk management system of coverage to NPLS do not represent the weakest link.
these banks. NPL stock of most of the PSCBs has surged
during CY15. Table 2.2
Asset Quality by Bank Size
On the other hand, infection ratio of local private banks Bank Category CY13 CY14 CY15
Infection Provision Infection Provision Infection Provision
(LPBs) has declined from 11.4 percent in CY13 to 9.3 Ratio Coverage Ratio Coverage Ratio Coverage
percent in CY15. LPBs appear to be managing their Ratio Ratio Ratio

credit risk better than PSCBs.

percent
Quartile 4 (Large) 12.2 81.6 11.8 80.4 9.8 92.0

In case of Foreign Banks (FBs), infection ratio rose by Quartile 3 (Medium) 14.8 70.0 13.9 78.0 16.4 74.9

20bps in CY15 mainly due to proportionally higher Quartile 2 (Small) 13.1 65.8 9.9 73.5 9.5 72.2
21.1 92.9 19.6 92.4 21.2 92.5
decline in advances (35 percent, YoY) as compared to
Quartile 1 (Very Small)
All banks 13.0 78.4 12.3 79.8 11.4 84.9
decline in NPLs (33 percent, YoY). FBs, however, have Source: FSD, SBP
the lowest NPLR among all banking categories.
Corporates becoming less riskier; while SMEs, despite
Table 2.1 improvements, carry higher credit risk…
Asset Quality by Bank Category
CY13 CY14 CY15
In terms of segments, NPLR has improved across most
Bank Infection Provision Infection Provision Infection Provision
Category Ratio Coverage Ratio Coverage Ratio Coverage categories (Corporate, SMEs, Consumers) since CY12
Ratio Ratio Ratio (Figure 2.2). From 15.0 percent in CY12, NPLR of
percent corporates has come down to 12.30 percent in CY15.
PSCBs 17.0 71.2 17.8 71.2 18.3 79.1 The level is still high but the declining trend is
LPBs 11.4 82.5 10.4 85.2 9.3 89.8
FBs 10.1 101.1 7.6 102.0 7.8 100.4 encouraging. If the corporate infection ratio continues to
CBs 12.6 79.4 11.9 80.9 11.1 86.3 improve, it would not only motivate banks to take on
SBs
All banks
25.5
13.0
62.3
78.4
23.3
12.3
61.1
79.8
18.9
11.4
59.3
84.9
more risks but also help corporates get loans at
Source: FSD, SBP reasonable rates.

In terms of size, there is gradual improvement in Figure 2.2

infection ratios for large and small banks, irrespective of SME sector has the highest infection ratio
their shareholdings, since CY13 (Table 2.2). However, Infection Ratio by Major Segments
gross NPLR of medium-sized56 banks have increased as (Percent)
they are struggling to reduce their infection ratios and Corporate SME Agriculture
bring them down to industry average. It appears that Consumer Finance Commodity Financing
some of these banks are unable to attract quality 90
borrowers and legacy debts persist. Further, another 80
cause of concern is that this category of banks has a 70
lower provision coverage ratio. 60
50
Banks falling in the lowest quartile (very small-size) also
40
have high NPLR (21.2 percent) but they possess
30
sufficient coverage (92.5 percent). Thus, these banks due
20
to their limited systemic impact (2 percent share in
10
0
CY12 CY13 CY14 CY15
56At the end of CY15, medium-sized banks have 22% share in Source: FSD, SBP
advances and 32% share in NPLs stock.

24
SMEs, with highest infection ratio (26 percent) in CY15, risk monitoring and mitigating mechanisms to ensure
still remain the most risky sector for the banks to lend. non-build up of bad debts in the energy sector.
Historically, SMEs have higher NPLs due to operating
vulnerabilities like lack of financial resources, limited Figure 2.3
technical upgrading and lack of training57. However, with Textile sector has the largest share and highest infection ratio

recent improvements in macro environment, especially Infection Ratio of Major Sectors

the cost of borrowings, SMEs are expected to fare better (Percent)

and downward trend in their infection ratio is expected Textile Individuals Energy Agribusiness Sugar
to continue. 35.0

Rising NPLs intensify textile, sugar, and energy sectors’ 30.0

concentration risk… 25.0

In terms of concentration, textile sector still represents 20.0

one of the largest sectors as its share in total advances, 15.0
though declining58, is still sizeable (14.3 percent in
10.0
CY15). In contrast, the infection ratio has been almost
stagnant during the last three years and have hovered 5.0
around 26 percent in CY15 (Figure 2.3). Persistent risk 0.0
in the textile sector has made it more vulnerable for the CY12 CY13 CY14 CY15
lenders. Advances to the textile sector in CY15 have
Source: FSD, SBP
declined by 3.8 percent (YoY). Subdued commodity
prices in international markets, slowdown in global
Figure 2.4
demand, and energy shortfall has also led to the decline
Flow of fresh NPLs considerably declined
in demand for credit by the sector. Being the largest
Fresh NPLs & Total Recovery
sector in terms of exposure, high infection ratio of textile (PKR billion)
sector has systemic implications (See Box 2.1). Fresh NPLs Cash Recoveries NPLs Upgraded
Write offs NPLs Restructured
Sugar sector, though not huge in terms of exposure (2.72 200.0
percent in CY15) but important for other reasons, has
also exhibited slight rise in infection ratio in the wake of 150.0

surplus sugar production and lower international sugar 100.0

prices. However, keeping in view its small share, the
sugar sector represents limited systemic risk to the 50.0
banking sector (See Box 2.2).
0.0
Apart from these two sectors, energy sector advances
-50.0
grew by 9.7 percent whereas its infection ratio worsened
by 1.3 percent over the last year. Due to the rising -100.0
exposure of banks on energy sector and persistence of CY12 CY13 CY14 CY15

circular debt issue59, banks need to put in place proper Source: FSD, SBP

Receding fresh NPLs and improved provision coverage ratio has

57 SMEDA,” State of SMEs in Pakistan” (www.smeda.org) increased the resilience of the banking sector…
58 The share of textile sector advances in total advances was 16.7
percent in CY12, 17.3 percent in CY13 and 16.1 percent in CY14. The flow of fresh NPLs is decelerating since CY12 on
59 Anecdotal evidence suggests that circular debt issue remains a

concern. the back of cash recoveries and better recovery efforts

25
 on the part of banks (Figure 2.4). In CY15, additions to A cause of concern is that the composition of NPLs is
NPLs amounted to Rs 103 billion which is 41 percent tilted towards the loss category which constitutes the
less than the peak of Rs 175 billion in CY12. Moreover, bulk (86 percent) of the total bad loans (Figure 2.6). In
the provision coverage ratio has improved to 85 percent CY15, an additional amount of PKR 24 billion was
in CY15 from 80 percent in CY14 and 78 percent in added to the loss category. However, considering that
CY13 (Figure 2.5). loss category of advances are, generally, fully provided
for (PKR 519 billion), the credit risk tapers down, to
Figure 2.5 some extent. Nevertheless, banks need to ensure that
Provisions held are higher than provisions required instead of allowing the bad debts to pile up, they need to
Provisions against NPLs
improve their credit risk evaluation and monitoring
(PKR billion) (Percent)
Provision required Provisions held
processes. Rise in bad debts would increase the cost of
Provisions to NPLs (RHS) Net NPLs to capital (RHS) lending which would eventually be passed on to the
600 90 customers.
80
500 Figure 2.6
70
Composition of NPLs is tilted towards loss category
400 60
Category wise Flow of NPLs
50 (PKR billion)
300
40 CY12 CY13 CY14 CY15
30
200 30
20
100 20
10
0 0 10
CY12 CY13 CY14 CY15

Source: FSD, SBP 0

The rise in provisions held by the banking sector against -10

bad debts is due both to the rise in specific provisions
which increased by 5.2 percent (YoY) and increase in -20

general provisions which grew by 41 percent (YoY) in

CY1560. The gradual diminution in the benefit of Forced OAEM Sub-standard Doubtful Loss
Sale Value (FSV), allowed earlier by SBP61, has induced Source: FSD, SBP
increase in the stock of specific provisions. Further, the
migration from substandard and doubtful categories to Cash Recovery against NPLs started decelerating after 2013…
loss category also led to an increase in overall
provisioning requirements. Overall cash recoveries are on a declining path and in
CY15 they have declined by 2 percent to reach PKR 63.7
Rise in bad debts in loss category may increase the cost of lending… billion (Figure 2.7). Recovery to Average NPLs ratio has
also decelerated from 12.2 percent in CY13 to 10.5
percent in CY15. Lengthy legal recovery process and lack
60 Total provision exceeds the required provisions as banks create
general provision under various Prudential Regulations, particularly of efforts on part of some banks to recover bad debts
for the Consumer Finance (CF) portfolio to protect banks from the appear to be the major reasons for the slowdown in
risks associated with the economic cyclical nature of this business. In
terms of regulation R-4 of the Prudential Regulation for CF, banks
recoveries. Moreover, persistent higher stock of NPLs in
are required to maintain a general reserve at least equivalent to 1.5 loss category implies slim chances of any further
percent of the consumer portfolio which is fully secured and 5 recoveries.
percent of the consumer portfolio which is unsecured.
61 BSD Circular No 1 of 2011

26
During 2015, LPBs have remained the main contributors Table 2.3
to recoveries with 65 percent share in total recoveries NPL Ratio of Consumer Financing
followed by specialized banks (SBs) & FBs with a share CY14 CY15
of 22 and 13 percent, respectively. PSCBs have again Share Infection Share Infection
been the poorest performers with less than 1 percent percent
share in total recoveries. Credit cards 7.8 10.5 7.4 9.7
Auto loans 24.1 5.1 28.3 2.8
Figure 2.7 Consumer durable 0.1 20.3 0.1 21.0
Cash recovery gradually receding Mortgage loans 17.8 27.0 16.2 24.8
Cash Recovery & Flow of Fresh NPLs Other personal loans 50.2 9.5 48.0 6.5
(PKR billion) (Percent) Total 100.0 11.6 100.0 8.7
Cash Recovery Against NPLs
Fresh NPLs Source: FSD, SBP
Recovery to Average NPLs (RHS)
210 12.5
Pakistan has the highest NPLs and the highest coverage ratio in
180 12.0 the region…
150
11.5 The regional comparison shows that Pakistan has the
120 highest gross infection ratio (Table 2.4). This is largely
11.0
90 due to legacy issues62 as the flow of new NPLs have
10.5 receded over the years. Due to the legal impediments to
60
writing-off long overdue loans and lengthy litigation
30 10.0 process, banks are reluctant to shed off bad loans from
their books. A prudent write-offs policy and dedicated
0 9.5
CY12 CY13 CY14 CY15 efforts to increase recoveries can improve the situation.
Source: FSD, SBP
Table 2.4
Infection Ratio & Provision Coverage Ratio (percent)
Among different products of Consumer finance, Mortgage loans
S.No Country CY13 CY14 CY15* CY13 CY14 CY15*
have the highest infection ratio…
Infection Ratio Coverage Ratio
Except consumer durables, all other consumer financing percent
categories exhibited improvement in infection ratio. The
1 Pakistan 13.0 12.3 12.5 78.0 80.0 82.0
stock of NPLs declined by 15 percent leading to a lower
2 Bangaldesh 8.6 9.4 9.3** 44.0 42.0 37.0
infection ratio of 8.7 percent in CY15 (Table 2.3).
3 India 4.0 4.4 4.8 47.0 49.0 49.0
Mortgage loans have the highest infection ratio (25 4 Indonesia 1.7 2.1 2.6 51.0 51.0 51.0
percent) in CY15. However, the share of residential 5 Sri Lanka 5.6 4.2 4.2 40.0 42.0 38.0
mortgage is less than 1 percent in total bank loans. The * September 2015 except Bangladesh
** June 2015
highest infection ratio can be attributed to the structural
Source: FSIs (http://data.imf.org)
issues faced by banks including weak foreclosure
standards, lengthy judicial procedures, non-automation
Pakistan’s banking industry, however, maintains adequate
of documentation and non-standardization of procedures
level of provisions against NPLs which is the highest in
amongst various housing schemes.
the region (Table 2.4). This provides comfort against
imminent idiosyncratic and systemic risks.
62An aging analysis of NPLs shows that more than 40% of the
amount under loss category is older than 5 years with remote chances
of recovery

27
 Results of credit shocks remain satisfactory, though there are some interest rate corridor has also been reduced to 200 bps64.
concentration concerns… These steps, along with the monetary easing, have
resulted in a significant reduction in volatility in the
Different hypothetical credit shocks aimed at testing the money market liquidity towards the second half of CY15.
borrower-wise concentration do not yield encouraging Not surprisingly, however, OMOs increased both in
results as around one-third of the banks become non- volume and frequency in order to achieve the
compliant with the local benchmark of CAR. On the aforementioned stability.
other hand, credit shocks based on historical data do not
pose much threat to the asset quality and solvency of the The calmness in the money market reduced risks to the
banking sector. Stress tests are discussed in detail in day to day liquidity management by the banks. (For
Chapter 3. details see Chapter 7).

Improving macroeconomic conditions suggest lower credit risk in the Fund based liquidity remained strong…
future…
Funding liquidity of the banking sector has also remained
Going forward, the improvements in macroeconomic healthy during CY15. Though there was increase in non-
environment signal diluted risks for the buildup of bad core liabilities65, deposits remained the backbone of the
debts. The economy is showing signs of recovery; credit funding mix.
to private sector is picking up amid lower interest rates;
Large Scale Manufacturing (LSM) is growing; law and Given the increase in long-term investments in
order situation is improving and energy shortages are government securities, banks have made efforts to raise
becoming less acute. The decline in oil prices is providing fixed deposits in order to match the maturities. Overall,
much needed support to the foreign exchange reserves funding liquidity indicators improved during the period
and helping to bring down the production costs. Thus, under review.
banks are anticipated to operate in a favorable
Core liabilities remained the mainstay of banks’ source of
macroeconomic environment which might alter their risk
funding…
taking behavior.
With a growth of 12.6 percent in CY15 (11 percent in
Nevertheless, outstanding stock of old NPLs and slower
CY14), deposits have been the major contributor
cash recoveries are the areas of concern for credit risk.
towards managing funding requirements (Figure 2.8).
Liquidity Risk However, some deceleration in the growth of deposits66
forced banks to turn to non-core liabilities to fund their
The liquidity profile of the banking sector is asset (advances and investments) growth. This is clearly
characterized by both market developments and the indicated by a 76.4 percent rise in borrowings during
funding position. CY15 compared to 38.4 percent in CY14. Overall, the
share of non-core liabilities has increased to 20.3 percent
Market liquidity: Calmness prevailed after introduction of SBP in CY15 from 16.6 percent in CY14. Despite this rise,
target rate … any significant funding risk does not arise as majority of
these non-core liabilities consists of secured borrowings.
To better manage market liquidity, SBP has introduced
changes to its interest rate corridor in May 2015. SBP’s
main policy rate, which is a target rate63, set 50 bps below
the ceiling rate has been introduced and the width of the 64 Besides, SBP also withdrew the penal rate on frequent access (7
times in a quarter) to SBP Reverse Repo and Repo facilities.
63 It
is to be noted that this target rate is for money market ONR 65 Customer deposits are core liabilities while all other liabilities are

where SBP manages liquidity (primarily through OMOs) in the referred to as non-core liabilities.
market to ensure that ONR remains close to the target rate. 66 In the preceding two years of CY13 and CY12, YoY growth in

http://www.sbp.org.pk/dmmd/2015/C9.htm) deposits was 14% and 17%, respectively.

28
 Figure 2.8 Figure 2.9
Deposits continued to be the main funding source Funding cost of non-core liabilties remained higher
Funding structure Funding Cost
(percent) (percent)
Borrowing-Secured Borrowing-Unsecured Deposits-customers Funding Cost - Core Liabilities
Funding Cost - Non-Core Liabilities
Deposits-FIs Equity other liabilities
Policy Rate
4.7 10.4 12
9.4
5.5 6.5 2.1
10.0 1.7 10
5.3
3.2 8.9 5.3 1.5
2.8 8
3.2

CY13 6

75.8 CY14 2

CY15 73.4
0
70.3 CY12 CY13 CY14 CY15

Source: FSD, SBP Source: FSD, SBP

…while funding cost of non-core liabilities remained higher Figure 2.10

Long term deposits registered consistent growth
Customer deposits have always been the cheaper source Maturity Profile of Deposits
of funds for the banks compared to non-core liabilities (PKR billion)
which are costlier (Figure 2.9). During CY15, the cost
CY12 CY13 CY14 CY15
of core liabilities also declined with the continuous fall in 3,000
interest rates. On the other hand, decline in cost of non-
core liabilities was lower due to higher volume of 2,500
borrowings compared to CY14.
2,000
Long term deposits registered consistent growth…
1,500
As banks are investing more in long-term securities, they
1,000
are also making efforts to raise long-term deposits.
During CY15 fixed deposits grew by 6.9 percent (YoY). 500
The maturity profile of the deposits also indicates that
deposits having maturity longer than three months have -
Up to 1m 1m to 3m 3m to 1 yr 1 yr to 5 yrs Over 5 yrs
increased, while the ones having maturity lesser than
three months have decreased (Figure 2.10). Source: FSD, SBP

The profile of liquid assets has not changed…

The structure of the liquid assets of the banks has not

changed as government securities continue to be the
major component during CY15 (Figure 2.11). Share of
government securities in total liquid assets has increased

29
 to 83.1 percent in CY15 from 80.7 percent in CY14 and In addition to the AFS category, over the last two years,
75.1 percent in CY13. banks have also looked to lock in their income stream
from investments by placing some of them in Held to
A structural shift towards investment in long-term Maturity (HTM)67 category, majority of which are PIBs.
securities was observed in CY14 owing to the anticipated Higher coupon rates and anticipation of decline in
fall of interest rates at that time. This motivation had led interest rates in the future were the reasons behind this
to an increase of 15.4 percentage points in the share of diversification.
PIBs in total assets during CY14.
Figure 2.12
On the other hand in CY15, in addition to PIBs, banks
Banks continued to prefer Available for Sale Category
have also invested considerably in MTBs owing to Government Securities by Category
uncertainty about future interest rates. Overall, the share (PKR billion)
of both PIBs and MTBs in investments has increased
Available for Sale Held for Trading Held to Maturity
during CY15.
8000

Figure 2.11 7000

Fund based liquidity further improved 6000
Liquid Assets as a percentage of Total Assets
5000
(percent)
MTBs PIBs 4000
Cash & Balances Balances with Other Banks
3000
Interbank lending
60 2000

50 1000

0
40
CY12 CY13 CY14 CY15
30 Source: FSD, SBP

20
Small banks exhibited comparatively lower liquidity…
10
Comparing liquid assets of the banks with their overall
0
CY12 CY13 CY14 CY15
assets reveals that not all banks are equally placed in
terms of liquidity during CY15 (Table 2.5). Some of the
Source: FSD, SBP growing banks (including three Islamic banks) belonged
to the second quartile (small banks), which continue to
…where banks continue to place majority of their risk free have the lowest amount of liquid assets, due to credit
government securities in Available for Sale category growth and branch expansion.
Banks have persisted with their liquidity preference Moreover, lack of high quality Shariah compliant debt
through placement of most of the securities into instruments and unsophisticated secondary markets for
Available for Sale (AFS) category of investments, which such instruments have also hampered Islamic banks in
allows banks to efficiently manage their liquidity this regard. On the other hand, large banks had the
requirements. Moreover, revaluation gains/losses on highest amount of liquid assets. Their ability to attract
AFS securities do not impact the profit and loss low cost deposits due to their wider market presence has
statement. In terms of share, 95 percent of MTBs and 71 helped them accumulate higher stock of liquid assets.
percent of PIBs are placed in AFS category as of end
CY15 (Figure 2.12). 67Share of HTM in gross investments remained around 17 percent
during last two years compared to 9 percent in CY13.

30
Table 2.5 Despite the aforementioned negative Gaps, it has to be
kept in mind that maturity Gap analysis does not account
Liquidity by Bank Size (percent)
for the tradability of the liquid assets. As mentioned
CY12 CY13 CY14 CY15 before, banks have had a large amount of highly liquid
Bank Category
Liquid Assets to Total Assets government securities at their disposal, which has
percent contributed to comfortable levels of liquidity throughout
the year under review.
Quartile 4 (Large) 47.2 48.4 51.5 55.4
Quartile 3 (Medium) 45.8 41.9 42.6 51.8 On the positive side, there is improvement in Gap for
Quartile 2 (Small) 50.6 45.8 45.9 45.7 “1m to 3m” and “6m to 1y” maturities. The latter can be
largely attributed to the higher stock of long term
Quartile 1 (Very Small) 57.0 58.3 48.5 54.1
securities accumulated by the banks over the last two
All banks 47.4 47.3 49.2 53.8 years.
Source: FSD, SBP
Figure 2.14
Figure 2.13 Liquidity Indicators stayed healthy
Gap remained negative over 30-day horizon Liquidity Indicators
Maturity Gap (Assets-Liabilities) as percent of Assets (percent) Liquid Assets to Total Assets
Liquid Assets to Deposits
(percent)
Liquid assets to Short-term liabilities
CY15 CY14 CY13 Advances to Deposits (RHS)
Currency to Deposits (RHS)
110 70
Over 1y
100
60
6m to 1y 90
80 50
3m to 6m 70
60 40

1m to 3m 50
30
40
upto 1m 30 20
CY12 CY13 CY14 CY15
(10) (5) - 5 10
Source: FSD, SBP
Source: FSD, SBP
Liquidity indicators stayed healthy…
Gap remained negative over 30-day horizon…
During CY15, more than half of the assets of the banks
The banking sector presents a mixed picture when it have fallen in the liquid assets category. As a result, all
comes to matching the maturity of assets and liabilities. liquid assets indicators improved (Figure 2.14).
During CY15, banks have fallen short over the 30-day Moreover, liquid assets maintained by the banks with
horizon as the deposits maturing within this period have SBP as per Statutory Liquidity Requirement (SLR)
exceeded the assets. In comparison, the Gap for “up to continue to remain well above the required level of 24
1m” is also negative in CY14, though it is somewhat percent (including 5 percent Cash Reserve Requirement)
lower than CY15. Similarly, the Gap for “3m to 6m” (Figure 2.15). The ratio stood at 50.8 percent at the end
bucket has also turned negative during the period under of CY15 compared to 46.8 percent last year.
review (Figure 2.13).

31
 Figure 2.15 does not bode well for the banking sector and banks
Banks maintained surplus liquidity need to devise ways to attract depositors, with ample
Required and Maintained Liquidity by Banks liquidity, in order to have sufficient funds in the future.
(PKR billion) (percent)
Liquidity maintained Banks would stand resilient towards various liquidity shocks…
Required Liquidity
Liquidity maintained to T&D Liabilities Banking sector would remain resilient in the face of
7000 70 different liquidity shocks. The results of stress tests on
6000 60 the banking sector reaffirm that system is satisfactorily
5000 50 placed to withstand liquidity shocks under different
4000 40 stress scenarios. For instance, severe liquidity shocks of
3000 30 significant deposit withdrawal for consecutive five days
2000 20 would have negligible effect on the short-term liquidity
of the banks. Further, the liquidity coverage ratio (LCR)
1000 10
of the banking system70, remained well above the
0 0
acceptable benchmark of 1, as defined under Basel III.
Mar-13

Mar-14

Mar-15

Stress tests are discussed in detail in Chapter 3.

Dec-12

Sep-13
Dec-13

Sep-14
Dec-14

Sep-15
Dec-15
Jun-13

Jun-14

Jun-15

Source: OSED, SBP Market Risk

Rising currency in circulation a risk to deposit growth… Market risk refers to the possibility of losses in the on
and off-balance sheet positions arising from adverse
In an easy monetary policy regime, currency in movements in market prices (interest rates, exchange
circulation (CiC) may increase as the overall money rates, commodity prices etc.).71 The market risk of the
supply increases. However, in an efficient intermediation banking system has remained manageable during CY15.
process, the rise in CiC is not prominent. Over the last
few years, the currency-in-circulation to deposits ratio Negative short-term rate sensitive Gaps, though within limits, may
(CDR) in Pakistan has exhibited minimal changes.68 raise repricing risk in case of increase in interest rates…
However, the ratio has increased by 4.0 percentage
During CY15, the Gap between the rate sensitive assets
points to reach 32.5 percent as of end December 2015
(RSA) and rate sensitive liabilities (RSL) remained
from 28.5 percent as of end December, 2014.69
negative for “up to 3m” maturity bucket (Figure 2.16).
The rise in CDR points towards depositors’ liquidity Moreover, the Gap for “3m to 6m” maturities also
preference. In a low interest rate environment and higher turned negative compared to positive value for CY14.
money supply, savers’ opportunity cost of holding cash These negative Gaps may expose banks to repricing risk
declines and they either increase consumption or look if the interest rates increase in the future as banks may
for better return assets (such as Stocks, CDNS, Property have to borrow at higher interest rates. On the other
market etc.) rather than keeping deposits in a bank. hand, banks can benefit in case of further decline in
interest rates.
However, normally, major part of these funds channel
back to the banks’ balance sheet in the form of deposits,
but it does not seem to be the case during CY15. Some
disincentive in the form of withholding tax on banking
transactions could be one of the reasons. Rise in CiC
70 The Liquidity Coverage Ratio will require banks to have sufficient
high quality liquid assets to survive a significant stress scenario lasting
68 CDR has been hovering around 28.6 percent, as of end December, 30 calendar days.
during the last three years (2012-2015). 71 For details see European Banking Authority
69 CDR has further edged up to 35 percent as of April 8, 2016. https://www.eba.europa.eu/regulation-and-policy/market-risk

32
 Figure 2.16 Figure 2.17
Gap (RSA-RSL) remained positive for long term maturities Market exposure stayed within limits
Gap (RSA-RSL) as percentage of Assets Foreign currency and equity exposures
(percent) (percent)
CY15 CY14 CY13 Foreign-currency-denominated loans to total loans
Foreign-currency-denominated liabilities to total liabilities
Over 5y
Net open position in equities to capital
16
3y to 5y
14
1y to 3y
12
6m to 1y 10

3m to 6m 8

6
upto 3m
4
(10) (5) - 5 10 15 CY12 CY13 CY14 CY15

Source: FSD, SBP Source: FSD, SBP

…while positive long-term rate sensitive Gaps may expose banks to

revaluation risk in case of rise in interest rates.

Risk sensitive Gap for maturities greater than six months,

which was already positive in CY14, has further
increased during CY15. This is largely due to the
anticipation of further decline in interest rates. Given
such high positive Gaps, banks may get exposed to
revaluation risk under an increasing interest rate scenario.

Banks’ foreign exchange and equity exposures stayed within

limits…

Both foreign exchange assets and liabilities have slightly

decreased, while equity exposures have exhibited minimal
increase. SBP’s prudent policies pertaining to limits on
foreign exchange and equity exposures72 are largely
behind the aforementioned trends in market exposures
of the banking sector (Figure 2.17).

72Prudential Regulations R-6 and O-5 for Corporate/Commercial

banking http://www.sbp.org.pk/publications/prudential/index.htm

33
 Box 2.1: Banking exposure on Textile Sector – a Table 1
stability perspective LSM Growth in Textile Sector
Weight in YoY Change
Percent
Textile sector has a special significance in the economy LSM FY13 FY14 FY15
of Pakistan due to its backward and forward linkages. Textile 20.91 1.6 1.3 0.5
Yarn 12.96 2.1 1.6 0.5
This important sector has deep rooted connection with
Cloth 7.19 0.6 0.7 0.1
the real sector in many ways i.e. (a) highest share in Jute Goods (Total) 0.33 9.3 -1.1 -7.2
export volume, (b) more than 40 percent absorption of Woollen & carpet yarn 0.33 -7.5 25.6 46.0
workforce employment, and (c) significant participation Woolen & worsted cloth 0.09 -3.3 -10.0 -11.0
in manufacturing activity with 8.5 percent share in Gross Knitting wool 0.01 8.5 -21.2 0.7
Domestic Product (GDP)73. Further, Pakistan is the 4th Woolen blankets 0.00 -27.0 -7.3 47.2
Overall LSM Index 4.1 4.1 3.3
largest producer of cotton74 with 8.8 percent share in the
Source: Pakistan Bureau of Statistics
global production75. The spinning industry is the key user Note: FY means here Fiscal Year
of cotton and enables Pakistan to hold around 10.33
percent share in global consumption of cotton. Table 2
Export Performance of Textile Sector in Pakistan
Textile sector is facing multiple challenges and showing
USD billion
dwindling performance in recent times with decelerating
FY14 FY15 Change
production. Growth in Large Scale Manufacturing (LSM)
Export - Overall Textile 13,720 13,476 -1.8%
index of textile sector76 has reduced to 0.53 percent
of which
during FY15 from 1.32 percent during FY14 and 1.6
Cotton Cloth 2,770 2,455 -11.4%
percent during FY13 (Table 1). Recently, during July15-
knitwear 2,294 2,417 5.4%
Jan16 (7 months), YoY growth in LSM index has fallen
Readymade garments 1,909 2,101 10.0%
to 0.95 percent compared to 1.05 percent in Bedwear 2,138 2,096 -2.0%
corresponding period last year. Cotton yarn 1,997 1,842 -7.8%
Towels 767 781 1.8%
The textiles’ export performance has also been negative. Other Textile Items 1,845 1,784 -3.3%
The export of textile & textile articles has touched USD Total exports 25,110 23,880 -4.9%
13.5 billion in FY15 as compared to USD 13.7 billion in Source: Pakistan Bureau of Statistics
FY14 and USD 13.0 billion in FY13 (Table 2). In the Note: FY means here Fiscal Year

first eight months (Jul-Feb) of FY16, textile exports have

declined by 8.8 percent and were recorded at USD 8.4 Not surprisingly, the financial information of listed
billion. The almost stagnant growth in textile export textile companies at Karachi (now Pakistan) stock
since last few years might have resulted in decline in exchange shows a clear decline in profits and meager rise
Pakistan’s share in global textile exports in contrast to in sales growth in FY15 as compared to the previous year
rising share of peer countries (China, Bangladesh, India (Table 3).
etc)77.

73 Source: All Pakistan Textile Mills Association (APTMA)

74 http://www.statista.com/statistics/263055/cotton-production-
worldwide-by-top-countries/
75 Source: “COTISTICS – Annual Cotton Statistics Bulletin”, Volume

44, August 2015

76 Textile sector has around 21 percent weight in LSM index.
77 Latif, R., Javid, A. Y. (2013), “Determinants for The Demand and

Supply of Textile Exports of Pakistan”, PIDE Working Paper,

2013:95

34
 Figure 1
Table 3 International cotton prices declined to historical low
International Cotton Pirce Index - Monthly
Performance of Listed Companies - Textile Sector
Price (US Cents/pound) Monthly Change Percent (R.H.S)
Top-20 listed Companies Textile Industry*
PKR million 250 25
2014 2015 growth 2014 2015 grwoth 20
200 15
Equity 160,653 185,037 15% 207,114 238,552 15%
10
Assets 409,041 449,360 10% 574,231 639,794 11% 5
150
0
Sales 350,963 359,471 2% 564,077 581,388 3%
-5
100
Profit (before Tax) 13,236 11,172 -16% 20,646 12,684 -39% -10
-15
Profit (after tax) 10,542 7,842 -26% 16,858 8,611 -49%
50 -20
* Available inforomatoin for companies as of Jun-15 is compared with same
companies as of Jun-14 -25
Source: Pakistan Stock Exchange 0 -30
Note: FY means here FY

Apr-11

Apr-12

Apr-13

Apr-14

Apr-15
Aug-11

Aug-12

Aug-13

Aug-14

Aug-15
Dec-10

Dec-11

Dec-12

Dec-13

Dec-14
The current state of textile industry in Pakistan could be
attributed to multiple reasons, of which, few are listed Source: IMF

below:
iii. Domestically, inadequate availability of energy and
i. The prices of the textile products in the international rising utility prices have compelled the firms to either
markets have plummeted in recent past. The make expensive alternate arrangements or shutdown
international cotton price index has fallen by 24 the production, in the extreme case. The rising cost
percent from 90.09 US Cents per pound in Sep-13 to of production has resulted in underutilized and/or
68.74 US Cents per pound in Sep-15. The decline is unutilized productive capacity making it difficult for
even more pronounced (62 percent) if referenced the firms to survive. The loss making firms to
from Jan-11 (Figure 1). Sluggish global demand due operating firms in textiles have risen from 36 percent
to consistent recessionary phase in the Euro Zone as of Jun-14 to 63 percent as of Jun-15.80
and slowdown in China is one of the major reasons
for the decline in international prices78. The steep fall iv. The ease of doing business in Pakistan is not up to
in prices has adversely impacted the export revenues the mark if compared to the rest of the world
of the textile sector in Pakistan. (Table 4).

ii. The subdued economic condition in China – one of

the key trading partners and buyer of Pakistan’s
textile goods- also dented the performance of textile
exports. The overall export to china declined during
Jul14-Jun15 by 15 percent to reach at USD 2.3
billion79.

78Source: World Bank, “Global Economic Prospects January 2016”

79Investigations have revealed that many of the large borrowers have
reduced their production due to inability to book orders from China. 80 Source: Pakistan Stock Exchange.

35
 Table 4
Country-wise Ranking in Ease of Doing Business for Year 2016
Overall Starting Dealing with Getting Registering Getting Protecting Paying Trading Enforcing Resolving
Ranking Business Construction Electricity Property Credit Minority Taxes Across Contracts Insolvency
Permits Investors Boarders
Malysia 18 14 15 13 38 28 4 31 49 44 45

Thailand 49 96 39 11 57 97 36 70 56 57 49

Turkey 55 94 98 36 52 79 20 61 62 36 124

China 84 136 176 92 43 79 134 132 96 7 55

Philpines 103 165 99 19 112 109 155 126 95 140 53

Sri Lanka 107 98 77 81 153 97 49 158 90 161 78

Iran 118 87 69 88 91 97 150 123 167 62 140

India 130 155 183 70 138 42 8 157 133 178 136

Pakistan 138 122 61 157 137 133 25 171 169 151 94

Bangladesh 174 117 118 189 185 133 88 86 172 188 155

Afghanistan 177 34 185 156 184 97 189 89 174 172 160

Source: World Bank
According to World Bank’s survey81 on “ease of export financing scheme (EFS), SBP provides short term
doing business”, Pakistan has been ranked at 138 financing facilities to exporters through banks for
(out of 185 countries) included in the survey. This exports of all manufactured goods especially value added
ranking was assigned considering various products. As of end December 2015, textile sector has
components important for doing business e.g. access around 60 percent share in EFS.
to energy and credit, registering property, trading
across boarder, taxes etc. Importantly, as per the Figure 2
report, Pakistan is one of the lowest ranked countries Textile sector exposure is well diversified
in terms of getting electricity, paying taxes, and Segment-wise Exposure as of End Sep, 2015 - Textile Sector
enforcing contract.
Textiles-Spinning

v. The deceleration in textile sector is reflected in the

slowdown in LSM growth in yarn and cloth 11%
Textiles-other
sectors82. The LSM growth in yarn and cloth 26%
decelerated to 0.5 percent and 0.1 percent during 13% Textiles-Weaving
Jul14-Jun15.
Textiles-Made-up
Why is textile sector important for banking sector?
15%

Textile sector has been one of the core users of the Textiles-Finishing

banking services in Pakistan. As of end September, 2015 34%

the overall gross lending of all banks to textile sector was
PKR 676 billion or 13.4 percent of the overall gross
advances83, of which, around PKR 86 billion exposure Source: FSD,SBP
was non-fund based (off-balance sheet). Under SBP’s
Viewing financing to textile’s subsectors, as of end
September 2015, highest exposure in textile sector
http://www.doingbusiness.org/rankings
pertains to spinning industry (PKR 138 billion, 26
81
82 Yarn and cloths carry 13 percent and 7 percent weight, respectively,
in LSM index out of 21 percent for textiles. percent) followed by weaving (PKR 86 billion, 16
83 Due to cyclical movement, the gross lending keeps moving

particularly during last two quarters of calendar year.

36
percent), textile made ups (PKR 66 billion, 13 percent), companies stands at PKR 126 billion or around 20
and finishing (PKR 57 billion, 11 percent) (Figure 2)84. percent of overall funded exposure.

As the performance of textile sector deteriorated and In terms of banks, the exposure to textiles is quite
non-performing loans increased85, its demand for credit dispersed as twenty nine out of 35 banks are directly
subsided (Figure 3). This has been more obvious in case serving the industry (Figure 4).
of working capital financing86; growth remained negative
2.9 percent during Sep14-15 compared to average Figure 4
positive growth of 4.5 percent during Sep10-14 (4 years). Several banks have high exposure in textile sector
However, since CY14, the general decline in interest Banks' Exposure in Textile - As percent of Equity (As of End Sep, 2015)
rates incentivized borrowing firms to enhance their
productive capacity (through borrowing for fixed 250

investment) where textile sector is no exception.

200

Figure 3
Infection ratio declined yet remained high in textile sector 150
Textile Sector - Advances and Non-performing Loan Ratio
billion PKR Percent
100
Gross Advances Infection Ratio (RHS)
900 40
50
850 35
800 30
-
750 25
B1
B3
B5
B7
B9
B11
B13
B15
B17
B19
B21
B23
B25
B27
B29
700 20
650 15 Source: FSD,SBP

600 10
550 5
However, in terms of equity, exposure of some banks is
quite high. Nine (9) banks’ exposure in textiles industry is
500 0
more than 100 percent of their equity; while 13 banks’
exposure is more than 50 percent of their equity.
Mar-11

Nov-12
Dec-09

Dec-14
Sep-08

Sep-13
Jul-09

Jan-12

Jul-14
May-10

May-15
Feb-09

Oct-10

Feb-14
Jun-12

Apr-13
Aug-11

Considering entity wise high concentration, few defaults

Source: FSD,SBP can quickly erode the equity of exposed banks and
The infection ratio of textiles is also at elevated level. As threaten the stability of the banking sector.
of Sep-15, gross NPLs of the textile sector stood at 29
percent; most of the bad debts were placed in the loss Interestingly, however, the five (5) largest banks of the
category with significant legacy (showing weak potential banking sector, though, have high exposure in absolute
of recovery). terms; the concentration in terms of their equity is
moderate hovering around 20-30 percent due to their
The interconnectedness of the textiles and banking relatively larger equity base.
sectors entails some risks to the financial stability. Bank’s
exposure in textiles is concentrated to a few large entities. Stress Assessment:
The outstanding loan disbursement against top-20 Given the current state of textiles, any further worsening
in the future would have consequences for the stability
84Source: e-CIB database, State Bank of Pakistan of the banking system. In the hypothetical scenarios of
Textile sector has the second highest infection ratio in CY15.
additional 5 percent, 10 percent, and 20 percent defaults,
85
86Most of working capital financing pertains to textile sector.

37
 the Capital Adequacy Ratio (CAR) of the banking sector financing from banks. The World Bank’s forecast on
reduces to 16.18 percent, 15.63 percent, and 14.55 global oil price is on downside due to excess supply. The
percent respectively, still well above the minimum spillover effect in terms of reduced oil prices in Pakistan
required level of 10.25 percent (Table 5). However, may continue to provide partial support to textile
solvency of banks with high concentration may come industry.
under pressure on default in textile exposure87.
Table 5 As per World Bank survey, consistently low cotton prices
are expected to bottom out with signs of mild recovery
Stress Test - Impact on Solvency with increase in NPLs in Textile Sector
in coming years of 2016 and 201790. This will help
If 5% If 10% If 20%
Existing Pakistan’s textile exports to grow with expected pick up
advances advances advances
PKR billion as of end in textile financing given other domestic bottlenecks are
become become become
Sep, 2015
NPLs NPLs NPLs
removed.
Advances - Textile Sector 673 673 673 673
Overall Risk Weighted
Besides, the performance of textile sector will also
6210 6210 6210 6210
Assets depend upon other important factors including stability
Total Eligible Capital 1038 1005 971 904
of exchange rate, international and local regulations,
CAR (in Percent) 16.72 16.18 15.63 14.55
political stability and law and order conditions in the
Decline in CAR -0.54 -1.09 -2.17
country. Importantly, the GSP plus status awarded to
No of CAR non-compliant
banks
2 2 3 6 Pakistan by EU is subject to fulfillment of various
Source: SBP conditions91. In case GSP plus status is withdrawn due to
failing of one or few conditions, it may negatively impact
Future outlook: the textile sector exports.

In addition to sluggish global demand, the prime

bottleneck hindering the textile sector’s growth appears
to be inadequate and high priced energy supply. The use
of alternates (furnace oil, self-generation of power etc)
may be feasible for few blue-chip corporates in short-
term but may not be appropriate for majority of the
firms. The materialization of government efforts to
resolve energy issue through bringing more power into
the system or tax incentives88 in favor of textile sector are
positive signs for the sector.

Further, the successful conclusion of dialogue between

APTMA and government on textile package89 may also
have some positive impact on textile production and

87 It has been observed in 2011 that default of few large borrowing

groups raised the infection ratio of the banking industry.
88 Recently, FBR has continued to keep its zero rating policy (i.e. zero

sales tax on use of gas and electricity) to textile, surgical, lather, 90 Source: World Bank, “Commodity Market Outlook”, October
carpets, and sports goods to spur exports. 2015.
89 APTMA has been requesting the government to withdraw three 91 Including signing and implementation of 27 core International

percent duty on import of cotton, remove surcharge of Rs3.60/unit Conventions pertaining to; Human Rights, Labor Rights,
of electricity, and do away with Gas Infrastructure Development Environment, Narcotics Control and Corruption besides vulnerability
Cess. Besides, the association is asking to release sales tax refunds criteria (https://www.tdap.gov.pk/eu-atp-
pending for years. assets/EU_GSP_Plus_FAQ.pdf )

38
Box 2.2: Sugar Sector and Banking Sector Stability92 The government has allowed export of sugar since 2011.
The second largest agro-industry of the country, However, due to non-competitiveness of domestic sugar
Pakistan’s sugar industry stands as the World’s eighth prices as compared to international prices, higher
largest producer and the fifth largest in terms of quantities could not be exported. Government also
sugarcane production93. Sugarcane crops cover 1.17 permitted subsidy on sugar exports, but it was not
million hectares of cultivated land and provides raw enough to cover the price differential between domestic
material to 89 sugar mills, playing a crucial role in and international sugar prices and sugar mills failed to
creating economic activity in the country. meet the export quotas. In order to support domestic
Table 1 sugar prices, Government has also imposed 20 percent
Pakistan Sugar Industry Facts
regulatory duty on import of cheap raw and refined sugar
in November 2014 which was subsequently increased to
Year Refined Carryover Sugar Cane Average Area under Sugarcane
Sugar Stock Support Retail Price Sugarcane Produced
Produced (Million Price of Sugar Cultivation (Million 40 percent in August 2015.
(Million Tones) (Punjab- (Rs per Kg) (Million Tones)
Tones) Sindh) (Rs Hectares) Table 2
per 40 Kg)
2009-10 3.14 0.87 100-102 63.41 0.94 49.37
Key Performance Indicators of Sugar Industry
2010-11 4.17 1.03 125-127 73.65 0.99 55.44 Financial Ratios FY10 FY11 FY12 FY13 FY14 FY15*
2011-12 4.65 1.11 150 57.16 1.04 58.04
2012-13 5.06 1.39 170-172 53.41 1.13 63.72
Current Ratio 0.7 0.9 0.8 0.8 0.8 0.8
2013-14 5.62 0.84 170-172 54.8 1.17 67.43 Cost of goods 89.2 88.2 90.8 92.1 92.4 89.6
2014-15 5.13 1.197 180-182 59 1.13 64 sold to sales %
Source: Pakistan Sugar Mills Association (PSMA) Annual Reports/Reviews Debt Equity Ratio 2.3 2.8 2.7 2.3 2.5 2.2
Geographically, 45 sugar mills are located in Punjab, 7 in Net profit margin 3.3 3.4 1.3 1.6 0.7 3.2
KPK and 37 in Sindh. Over the last five years, problems before tax %
like high cost of production, narrow profit margins94, Return on Assets 4.6 4.5 1.5 2.0 0.8 2.9
before tax
serious productivity growth problems and province-wise
Return on Equity 17.3 16.2 5.5 6.9 2.5 9.2
support price differential have hurt the sector and limited
before tax
the mills ability to meet their financial liabilities95.
Source: Statistics & DWH Department, SBP 2015. Data
represents financial results of 31 listed sugar mills.
An analysis of the last six years revealed that sugar * Data is based on audited financials of 15 listed sugar mills. The
industry is facing issues of surplus stock and lower sugar selection of sugar mills is based on the availability of financials for
prices. The persistent higher sugarcane support prices the year 2015.
since 2009-10 have led to the increase in area under The financial condition of sugar industry reveals rising
sugarcane cultivation and consequently higher availability cost of production with narrow profit margins (Table 2).
of sugarcane. Farmers got better income but cost of Return on Assets (ROA) and Return on equity (ROE)
production rose for the mills. Carryover stocks and has declined to historically low levels at 0.75 percent and
bumper sugarcane crops created a glut in the domestic 2.54 percent, respectively in 2013-14. However, financial
sugar market which subdued the prices in 2011-2012 and results for 2015 suggest encouraging picture for sugar
onwards making it difficult for the mills to cover the cost industry.
of production. From 2010-11 onwards, surplus sugar
stock along with suppressed sugar prices can also be Banking Sector Exposure on Sugar Industry
observed in the international markets96.
The banking sector’s total advances in Pakistan reached
to their historic high of PKR 5.051 trillion as of 30-09-
92 The financial year of sugar mills end in September of every year.
Therefore, end September data is used for analysis in this box. 2015 with sugar sector financing97 of around PKR
93 Pakistan Sugar Mills Association (PSMA) Annual Report 2014.
94 For further details, see Table 2.
95 Overview of sugar industry in Pakistan, June 2013, Lahore 97 Sugar sector financing comprises of two parts; commodity
Chamber of Commerce and Industry. financing extended for trading of sugar and sugar financing extended
96 ISO Quarterly Market Outlook Aug 2014. to sugar mills for manufacturing.

39
 184.475 billion (3.65 percent of total banking advances). higher sugarcane support prices; lower sale prices due to
The last five years statistics show that, on average, the excess supply resulting from higher than expected
share of sugar sector in total banks’ advances accounts sugarcane crops during the last five years along with
for a notable 4.0 percent, with commodity financing carryover stocks of sugar; and lower than domestic sugar
share of 1.0 percent and sugar financing share of 3.0 prices in the international market98.
percent (Table 3). Private sector stood as the major Figure 1
contributor of sugar sector financing with 2.95 percent After Mar 2015, upward trend in infection ratio
share, followed by the public sector with an average Infection Ratio of Sugar Industry
share of 1.10 percent. (PKR billion)
Total Banking Sector Total Sugar Sector
Table 3 Private Sector Public Sector
18%
Sugar Industry Exposure Bifurcation (PKR Billions) 16%
Years Commodity Sugar Total Sugar 14%
Financing Financing Industry 12%
Exposure 10%
FY11 39.0 95.0 133.9 8%
FY12 44.2 97.9 142.1 6%
FY13 38.6 108.0 146.6 4%

FY14 43.7 139.2 182.9 2%

FY15 48.8 135.6 184.5 0%

Source: FSD, SBP

Sep-11
Dec-11

Sep-12
Dec-12

Sep-13
Dec-13

Sep-14
Dec-14

Sep-15
Jun-12

Jun-13

Jun-14

Jun-15
Mar-12

Mar-13

Mar-14

Mar-15
Source: FSD, SBP
Infection Ratio Analysis of Sugar Industry

During the last five years, the average infection ratio of A granular analysis of sugar financing as reported in e-
sugar sector financing stood at 5.26 percent, in CIB (30-09-2015) highlights the following facts:
comparison to the overall banking sector’s infection ratio  Sugar exposure is significantly concentrated in
of 14.15 percent. Further, the ratio gradually came down top 5 banks which constitute around 54 percent
after touching the peak of 11.2 percent in Dec 2011 to as of total sugar financing.
low as 2.63 percent in Mar 2015 (Figure 1). Afterwards,  Approximately 44 percent of the funded
there is an uptick in bad debts in sugar sector and the exposure is concentrated in top 10 borrowers.
infection ratio, as of 30th September 2015 stands at 5.08  Among top 20 borrowers, only one borrower
percent. was reported as defaulter.

Following the same trend of overall sugar financing, the Future Outlook
infection ratio exhibits high average for private sector in
comparison to public sector. Public sector infection ratio The International Sugar Organization (ISO) in its report
was essentially nil (due to the exposure being backed by for August 2015 has reported world production for 2015
government guarantees) as compared to private sector’s at 170.911 million tons against the consumption of
NPL ratio of 7.49 percent on average over the last five 173.398 million thus creating a deficit of 2.487 million
years. Hence, the trend in infection ratio in sugar tons. As such it may have some impact on price of sugar
industry is entirely driven by the private sector. in international market. Also the World Bank
Commodity Markets outlook 2015 predicts that, nominal
The main drivers behind the infection ratio of sugar
financing could be the rising production costs due to 98 For further details, See table 1

40
annual sugar prices ($/kg) is expected to show an
increasing trend in 2016 and onwards due to decrease in
world sugar production. Moreover, domestic average
retail sugar prices have registered a rise of Rs 4/kg in
2014-15 after announcement of sugar export quota by
the government99. The expected rise in sugar prices may
bring some respite to the industry.

Moreover, the improving financial results for 2015 also

bode well for sugar industry. The government, in
addition to the measures already taken, may also look at
the incentives given by neighboring countries to support
their sugar industry.

All in all, the outlook of sugar industry is positive and its

impact on banking sector is likely to be less risky.

99 Pakistan Sugar Mills Association, Statistics National

41
42
 3 Profitability, Soundness and Resilience

The momentum in banking sector’s earnings continues as the sector has posted healthy profits in CY15 on the back of both
markup and non-markup income. The solvency of the system improved further due to increase in capital base fuelled by retention
of earnings. Both risk based and non-risk based solvency indicators have improved; Capital Adequacy Ratio (CAR) stood well
above the minimum regulatory benchmark and Leaverage ratio is also higher than the level suggested under Basel-III. In the
coming year, profitablity of the banking sector might come under pressue due to low yield on maturing government debt. Slower
internal capital geneartion through profits and incerasing riskiness of the balance sheet might also effect solvency profile. Banking
sector, at the moment, has enough cushion avilable to withstand a range of stress shocks.

Profitability Figure 3.1

Profitability indicators have improved
Banks’ profitability represents first line of defense Trends in Banks' Profitability
against unexpected losses. Retention of earnings is (PKR billion) (Percent)
an important source to build capital buffers which Profits (pre-tax) ROA(RHS) ROE(RHS)
350 30
improves shock absorption capacity of banks.
300 25
All the profitablity indicators show improvement…
250
20
Earnings, being an important barometer of the 200
financial health of a banking sector, have improved 15

significantly over the last three years in Pakistan.

150
10
Profit before tax has doubled during this time from 100
PKR 165 billion in CY13 to PKR 329 billion in 50 5
CY15. Accordingly, all the profitability indicators
saw improvement; ROA to 2.5 percent (up from 1.7 0
CY12 CY13 CY14 CY15
0

percent in CY13) and ROE to 25.8 percent (up

Source: FSD, SBP
from 18.4 percent in CY13) (Figure 3.1).

The recent income surge in CY15 came at the back Increasing markup on investments and declining cost of
of high net mark-up income contributed not only by deposits increased Net Interest Income (NII)…
21 percent (YoY) growth in interest earned on
During the last three years, NII of the banking
government securities but also by 13 percent (YoY)
sector has witnessed a surge of 14 percent (YoY), on
saving on interest expense on deposits100. The 25
average, due to improvements in markup income on
percent growth in non-interest income, primarily
investments that registered average growth of 15.9
due to high gains on the sale of PIBs, further
percent (Figure 3.2). Markup income on loans, at
improved the profitability of the banking sector.
the same time, has declined by an average of 1.8
percent (YoY).

100Subsequent to decline in policy rate by 350 bps, WADR during

this period dropped by 160 bps.

43
 Figure 3.2 incurred mainly to address the liquidity stress faced
Net interest income continued its rising trend by the market.
Net Interest Income
(PKR billion)
Loans income Investments income
..but Net Interest Margin (NIM101) observerd nominal
Deposits income Repo income decline.
Deposits expense Repo expense
Borrowing expense Net Interest Income (RHS)
1000 500 Despite the rise in NII, NIM remains anchored at
800 450 4.4 percent in CY15 (Figure 3.3). Declining interest
600 400 rates along with increase in cost of Repo borrowings
400 350 have decelerated the growth in the net interest
200 300 income. Also, the portion of higher income
0 250
generating asset (i.e. advances) in earning assets has
-200 200
been slower. Consequently, NIM has registered a
negligible fall of 4 bps in CY15. Given the falling
-400 150
yields on maturing government securities, NIM
-600 100
CY12 CY13 CY14 CY15 could come under pressure in the coming months.
Source: FSD, SBP
Figure 3.3
NIM remained stable
The divergence in interest income from two main Net Interest Margin
sources of earning assets comes as a no surprise. A (Percent)
cumulative 400 bps decline in policy rate over the NIM
period CY14 to CY15 has impacted the returns on 6

KIBOR linked earning assets. On the contrary, 5

investments, largely in government securities, have
continued to accumulate, resulting in growing 4

interest income. Interest from investments have 3

helped off-set the reduction in the markup/interest
earnings from advances. 2

The cost leg of net markup income, predominantly 1

comprising of deposit and borrowing costs, has 0

increased by only 2.1 percent, on average, during the CY11 CY12 CY13 CY14 CY15

last three years. In fact, in CY15 markup expense Source: FSD, SBP
declined by 3.8 percent mainly due to 13.2 percent
savings on interest paid on deposits. As a whole, the Provision charge surges due to shift in NPLs portfolio…
markup cost on deposits grew by only 0.5 percent,
on average, during CY14 to CY15. As for the Despite decelerated growth in NPLs of the system
borrowings, the cost (mainly on repos) surged by in CY15, the provision expense increased by 53.5
34.7 percent, on average, during the same period. percent (YoY) during CY15. This rise largely
Rising cost of Repo borrowings observed a resulted from shifting of existing NPLs to ‘loss”
phenomenal growth of 137 percent in CY15, category where provision charge is 100 percent of

101 NII over average earning assets equals NIM.

44
the outstanding amount and phasing out of FSV 20 percent indicating that banks have maintained
(Forced Sale Value) benefit102 (Figure 3.4). their interest in healthy corporates.

Figure 3.4 Figure 3.5

High provision expense due to shifting of NPL categories Non mark-up income largely driven by fee income and other
Provision charge during the year income
Composition of Non Markup Income
(PKR billion)
(PKR billion)
45 Fee Income Dividend Income FX income Others
40 250

35
200
30

25
150
20

15 100
10

5 50

0
CY12 CY13 CY14 CY15 0
CY12 CY13 CY14 CY15
Source: FSD, SBP
Source: FSD,SBP

Non-mark up income contributed significantly towards

Gain on sale of PIBs are an important source of other non-
profitability…
markup income…
Non markup income is generally driven by fee based
Gain on sale of securities is a significant contributor
business of banks and dynamic treasury
towards non-markup income in CY15. Previously,
management which pays off in the form of capital
capital gains on quoted shares used to be the major
gains in stocks, FX and bond markets. Along with
component of this type of income as the banks
growth in the core income103 in CY15, the non-mark
benefited from positive movement of capital
up income of banks has grown at an accelerated
markets (Figure 3.6).
pace of 24.7 percent on YoY basis. The growth is
largely supported by improved fee based income However, in recent years, the accumulation of
from trade and insurance related services offered by longer tenor government bonds with higher rates, in
banks and other income where substantial gains are anticipation of declining interest rates and
booked on sale of PIBs (Figure 3.5 and 3.6). subsequent movement of interest rates as per
expectations, have largely contributed towards this
In CY15, the fee income, which contributed 40
component. As the interest rates declined, banks
percent towards non-markup earnings, improved by
realized huge capital gains in CY15 by selling longer
17.4 percent. The dividend income, though a smaller
tenor government bonds of higher yields.
component of non-mark up income has grown by

102 BSD Circular No 1 of 2011

103 Please see Box 3.1 on income composition.

45
 Figure 3.6 Figure 3.7
PIBs largely contributed towards gain Spread in tandem with policy rate
Gain on Sale of Securities Movement of Deposit, Lending and Policy rates
(PKR billion) (Percent)
MTBs PIBs WALR WADR Spread Policy Rate
Fully paid up ordinary shares Quoted Shares
Other Securities 12
50
45 10
40
8
35
30 6
25
20 4
15
2
10
5 0
0

Nov-12

Nov-13

Nov-14

Nov-15
Mar-13

Sep-13

Mar-14

Sep-14

Mar-15

Sep-15
Jan-13

Jul-13

Jan-14

Jul-14

Jan-15

Jul-15
May-13

May-14

May-15
CY11 CY12 CY13 CY14 CY15

Source: FSD, SBP Source: SBP

Banking spread has considerably reduced in the last three Figure 3.8
years… Number of loss making banks has reduced
Pre-tax profitability of banking sector
Interest rate movement has also impacted retail (PKR billion)
rates, such as Weighted Average Lending Rate [above 35]

(WALR) on fresh loans and Weighted Average [25, 35]

[15, 25]
Deposit Rate (WADR) on fresh deposits. Both
CY14

[5, 15]
these retail rates are, to a large extent, synchronized [0, 5]
with the SBP policy rate (Figure 3.7). [less than 0]
[above 35]
Against the policy rate decline of 4 percentage [25, 35]
points over CY13 to CY15, WALR declined by 3 [15, 25]
CY15

percentage points and WADR by 1.96 percentage [5, 15]

[0, 5]
points to stand at 7.74 percent and 4.04 percent, [less than 0]
respectively, in CY15. Relatively lower decline in 0 5 10 15 20
WADR is understandable as SBP, to protect the No. of Banks
depositors’ interest, has put in place MSR since Source: FSD, SBP
2008.
Concentration in earnings has also reduced…
Consequently, the spread charged by banks has
reduced by 100bps to 3.69 percent in CY15 from Bank-wise statistics reveal a broad based
4.72 percent in CY13. Despite this decline in spread, contribution in banking profits as 32 banks posted
yield on rising volume of investment portfolio is profits, while the count of loss making banks has
supporting profitability of the banking system which come down to 3 in CY15 from 6 in CY14 (Figure
should have otherwise declined. 3.8).

46
Concentration of earnings has further reduced as (MRWAs). The leverage ratio104 after a slight decline
the share of large banks in total profits declined to stood at a comfortable level of 5.8 percent in CY15–
72 percent in CY15 from 78 percent in CY14. While well above the Basel-III standard requirement of 3
share of medium banks increased from 18 percent percent. Most of the banks are also compliant with
in CY14 to 19 percent in CY15; whereas small the prescribed Minimum Capital Requirement
banks’ share in profitability doubled to 8 percent in (MCR) of SBP.
CY15 from 4 percent in CY14. Very small banks Figure 3.9
have also been successful in sharing 1 percent of Solvency of the banks gets stronger
earnings in CY15 from their negligible share in Solvency profile

CY14 (Table 3.1). (PKR billion) (Percent)

Tier-1 Tier-II Required CAR Maintained CAR

Table 3.1
Concentration of Earnings by Bank Size 1400 20
18
CY14 CY15 Change 1200
16
Bank Category Share in (percentage 1000 14
earnings(before tax) points) 12
800
(percent) 10
Quartile 4 (Large) 78 72 -6 600 8
Quartile 3 (Medium) 18 19 1 400 6
Quartile 2 (Small) 4 8 4 4
200
2
Quartile 1 (Very Small) 0 1 1 0 -
CY12 CY13 CY14 CY15
Source: FSD, SBP

Solvency Source: BPRD, SBP

Improvement in CAR is seen across all the categories of

Both risk based and non-risk based indicators of solvency banks
show improvement…
In terms of size, CAR has improved among all
Despite the implementation of a comparatively strict categories of banks (Table 3.2). Large banks, which
Basel III Capital Accord, the overall capital are holding 70 percent of the industry’s risky assets,
adequacy of the banking sector remains well above have maintained their CAR above the local
the local benchmark of 10.25 percent. Over the benchmark. On the other hand, CAR of medium
years, guided by proactive and effective policies of sized banks has improved over the years due to
SBP, banking sector has been successful in capital build up in these banks, which will pay off in
maintaining a healthy capital adequacy profile. expanding their balances sheets in future. Small
banks followed this trend as they build their capital
Capital Adequacy Ratio (CAR) exhibited a healthy base in CY15 and expanded their balance sheets in
jump of 249bps in the last three years to reach 17.3 tandem.
percent in CY15, at the back of relatively higher
growth in capital than Risk Weighted Assets
(RWAs) (Figure 3.9). During the same period,
RWAs also grew at an average rate of 9 percent; 104Leverage ratio is defined as Tier-I capital as proportion of total
largely contributed by Market Risk Weighted Assets assets (adjusted both sides for intangible assets). The inverse of
leverage ratio is called leverage multiples.

47
 Table 3.2 bringing its share in the regulatory capital to 83
Capital Adequacy Ration(CAR) by Bank Size percent in CY15.
Bank
CY13 CY14 CY15 Credit Risk Weighted Assets(CRWAs) share decreased
Category
percent slightly…
Large 15.2 15.8 15.9
Medium 12.1 13.8 14.8 In line with private sector’s credit uptake, CRWAs
Small 13.6 15.2 16.3 witnessed a growth of 9 percent during CY15
Very Small 17.5 15.0 18.2 (Figure 3.11). This rise was largely for unrated
Source: FSD, SBP borrowers carrying a risk weight of 125 percent and
retail exposure including residential mortgage with
Figure 3.10
risk weights of 75 and 35 percent, respectively.
Profit retention remained the main source of capital buildup
Share in growht of equity
However, the contribution of CRWAs in total
(Percentage Points) riskiness of the banking system has declined
Assigned Capital Reserves Unremmitted profit marginally (74.7 percent in CY15 compared to 75.2
1200 percent in CY14) due to accelerated rise in MRWAs.
1000
Figure 3.11
800 Credit risk remains dominant
Riskiness of the banking sector
600 (PKR billion)
Credit RWA Market RWA Operational RWA
400 8000

200 7000

6000
0
CY12 CY13 CY14 CY15
5000
Source: BPRD, SBP
4000

3000
Improved profitability augmented Tier-I capital… 2000

Pecking order theory105 strongly holds in case of 1000

local financial sector as most banks widely utilized 0

CY12 CY13 CY14 CY15
profits generated internally to increase capital
positions (Figure 3.10). In CY15, the increase in
Source: BPRD, SBP

Tier-1 capital has been supported by 28 percent

…while MRWAs continue to grow at a faster pace
growth in the retained earnings and some
enhancement in the paid-up capital of the banks. MRWAs have witnessed a sizeable growth of 16
Hence, Tier-I capital increased by 10.5 percent; percent (YoY) that has enhanced its share in total
RWAs by 60 bps in CY15 to reach 11.7 percent.
In corporate finance, pecking order theory postulates that
Among the MRWAs, Interest rate risk (IRR)
105

companies prioritize their sources of financing, first preferring

internal financing, and then debt, lastly raising equity as a “last resort”. provided most of the increase in capital charge due
to significant increase in stock of investments in

48
long term PIBs. With 10.5 percent growth in equity RWAs has marginally declined to 13.6 percent (a
investments by the banks, the associated capital nominal dip of 13bps) due to accelerated rise in
charge also grew in tandem. MRWAs.

The foreign currency position related capital charge The riskiness of the banking sector remains low…
showed a significant growth of 57.5 percent
probably due to revaluation of FX positions in Despite growth in RWAs, the overall riskiness of
CY15. FX related charge’s share in total market the banking sector (CRWA assets to average earning
related capital charge has increased to 18 percent in assets) continues to subside (Figure 3.13). This is
CY15 from 13 percent in CY14 (Figure 3.12). reasonable as major part of the 21 percent
expansion in earning assets during CY15 carries low
Figure 3.12 or zero risk weights. In line with the large share of
Interest Rate Risk (IRR) remained major component of market risk public sector investments, share of zero risk
Market Risk Components weighted asset reached its highest level of 45
(PKR billion)
percent during CY15 from 39 percent in CY14.
IRR Equity FX Capital charge
700
Figure 3.13
600 Declining banking sector riskiness
CRWAs to Average Earning Assets
500 (Percent)
60
400

300 50

200
40
100
30
0
CY12 CY13 CY14 CY15
20
Source: BPRD, SBP

10
Share of Operational Risk Weighted Assets (ORWAs)
observed marginal decline… 0
CY12 CY13 CY14 CY15
The ORWAs have increased by 9 percent during Source: BPRD, SBP
CY15 mainly due to stable profitability of the
banking system. Most of the banks in Pakistan use Share of assets in rest of the risk weighted categories
Basic Indicator Approach (BIA) to measure (usually assigned to the advances extended to private
operational risk charge. Under the BIA, operational sector) continued to decline, an outcome of slow
risk charge is 15 percent of the average of last three growth in private sector credit (Figure 3.14). Since
years’ positive annual gross income. As the CRWAs observed relatively low growth of 9
methodology of calculating ORWAs is dependent percent, share of CRWAs as a percentage of average
on gross income of the banks, so ORWAs naturally earning assets declined by 1.9 percentage points in
increases with increase in gross income. Despite CY15. This trend though favorable in short run,
growth in ORWAs in CY15, their share in total

49
 may compromise risk management capacity of the Table 3.3
banking sector in the future. Distribution of Banks by CAR
CY12 CY13 CY14 CY15
Figure 3.14
CAR<Required 5 5 3 3
Expanding balance sheet fuelling little to CRWAs
Distribution of CRWAs as per weights assigned Required<CAR<15percent 9 12 12 13
(PKR billion)
> 15 percent 24 21 22 19
0 20 35 50 75 100 125 150 1000
Total 38 38 37 35
14,000
Source: BPRD, SBP
12,000

10,000 Figure 3.15

Banks have margin to increase leverage
8,000
Leverage ratio
6,000 (PKR billion) (Percent)
Tier I capital Total Exposure
4,000 Leverage ratio benchmark
20000 7
2,000 18000
6
16000
0
14000 5
CY12 CY13 CY14 CY15
12000 4
Source: BPRD, SBP
10000
3
MCR policy guiding CAR… 8000
6000 2
A higher capital base above the regulatory 4000
1
requirements provides banks with sufficient cushion 2000

against unexpected idiosyncratic shocks and severe 0

CY13 CY14 CY15
0

macroeconomic conditions. As part of its policy to

Source: BPRD, SBP
strengthen common equity base of banks, the SBP
over the period has enhanced the MCR Banking system’s leverage remains well within the prescribed
requirements in gradual manner. The outcome of limit…
this approach is obvious in comfortable CAR of
most banks (Table 3.3). Banks falling short of The leverage ratio, a non risk based indicator of
minimum CAR represent merely 1.4 percent of total solvency, despite slight decline remained at a
asset of the industry and as such do not pose any comfortable level; thanks to growing Tier-I capital
serious concern to the solvency of the banking which kept on supporting the increased asset base.
sector. However, during CY15, leverage ratio declined by
61 bps due to higher expansion in the asset base
relative to Tier-I capital. In CY15, the leverage ratio
stood at 5.8 percent, much higher than the
minimum 3 percent set by the Basel Committee on
Banking Supervision106 (Figure 3.15). However,

The parallel run period of leverage ratio in Pakistan is from

106

December 31, 2013 to December 31, 2017.

50
industry has still the gap of 285 bps between actual Under sensitivity analysis, the after-shock CAR of
leverage and benchmark leverage which can be the system would stay strong, though certain shocks
exploited to increase its asset base with existing level to the credit risk portfolio would have significant
of equity. impact on the solvency profile of the banking
system. In case of the credit shocks; including,
Risk based measure of CAR is also reinforcing the shock (C-1) assuming an increase in NPLs
room for further risk taking in banks’ balance equivalent to 10 percent of performing loans, (C-2)
sheets. With current level of regulatory capital, default of top 3 private sector individual borrowers
benchmark CAR will remain within prescribed limit (fund based exposures only), and (C-3) a shock of
even if banks expand their risk weighted assets by default of top three borrowers (both fund and non-
69 percent (Table 3.4). fund based) the highest decline in CAR of the
With a comfortable level of both CAR and Leverage banking system would be up to 380 bps (Figure
indicators and potential of growth in the economy, 3.16). Keeping in view their systemic implication of
banking industry enjoys enough buffer to further high concentration of top corporate and group
increase its exposure to the private sector in the exposure, banks need close monitoring of such
future. exposures.
Figure: 3.16
Table 3.4 Banking system found resilient under multiple stress shocks
Capital Cushion CY15(PKR billion) Impact of Sensitivity Tests on Solvency
Existing Simulated Cushion (Percent)
CAR before Shock CAR after Shock Benchmark CAR
Capital 1,190.4 1,190.4 -
C1
RWAs 6,865.3 11,614.1 4,748.9 R1 C2
EQ2 C3
CAR 17.3% 10.3%
EQ1 C4
Source: BPRD, SBP
ER3 C5

ER2 C6
Resilience
ER1 C7
The banking system exhibited resilience under stress IR4 C8
due to strong CAR of 17.3 percent as of CY15. IR3 C9
Results of adverse scenarios for the credit, market, IR2 C10
IR1
liquidity and contagion risk on the banking sector
Source: FSD, SBP
reaffirms that the system has sufficient cushion to
withstand the stressed shocks107. Importantly, all
banks with before-shock CAR of above 12.2 Despite considerable rise in MRWAs, overall 12.0
percent, including top 5 banks of the industry, percent share in total risk weighted assets continued
would comfortably bear the solvency shocks. to present a subdued market risk profile. However,
market risk related sensitivity shock which, assume a
parallel shift of yield curve by 300bps results in
significant impact on banks CAR (industry CAR
107For details of the shocks, please see Table 1.13 of the Quarterly would experience a decline of 240bps). Similarly,
Compendium: Statistics of the Banking System, December 31, 2015
http://www.sbp.org.pk/ecodata/fsi.asp analysis of liquidity stress tests, which envisaged

51
 significant withdrawals of deposits and volatile To stress test the banking portfolio, for this FSR, we
funds, and dip in value of liquid securities, showed have designed a baseline (or business as usual)
that the ample fund based liquidity in the system, scenario and a separate stressed scenario. The
would provide enough cushion to meet significant reference period for this hypothetical analysis is
withdrawals of deposits and volatile funds. Also, from Q2CY16 to Q2CY18 i.e. 9 quarters.
industry’s liquidity coverage ratio (LCR) - a measure
of 30-days stressed liquidity position of banks under For assessing credit risk, one of the models bank
Basel III framework- would remain well above the uses is the Credit Portfolio View (CPV) model
required minimum level of 100 percent in a scenario based on Blaschke et al (2001)110. Under this
assuming the value of government securities would approach, in case of Pakistan, it is assumed that the
marginally decline. GNPLR is a function of growth in output (GLSM
index), growth in exports (GEXP), developments in
Macro Stress Testing stock markets (PSE index) and monetary policy or
discount rate (DR). The model estimated is as
In addition to sensitivity analysis, SBP performs follows:
macro stress tests on aggregate data, using a top
down approach, on quarterly basis. The objective is
= +∑ +
to assess the loss absorption capacity of the banking
∑ + ∑ +
sector in terms of ‘capital adequacy ratio’ or CAR in
∑ + … (1)
the event of adverse macroeconomic shock(s). By
employing a suit of models, the scope of macro
stress testing exercise currently focuses on both the Variables in equation (1) are in logs and non
credit risk posed by the lending portfolio and stationary variables (the dependent variable,
market risk posed by investment portfolio of the GNPLR, and explanatory variable, PSE) are made
banking industry. stationary by taking the first difference. In addition,
the dependent variable GNPLR is logit transformed
Macro stress testing was first introduced in 2008 by to avoid non-Gaussian errors111 and Inverse
SBP as a tool for macro-prudential surveillance108. Hyperbolic transformation is performed for GEXP
While, the preliminary work essentially proposed and GLSM to handle non-positive values. The
processes and components of the framework, over model is estimated using step-wise OLS regression
time it has kept evolving and changing with the on quarterly data from June, 2002 to December,
expansion of the banking sector. Various bank’s 2015.112
publications had quantitatively evaluated and
discussed the impact of macroeconomic The market risk is analyzed based on dynamic
developments on industry’s performance in a sensitivity approach. In the baseline and stress
macro-financial modeling setup.109
110 Blaschke, W., M. T. Jones, G. Majnoni, and S.M. Peria (2001),
“Stress testing of Financial System: An Overview of Issues,
Methodologies, and FSAP Experiences” IMF Working Papers
WP‐01/88.
111 Vazquez, F., Tabak, B. M., & Souto, M. (2012). A macro stress test

108Financial Stability Review 2007-08. model of credit risk for the Brazilian banking sector. Journal of
109For instance, Financial Stability Review 1st Half 2011, Quarterly Financial Stability, 8(2), 69-83.
performance review of the Banking System (September 2008, 112 The results of the model and its diagnostics are given in “Technical

December 2008, March 2009). Appendix”.

52
scenarios, it is assumed that the risk sensitive Stress scenarios are, generally, hypothetical extreme
investments, at the end of March, 2016 quarter, events designed with the objective to assess
evolve till June, 2018 quarter based on the resilience of the banking system in case of a severe
assumptions of the respective scenarios. The and prolonged stressed period.114
exposure at risk over this horizon is then adjusted to
the corresponding changes in the interest rate. The The stress scenario has taken into consideration the
combined effect of estimates of credit risk (GNPLR forecasts of weak and uncertain global output
forecast) and market risk are then used for growth115. According to World Economic Outlook
computing impact on banks’ earnings and (WEO) April, 2016, world economy is expected to
consequent calibration on sector’s CAR. expand by 3.2 percent if the challenges of slow and
fragile recovery in advanced economies such as US
Baseline Scenario and EU and a general slowdown in developing and
Baseline scenario assumes business as usual i.e. current emerging markets such as China and commodity
macro-economic environment continuing its course exporting countries, are managed successfully.
from 2016 through first half of 2018113. During the
past few quarters, Pakistan economy’s major Particularly, China’s ongoing economic transition
macroeconomic indicators have improved. has global implications. Being one of the key trading
Specifically, inflation remains subdued, large scale partners of 100 countries which account for 80
manufacturing has started picking up, external percent of world GDP, a deceleration in China has
sector, despite difficulties, continues to perform well resulted in subdued outlook for global trade and
and private sector credit off take is gradually international commodity markets.
improving.
While designing stress scenario, it is assumed that
The gains can be explained in terms of low the global economy would derail from the recovery
oil/commodity prices, improved energy availability, path. The postulation is in line with projections of
higher disbursements from bilateral and multilateral adverse scenarios considered by other central banks
agencies, CPEC factor and better law and order such as Bank of England116. They assume that
situation. around 2 percent contraction will take place in
world GDP in the first year of stress and that it will
In the baseline scenario, it is assumed that remain below baseline during the remaining years.
improvements on the macroeconomic front would
continue to support positive trends in banks risk Pakistan’s economy is, to some extent, vulnerable to
taking, market developments and earnings. More the developments in the international economies.
specifically, there would be an increase in credit With forecasts of possible slowdown or contraction
disbursements, LSM would perform better, the in Pakistan’s largest trading partner economies: US,
stock exchange will register gains and the external EU, China and some Gulf countries, the downside
sector will grow positively. risks to external sector is assumed to materialize.

Stressed Scenario The data for March 2016 was not completely available at the time
114

of analysis hence the data set used is till Dec, 2015.

115 By April 2016 WEO world forecasts have been revised downward

Baseline forecasts for LSM, PSE indices and growth in exports are
113 twice since October, 2015.
made using the exponential smoothing methodology. While for the 116 Stress testing the UK banking system: Key elements of the 2016

monetary policy variable, discount rate, discretion is applied. stress test, Bank of England, March 2016.

53
 The stress is assumed to transmit through trade and hypothetical depreciation of domestic currency
financial linkages that may spread to the rest of the resulting in increase in the cost of imported goods
economy. and inflation expectations. Therefore, the threats to
the country’s growth prospects remain
Given that export industry is already passing predominantly external in nature and global in
through a difficult phase117 and exports have been dimension in the stressed scenario.
falling for the last four quarters, stress scenario
assumes further drop in foreign demand and thus On the fiscal front, it is assumed that a decline in
exports. For the stressed scenario, it is assumed that industries’ profits will affect government’s revenue
export growth would follow the same trend as collection. Government’s taxation revenues from
observed in the past during the Global Financial corporates, excise and custom is assumed to fall
Crisis (GFC) of 2007-08. Due to assumed increasing resulting in a higher budget deficit. To bridge the
external vulnerability, downward pressure on gap, stressed scenario assumes borrowings from
exchange rate is also assumed. both banking and non-banking channels. In this
case, private sector credit disbursements are
Under the stressed scenario, global slowdown may assumed to come under renewed pressure.
shake investor’s confidence. While the domestic
investors might put investment decisions on hold till Decrease in revenues of LSM industries, listed on
things improve, foreign investors are assumed to the stock market, is assumed to add additional
disinvest and leave for safe havens. In the short to pressures on the stock market.
medium term, significant withdrawals of foreign
portfolio investment from the stock market are In order to ease pressure on external account and
assumed which would partially erode stock market ease inflationary pressures, it is assumed that there
capitalization and may dent the sentiments of local might be some monetary adjustments in the stressed
investors. The equity market losses are assumed to scenario. In such a case, banks would be facing
result in stock market becoming bearish throughout credit and market risks. The magnitude of the losses
the span of the adverse scenario. would depend on the profile of bank’s risk sensitive
assets and liabilities.
Waning global demand and declining exports is
assumed to slowdown production activity in the Given this hypothetical extreme scenario, it is
related industries in the LSM sector. The expected that the repayment capacity of borrowers
movements in LSM index during the stress scenario across the horizon will be affected which may lead
are derived from variation in LSM series. Under to increase in non-performing loans. Box 3.1
these considerations, it is assumed that the LSM will explains some technical assumptions.
contract and would remain less than the baseline
forecasts throughout the stressed period.

During the stressed period, it is assumed that

inflationary pressures would come from

117Baseline export projections are also lower to account for stress on

exports.

54
 Box 3.1: Key Technical Assumptions: percentage points from the level of 11.7 percent in
March, 2016 (Figure 3.17). Furthermore, market
 The growth in risk weighted assets (RWA) would risk would remain subdued in a largely stable
correspond to the growth in advances in both the
baseline and stressed scenarios on quarterly basis. interest rate scenario.
For baseline, average growth in advances (since
2002Q2) has been applied (3.4%). For stressed Figure 3.17
scenario it is assumed that risk weighted assets Infection Ratio Rises under Stress Scenario
would rise by 0.8% per quarter. The assumption is Forecasts for Baseline and Stressed GNPLR
consistent with the growth observed during the
(Percent)
historical stress period of GFC. GNPLR GNPLR_Baseline GNPLR_Stressed
 In the baseline scenario as bank’s earnings would 16 1
rise, banks’ capital base is projected to grow by 15 0.9
4.0% on quarterly basis (consistent with last nine 14 0.8
quarters’ growth rate). While during stressed 13 0.7
period the growth in capital base is assumed to be 12 0.6
lower compared to the baseline (2%). 11 0.5
0.4

10
For impact on asset quality, provisions against 9 0.3
stock of NPLs, in both scenarios, is assumed to be 8 0.2
90% which is based on the current level. We also 7 0.1
assume 100% pass through to Capital from 6 0
increase (decrease) in profits (losses) arising from
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
credit and market risks.
 For estimation of market risk: Source: FSD, SBP
 Only interest rate exposure is being considered
for banks’ risk sensitive investment portfolio. As the economy follows its growth path and credit
 The stress scenario assumes an upward parallel to private sector rises, the RWA of the banking
shift of the yield curve in every quarter. In the sector would also rise proportionately. In the
baseline and stressed scenarios, interest rates baseline scenario, therefore, it is anticipated that the
along the yield curve would change by the
same magnitude as assumed for the discount
industry’s CAR could fall to15.4 percent by June
rate. 2018; which is well above the required benchmark
 The growth in risk sensitive investments CAR of 11.275 percent at that time118 (Figure 3.18).
during the stressed period would be by the This lower level of CAR indicates better utilization
same rate as observed during the stress period
of capital in case the private sector credit picks up.
of GFC.

Stress Test Results

Under the baseline scenario, forecasts of the
banking performance indicator, GNPLR, over the
next nine quarters shows a declining trend. This
implies, if supportive macro environment persists,
infection ratio might gradually fall to 9.5 percent by
end 2016. As the economic fundamentals further
BPRD circular # 06 dated August 15, 2013 on ‘Instructions for
strengthen, the ratio would drop further by 800 bps
118

Basel III Implementation in Pakistan’.

to reach 8.7 percent by June 2018; a fall of 2.9

55
 Figure 3.18
CAR declines under Stress Scenario Conclusion of Macro Stress Testing Exercise
Forecasts for Baseline and Stress CAR
(Percent)
CAR CAR_Baseline CAR_Stress
Stress tests performed to gauge industry’s resilience
19 1.0 reinforces the view that if economy continues on
18 0.9 the current growth path, higher capital charge on
17 0.8
private sector credit would start utilizing the capital
0.7
16 buffers industry is maintaining. Yet, positive trends
0.6
15 would enable overall industry to sustain CAR
0.5
14
0.4
noticeably above the minimum benchmark.
13
0.3 However, banks may have to generate additional
12 0.2 capital to provide cushion for expected growth in
11 0.1 private credit.In case of economic distress, however,
10 0.0 current capital cushion might be inadequate to
absorb losses. In such a scenario, banks would need
2014Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2

to prop up their capital base for complying with the

Source: BPRD and FSD, SBP
minimum capital requirements.
On the contrary, stressed scenario would result in
significant losses due to higher credit risk Outlook
materialization together with repricing of banks’ In an environment of low interest rates and falling
assets and liabilities. In the stressed scenario, the yield on public debt, profitability of the banking
CPV model predicts GNPLR rising gradually. The system is expected to come under pressure in future.
ratio is projected to climb to 15.1 percent by June Though lower provisioning charge, low interest
2018 from the existing level of 11.6 percent as of expense on deposits and off take of high yielding
March 2016 (Figure 3.17). private credit might partially offset the downward
pressure on income, yet growth in profitability is
As the impact of global shocks become widespread, expected to decelerate in CY16119. Parallel to this,
banking industry’s CAR is anticipated to experience the growth in credit may take its toll in the form of
a steady decline. In the prolonged adverse scenario, high capital charge and may impact CAR of the
banks’ CAR would decline and is estimated to end industry. As such banks need to closely review the
up at 11.1 percent by June 2018 (Figure 3.18). situation and plan for augmenting capital generation
While the drop is significant, the stressed CAR is ahead of time for enhancing their resilience.
still close to benchmark of 11.275 percent required
by 2018.

In the stress scenario, reduction in CAR is due

primarily to banks’ suffering credit losses
compounded by losses due to adverse movement in
market interest rates. The seemingly large capital
cushion currently available to absorb shocks might
shrink in the face of extreme credit and market
Forecast generated on the basis of exponential smoothing
shocks.
119

methodology.

56
Box 3.2: A framework for the assessment of bank’s Table 1

earnings Proposed structure for the income statement(PKR billion)

CY12 CY13 CY14 CY15

The strength of earnings has a strong bearing on an

Interest earned on loans 428 396 437 404

Interest earned on investments 353 361 450 545

institution’s long term sustainability. It also provides Interest earned-others 19 20 33 33
information about distribution of risk among different Total interest income 801 777 920 982

activities. As per framework for the assessment of bank’s Structural Total Interest expense 461 444 505 486

earnings suggested by Cuoto (2002)120, the income of an Net interest income 340 332 415 496

institution can be distributed between structural121 and Fee income 54 62 70 83

secondary sources. Net interest income, fee income and

Operating expenses 253 268 305 330

operating expenses; being core income and expense

Total structural income 141 127 181 249
Provision for loan losses 32 36 25 39
items, are the structural determinants of profitability
Secondary
Other secondary expenses 5 3 6 7
while provisions and exposures affected by interest rate Treasury results 84 78 97 126

and FX movement are considered secondary Other secondary income 0.8 0.0 0.0 0.0

determinants of profitability. The reliance of an Total secondary income 45.8 38.6 65.9 80.0

institution on non-recurring income is a sign of earning Profit/(loss) from banking activities 187 165 247 329

weakness and signals that the bank is engaging in risky

Results of non-banking subsidiaries 0 0 0 0

practices in an attempt to boost earnings.

Profit/(loss) before taxes 187 165 247 329

Income taxes 65 54 83 130

As per this framework, the traditional profit and loss

Net profit/(loss) 121 111 163 199
Source: FSD, SBP
statement of a financial institution can be presented as
follows: As per the above structure, the profitability of our
banking system is quite stable as share of income from
core business sources is higher (76 percent). Income
arising from these sources is sufficient to cover operating
expenses, provisions and taxes, and to provide an
adequate return on capital. Though income from
secondary sources has also increased over the years, yet
reliance of industry on non-structural sources is not that
high (24 percent).

120 Couto, R. L. R. (2002). “Framework for the assessment of bank

earnings”. Bank for International Settlements, Financial Stability
Institute.
121 The structural determinants of profitability are those items of

income and expense that satisfy three conditions: they arise from the
operational activities of a bank, can properly be considered
sustainable, in the case of income, or recurring, in the case of
expenses, and are not particularly subject to misrepresentation.

57
58
 4 Islamic Banking

The increase in assets base of Islamic banking outpaces the growth in the overall banking sector as share of Islamic banking
reaches 11.4 percent during CY15 in line with the 5 year strategic plan for Islamic banking industry (2014-18). In contrast to
conventional banking industry’s trend, flow of funds for financing activities outpaced investments. A major portion of financing
has been extended under Diminishing Musharakah and Murabaha. The asset quality indicators show slight improvement;
though Non-Performing Financings have increased marginally. The earning performance moderated due to high operating cost of
IBIs owing to expansionary phase of Islamic Banking industry. The capital adequacy indicators remain lower than the
conventional banking industry as few Islamic banks are in the process of building up their capital base.

Islamic Banking continues to grow both globally and Table 4.1

domestically… Performance of Islamic Banking
IBIs Conv. Banks
The global Islamic financial services industry has CY12 CY13 CY14 CY15 CY15
reached an overall total value of USD 1.88 trillion as PKR billion
of 2015 despite facing a series of economic Total Assets 837 1,014 1,259 1,610 12,533

challenges such as prolonged low energy prices, Investments (net) 394 394 357 432 6,449
Financing (net) 231 315 409 645 4,171
downward revised economic growth outlook, Deposits 706 868 1,070 1,375 9,015
geopolitical conflicts, exchange rate depreciations percent (YoY)
and an assets sell-off spree in emerging markets. 122 Total Assets 30.5 21.2 24.2 27.9 15.5

The share of Islamic banking assets (USD 1.5 Investments (net) 43.8 (0.0) (9.5) 21.1 30.2
Financing (net) 15.5 36.2 29.7 57.9 3.3
trillion) constituted around 80 percent of Islamic Deposits 35.6 22.8 23.3 28.5 10.5
financial services industry’s assets. Source: FSD, SBP

In Pakistan, the growth trend of Islamic banking

 Increasing branch expansion of IBIs123;
industry continued in CY15 as well (Table 4.1).
 Establishment of first Islamic Banking
Besides favorable domestic macroeconomic subsidiary;
environment coupled with regulatory focus on  Merger of two former conventional banks
development, following other factors have also into Islamic banks;
contributed to the growth in the Islamic banking  Expansion in virtual banking services
sector: including branchless banking.

122 IFSB, “Islamic Financial Services Industry Stability Report”, 2016. 123 Islamic Banking in Pakistan is offered through full-fledged Islamic
According to the report, Banking Assets amounted to USD 1496.5 Banks (IBs), Islamic Banking subsidiary of a commercial Bank
billion, Sukuk Outstanding were USD 290.6 billion, Islamic Funds’ (practically a full-fledged Islamic Bank) and stand-alone Islamic
Assets were USD 71.3 billion and Takaful contributions stood at Banking Branches (IBBs) of conventional Banks. Together, these are
USD 23.2 billion. For more details, please see Table 1.1.1 and its called Islamic Banking Institutions (IBIs). Presently, 22 IBIs including
explanatory note on page 7 in the IFSB’s report. 6 IBs (having 1028 branches) and 16 conventional banks (having 1047
IBBs) are offering Shariah compliant products and services.

59
 IBIs assets are recorded at PKR 1.6 trillion which is percent has remained the hallmark of CY15. Apart
11.4 percent of the asset base of the overall industry from regular rise in financing, the sharp increase can
(9.6 percent in CY13). The assets growth rate of also be attributed to other factors, which include
27.9 percent (YoY) of IBIs during CY15 outpaced merger of two conventional banks into Islamic
the 15.5 percent growth rate of conventional banks. In addition, SBP’s instructions wherein banks
banking industry. Main contributors in the assets having IBBs were advised to show Islamic
growth are financings and investments (largely in Financing and Related Assets under the head of
Sukuk). In terms of penetration, the branch network “Advances” in their financial statements,124 also
of IBIs has also expanded by 501 branches as the provided boost to financings.
branch network increased to 2,075 branches in
CY15 as compared to 1,574 branches in CY14 Private sector the main beneficiary of IBIs financing…
(Figure 4.1). Private sector, with predominant share of 88
percent, has remained the main beneficiary of funds;
Figure 4.1 with major allocation to textiles, chemicals and
Share and network of Islamic Banking continued to grow
pharmaceuticals, sugar and agribusiness. Out of
Share and Network of Islamic Banking
(percent) (number)
remaining 12 percent financing to the public sector,
agribusiness and ‘production and transmission of
Branch Network (RHS) Share in Assets
energy’ received the major chunk.
Share in Deposits
14 2,500
Diminishing Musharaka dominates the modes of financing…
12
2,000
10 During CY15, 31.7 percent share of Diminishing
8 1,500 Musharaka in overall financings of IBIs is more than
any other mode of financings; while financing under
6 1,000
Murabaha has 24.5 percent share (Table 4.2).
4
500
Combined share of Ijara, Salam and Istisna
2 comprises almost 20.5 percent of the financing
0 - portfolio of IBIs; whereas Musharaka and Mudaraba
CY12 CY13 CY14 CY15
constitute 14 percent of the total financings.
Source: FSD, SBP and IBD, SBP

This growth of Islamic banking industry, especially

the share in the banking industry, is in line with
SBP’s 5 year Strategic Plan for Islamic Banking
industry (2014-2018), which, inter alia, envisions
Islamic banking industry to achieve 15 percent share
in the entire banking industry’s assets by the year
end 2018.

Financing growth of IBIs outpaces the industry…

IBIs’ financing growth at 57.9 percent as compared 124 BPRD Circular Letter No. 5 dated February 29, 2016. If this factor
is netted out, the growth of financing turns out to be around 40
to conventional banking industry’s growth of 3.3 percent which is still a handsome growth.

60
Table 4.2 sector which is the top beneficiary of IBIs’ financing
Islamic modes of financing with PKR 503.3 billion (74.4 percent of financings).
CY12 CY13 CY14 CY15 Out of the such financing, PKR 215.1 billion (or
percent share in total financings 42.7 percent) are utilized for long-term investment,
PKR 228.7 billion (or 45.4 percent) of the funds are
Murabaha 39.7 40.6 30.1 24.5
Salam 3.0 4.0 4.5 5.3 utilized for working capital needs and PKR 59.5
Istisna 7.2 5.6 8.3 8.6 billion (or 11.8 percent) for trade financing. The
Musharaka 0.8 6.7 11.0 14.0 financing to corporate sector has registered a growth
Ijara 9.2 7.7 7.7 6.6 of 53.9 percent (YoY) (Table 4.3).
Car Ijara 4.4 4.9 5.3 4.2
Plant and machinery Ijara 2.1 1.6 1.5 1.4 Table 4.3
Equipment Ijara 2.4 0.5 0.3 0.1 Segement wise financing
Others Ijara 0.3 0.7 0.6 0.9 CY12 CY13 CY14 CY15 Growth
Diminishing musharaka 35.7 30.8 32.6 31.7 PKR billion percent
Other Islamic modes of finance 4.3 4.4 5.6 9.2
Corporate Sector: 179.0 236.2 327.0 503.3 53.9
Mudarabah 0.2 0.2 0.1 0.0
Working Capital 76.9 94.5 138.8 215.1 54.4
Qard/Qard-e-Hasan 0.01 0.01 0.01 0.01
Fixed Investment 89.4 109.3 148.1 228.7 55.0
Total 100.0 100.0 100.0 100.0 Trade Finance 12.6 32.4 40.1 59.5 48.4
Source: FSD, SBP SMEs: 10.1 16.8 15.1 20.8 37.6
Fixed Investment 2.5 5.2 5.4 6.0 9.5
Musharaka Financing, though saw an increase of Working Capital 1.2 2.9 1.3 1.6 57.7
97.9 percent (YoY), still comprises only 14 percent Trade Finance 6.4 8.6 8.4 13.2 26.3

share in total financing. The reluctance of the IBIs

Agriculture 0.2 0.3 1.8 4.3 142.5
Consumer Finance: 32.0 38.2 50.5 67.7 33.9
to venture into the sharing based mode of financing Housing Finance 13.5 15.9 19.0 25.0 31.5
not only signifies their risk-averse approach but also Commodity Financing 17.8 31.6 22.7 58.2 157.0
calls for adaptation of better risk management Staff Loans 4.1 5.2 6.8 8.8 28.9

practices to tap the underserved/neglected sectors

Others 0.4 0.8 1.5 13.9 836.8
Total 243.7 329.1 425.4 677.0 59.1
of the economy with better returns. Moreover, Source: FSD, SBP
challenges like moral hazard, displaced commercial
risk, weak contract enforcement mechanism and Other sectors such as Consumer, SME and Agriculture also
reluctance by prospective borrowers to undertake registered noticeable growth…
profit & loss sharing commitments with the bank
Consumer finance with PKR 67.7 billion (10.0
needs to be addressed so as to ensure a significant
percent of financing) has registered an increase of
share of participatory modes in the financings of
33.9 percent. Housing Finance has registered 31.5
IBIs. In this regard, the Strategic Plan for the
percent (YoY) growth. Out of total Housing finance
Islamic Banking Industry (2014-18) envisages
of PKR 43.3 billion, the share of IBIs has amounted
developing incentive mechanisms and enabling
to PKR 25.0 billion (57.8 percent share) as
policy environment to stimulate Musharaka and
compared to conventional banks’ amount of PKR
Mudaraba based financing.
18.3 billion (42.2 percent share) (Table 4.4).
Corporate sector remains the main recipient of IBIs funds…

In line with the historical trend, client-wise financing

of IBIs has remained concentrated in corporate

61
 Table 4.4 During CY15, the major investment avenue for IBIs
Housing Finance has remained the Government of Pakistan (GOP)
CY12 CY13 CY14 CY15 Ijara Sukuk which got a major boost after issuance
PKR billion of Rs 117.7 billion three-year Ijara Sukuk in
IBIs 13.5 15.9 19.0 25.0 December 2015. As a result, IBIs investment in
Conventional 26.4 23.0 20.9 18.3 Federal Government securities registered an
Industry
39.9 38.9 39.9 43.3
increase of 27.9 percent (YoY), thereby constituting
(IBIs+Conventional)
71.2 percent of IBIs investment (net). On the
Percent share of Industry (IBIs+Conventional)
contrary, the conventional bank’s investment in
IBIs 33.9 40.9 47.7 57.8 Federal Government securities constituted 93.3
Conventional 66.1 59.1 52.3 42.2
percent of their industry investment (net) portfolio.
Source: FSD, SBP
This comparative position puts the IBIs at a relative
Although, SME and Agriculture financing constitute disadvantage with respect to liquidity management,
less than 4 percent share in total financing, SME has particularly short term liquidity. To overcome this
grown by 37.6 percent and Agriculture by 142.5 issue, SBP is working to develop some Sukuk
percent in CY15. SMEs and agriculture are among structures of shorter tenor in collaboration with
the potential sectors of growth for Islamic banking SECP.
according to the findings of KAP survey released by Table 4.5
SBP in October 2014125. In line with SBP’s Investments
Guidelines on Islamic Financing for agriculture, CY12 CY13 CY14 CY15 Growth
Islamic Microfinance Business and Handbook on PKR billion
percent

Islamic SME Financing, IBIs are moving forward

(YoY)
Federal Government Securities 278.5 266.7 240.5 307.4 27.9
with innovative products to tap the benefits of Fully paid up ordinary shares 3.5 4.3 5.4 12.0 125.1
underserved sectors of the economy such as Bonds/ PTCs/Sukuk certificates 33.9 34.0 45.1 56.7 25.8

agriculture, SMEs and microfinance. Other investments 79.6 90.9 67.3 62.5 (7.2)
Total Investments 395.6 395.9 358.2 438.7 22.5

Investments of IBIs grow steadily… Provisions & deficit/ (surplus) (1.2) (1.5) (1.5) (6.7) 354.4
Investments (net) 394.4 394.4 356.7 431.9 21.1

After witnessing negative growth during CY13 and Source: FSD, SBP

CY14, CY15 bode well for investments of IBIs as

the growth surged to 21.1 percent (Table 4.5). This Deposits, the key funding source of IBIs, maintain growth
rise, however, is still below the overall growth in momentum…
investments of the conventional banks i.e. 30.2
percent. Lack of adequate supply of Shariah Deposits have remained the main funding source as
compliant liquidity instruments mainly contributed IBIs successfully maintained their deposit growth
to lower than average growth in investments for momentum at 28.5 percent which outpaced the 10.5
IBIs. percent growth rate of deposits of the conventional
banks. Customers’ deposits, at 93.4 percent of total
deposits base, provided the pedestal for upholding
the expansion in Islamic banking assets (Figure
4.2). Savings and Fixed deposits (generally,
Knowledge, Attitude and Practices (KAP) Survey
Mudaraba based) were recorded at 63.9 percent of
125

http://www.sbp.org.pk/publications/Kap.htm

62
the deposits whereas Current accounts (generally, Figure 4.3
Qard based) remained at 29 percent of the total IBs outpaced the deposits growth in IBBs
deposits. Average deposit increase per Islamic Bank Proportionate Growth in Deposits

(excluding IBBs) works out to PKR 51 billion in (percent)

CY15 compared with PKR 29 billion per

Islamic Banking Branches Islamic Banks

conventional bank, on average. 50

45
40
Figure 4.2
Deposits maintain growth momentrum 35

Deposits 30
(PKR billion) 25
Fixed Saving 20
Current Customer Deposits - Others 15
Financial Institutions Deposits 10
1600 5
1400 0
CY12 CY13 CY14 CY15
1200
1000 Source: FSD, SBP
800
600
Figure 4.4
400 Liquidity profile remained satisfactory
200 Liquidity Ratios
0 (percent)
CY12 CY13 CY14 CY15 Liquid Asset to Total Assets
Liquid Assets to Deposits
Source: FSD, SBP Financings to Customer Deposits
90
In terms of share in the deposits of IBIs, IBs 80
outperformed the deposits growth of IBBs as IBs 70

deposits grew by 29.9 percent as compared to IBBs 60

deposits growth of 26.2 percent (Figure 4.3). 50

40

Fund based liquidity profile of IBIs remains comfortable… 30 IBIs Conv.

Banks
20
The liquidity profile has remained satisfactory in 10
CY15. Liquidity indicators like Liquid Assets to 0
CY12 CY13 CY14 CY15 CY15
Deposits and Liquid Asset to Total Assets, at 41.2
percent and 35.1 percent, respectively, have showed Source: FSD, SBP

signs of slight improvement over the previous year

(Figure 4.4). Asset quality remains at comfortable level…

Financing to deposit ratio (FDR) at 46.9 percent, On the asset quality front, IBIs have performed
with an increase of 8.7 percent, has marginally fairly well. Though Non Performing Financings
surpassed the conventional banks’ ADR of 46.3 (NPFs) to Total Financings registered an increase
percent in CY15. from 4.7 percent in CY14 to 4.9 percent in CY15,

63
 the provision coverage ratio has increased from 83.9 (e.g. Ijara Sukuks) whereas conventional banks have
percent in CY14 to 95.6 percent in CY15. access to ample interest based Government
Resultantly, Net NPFs to Financing Ratio has securities (PIBs and T-bills).
declined from 0.8 percent in CY14 to 0.2 percent in
CY15, whereas conventional banks’ average is Figure 4.5

recorded at 2.2 percent. Similarly, Net NPAs to

IBIs earnings moderated
IBIs' Earnings and Expenses
capital for IBIs has remained at 1.6 percent against (PKR billion) (percent)
the conventional banks’ average of 7.8 percent NII Non Markup income
(Table 4.6). All these indicators point to a Expenses Provisioning Charges
PBT ROE (Before Tax) - RHS
comfortable level of asset quality of Islamic banks. 80 40

60 30
Table 4.6
40 20
Assets Quality
20 10
Conv.
CY12 CY13 CY14 CY15 Banks 0 -
CY15
-20 (10)
percent
-40 (20)
NPFs to Total Financing 7.6 5.7 4.7 4.9 12.3
-60 (30)
Provision to NPFs 66.5 74.4 83.9 95.6 84.3 CY12 CY13 CY14 CY15
Net NPFs to Net Financing 2.7 1.5 0.8 0.2 2.2
Source: FSD, SBP
Net NPFs to Capital 9.8 6.9 3.9 1.4 7.4

Net NPAs to Capital 11.1 7.9 4.8 1.6 7.8

Moderation in earnings indicators can be attributed
to a host of factors such as decline in spread
Source: FSD, SBP
between financing and deposit rates (from 7.5
Earnings under pressure due to expansion of outreach… percent to 5.2 percent), decrease in income from
dealing in FX and fall in profit on investments by
IBIs’ earnings has, somewhat, moderated during 18.1 percent. Moreover, due to expansion in branch
CY15 as Return on Assets (ROA-before tax) has network, the administrative expenses have increased
declined to 1.2 percent in CY15 as compared to 1.5 by 24.8 percent; operating expenses to Gross
percent in CY14; which is also lower than the Income has surged (from 66.0 percent in CY14 to
conventional banks’ average of 2.7 percent. Net 70 percent in CY15) along with personnel expenses
profit income to Gross income, with 80.9 percent to operating expenses (from 38.6 in CY14 to 40.3
share, has remained the major contributor towards percent in CY15). The declining interest rate
the IBIs’ earnings; while there is minimal support environment poses further challenge to the
from Non Profit Income, with 19.1 percent share. profitability of IBIs.
Return on Equity (ROE-before tax) has also
declined from 20.9 percent in CY14 to 18.7 percent Capital adequacy is below industry average…
in CY15; which is lower than the conventional
Overall, IBs have maintained CAR well above the
industry average of 26.6 percent (Figure 4.5).
required level of 10.25 percent. But, their CAR at
Lower profitability for IBIs is understandable as
13.8 percent is well below the conventional banking
they have access only to limited investment avenues
industry’s CAR of 17.4 percent. Few IBs are in the

64
process of building up their capital base, therefore, To address various issues and challenges faced by
capital adequacy indicators like Capital to Assets and IBIs and to ensure fast paced development of the
Total Capital to Total RWA of IBs are lower than industry, concerted efforts are required from all the
those of coventional banking industry’s averages stakeholders. To this end, SBP has already launched
(Figure 4.6). comprehensive strategic plan for Islamic banking
industry (2014-18) which sets out direction for the
industry and also provides strategies with action
Figure 4.6 plans. In this regard, the focused areas are: (i)
IBIs CAR remained steady
enabling policy environment (ii) Shariah governance
Solvency Ratios
(percent)
and compliance (iii) awareness and capacity building
Capital Adequacy Ratio Tier 1 Capital to RWA and (iv) market development.
Capital to Total Assets
20 Accordingly, various steps under the strategic plan
18
16 have already been taken (summarized below) while
14 others are expected to be completed by 2018:
12


10
8
Implementation of Shariah Governance
6 Framework for Islamic Banking Institutions
4
2
IBIs Conv. (IBIs)

Banks
0 Rationalization of Minimum Capital
CY12 CY13 CY14 CY15 CY15
Requirements (MCR) for Islamic Banking
Capital Adequacy Ratio and Tier 1 Capital to RWA ratio are for Islamic Banks
only, while Capital to Total Assets include both Islamic Banks and Islamic Banking
Subsidiaries
Branches.
Source: FSD, SBP and BPRD, SBP
 Awareness Creation and Capacity Building
Programs for Islamic Banking Industry
 Establishment of Centers of Excellence in
Way forward… Islamic Finance Education (CEIFEs)
In view of the foregoing, it is obvious that the  Steering Committee for Promotion of
growth of Islamic banking has been quite Islamic Banking
impressive. The industry is still confronted with a
number of challenges, though. Besides managing the In line with the enabling regulatory environment
risks faced by conventional banks, IBIs have to and governmental support, IBIs in their individual
manage additional risks associated only with Islamic capacity and as an industry should also play an
banking, such as Shariah non-compliance risk and active role in further development of Islamic
displaced commercial risk. Similarly, Islamic banking banking industry in Pakistan.
is also facing limited availability of qualified and well
trained human resource. Also, lack of understanding
of prevalent Islamic banking theory and practice
among the target audience is a stumbling block in
sustainable development of the Islamic banking
industry.

65
66
Section B: Non-Banking Financial Sector

67
68
 5 Non-Bank Financial Institutions (NBFIs)

NBFIs have registered average asset growth of 7 percent over the period 2012-2015. Mutual funds having almost 60 percent
share in assets is leading the sector followed by DFIs having a share of 26 percent. Despite registering strong bottom-line trends,
leasing sector could not contain dampening of the overall sector’s profitability led by DFIs. Leasing companies are able to
overtake Modaraba companies in market share despite large number of players in the latter category; while investment finance
companies are continually going down in terms of profitability and sustainability of the participating businesses. The NBFIs
with their small market share in financial assets are less risky for the stability of the financial system.

Besides banks, a range of other Non-bank financial of NBFIs except Investment banks (Figure 5.1).
intermediaries, comprising Non-Bank Financial The industry closed the year128 with an asset size of
Companies (NBFCs)126 , Modaraba companies and PKR 738 billion. Despite expansion in balance sheet
Development Finance Institutions (DFIs) – of NBFIs, profitability of the sector has declined.
collectively known as NBFIs (Non-bank Financial The sector posted profit after tax of PKR 8 billion;
Institutions) – also operate in Pakistan127. 12 percent lower than the previous year. With the
exception of leasing, profitability in rest of the sub
The NBFI’s sector constitutes a diverse set of sectors has declined where major drop is observed
financial intermediaries with varying business under DFIs segment (Table 5.1 and 5.2).
models. Yet, the presence of an ever imposing
banking sector with deep resources that offers Figure 5.1
matching products continues to challenge the Growth trends in Non-Bank Financial Institutions
existence of NBFIs. The non-bank players with an Asset Growth

asset base of 7 percent of that of the banking sector (Percent)

assets in (Financial Year) FY12 have seen their share Mutual Funds
Modarabas
Leasing
DFIs
fall to 6 percent in FY15. 30
IFCs Sector Asset Growth

Decline in operating performance despite modest growth in 20

asset base….
10
The NBFIs have witnessed modest growth over the
0
period 2012-15 (7 percent on average) on the back
of reasonable growth observed in all the sub-sectors -10

-20
126 As per section 282A of Companies Ordinance,1984, Non-banking
finance companies (NBFCs) include companies licensed by the -30
Commission to carry out any one or more of the following forms of FY13 FY14 FY15
business, namely Investment Finance Services, Leasing, Housing Source: MUFAP, Annual Audited Accounts of Leasing and Modaraba
Finance Services, Venture Capital Investment, Discounting Services, companies and FSD,SBP
Investment Advisory Services, Asset Management Services and any
other form of business which the Federal Government may by
notification in the official Gazette specify from time to time.
127 Our coverage of NBFIs is limited to only operative NBFIs for 128 FinancialYear (FY) for DFIs ends in December, while for other
which data is available. sectors their relevant FY ends in June.

69
 Table 5.1 to regulate the non-bank micro finance institutions.
Asset Profile of NBFIs For details please see Box 5.1.
FY12 FY13 FY14 FY15
(PKR billion)
Mutual funds competing for investor’s interest amid falling
Mutual Funds(Net Asset Value) 377.8 356.8 407.9 429.8
interest rate…
Pension Funds(Net Asset Value) 2.7 4.8 8.2 13.6
REITS(Net Asset Value) - - - 22.6 Mutual Funds, leading the NBFI sector with an
DFIs 143.2 149.4 176.1 190.5
average growth of 6 percent in the last three years,
Leasing companies 33.0 34.3 36.5 40.3
have closed the year with Net Asset Value (NAV) of
PKR 443 billion. Shariah-compliant funds and
Modarabas 28.3 30.5 30.0 30.7
Investment Finance companies 15.8 11.6 11.3 10.5
Total Assets 600.8 587.4 670.0 738.0
pension funds have gained increasing popularity as
Source: MUFAP, Annual Audited Accounts of Leasing, IFCs, Modaraba companies, REITs reflected by their share in funds market and addition
and FSD,SBP
of 25 new such funds in FY15. Pakistan’s first Real
Table 5.2
Estate Investment Trust fund (REIT) has also been
Profitability Profile of NBFIs launched on June 12, 2015129. The share of Shariah-
FY12 FY13 FY14 FY15 compliant funds has increased from 14 percent in
(PKR million) FY12 to 29 percent in FY15; while pension funds
DFIs 3,275.0 4,286.0 7,276.0 6,161.0 expanded their position from 1 percent to 3 percent.
Leasing companies (371.0) 498.0 563.0 640.0
Modarabas 1,225.0 1,969.0 1,410.0 1,353.0 Constant Proportions Portfolio Insurance (CPPI)
Investment Finance companies (1,688.0) (783.0) (135.0) (162.0) funds, with their unique product features of offering
Total Profits 2,441.0 5,970.0 9,114.0 7,992.0 limited downside risk (via setting a floor for
Source: Annual Audited Accounts of Leasing, IFCs , Modaraba companies, REITs and
FSD,SBP
investments in money market and fixed income
instruments) and simultaneous participation in the
Funding remained the key risk faced by NBFIs… up-equity markets, have drawn attention of the
investment community. This is evident from their
Funding risk remains the prominent risk faced by market share which has doubled in one year from 3
the sector. Also, the diversification of clientele percent last year to 6 percent this year and addition
suggested in the business models of NBFIs has yet of 6 new funds in this category.
to be achieved. NBFIs are serving similar market
segments as the banks, in which they do not possess Nevertheless, lack of awareness about investment
competitive advantage. options among the general public coupled with
expenses at the fund level, which places direct
SECP revamps the regulatory framework for NBFCs in investments at an advantage, continue to constrain
2015… the emergence of mutual funds as a viable conduit
SECP has introduced major amendments to the for retail savings.
regulatory framework for NBFCs in November, The sector seems promising though: a total of 26
2015. The amendments seek to improve on the risk new funds were launched in FY15. However, in the
management practices of NBFCs, link Minimum falling interest rate environment net redemptions of
Equity Requirements (MER) with the respective PKR 22 billion has been observed during FY15.
business activities of the NBFCs and enable SECP Money market funds have become less attractive;

129 Please see Box 5.2 for details on REITs.

70
while equity funds are in competition with other For modarabas sector, Ijarah exposure to the plant,
high yielding assets (such as property market). machinery and equipment led to build-up of
impairment losses which has dented their
Despite some encouraging trends, the savings profitability in FY15. The 24-company sector’s asset
mobilized through mutual funds are still meager, in base, while expanding over the years at an average
general, relative to the deposits of the banking rate of 3 percent, accounts for a meager 4 percent of
sector (PKR 9.27 trillion in FY15) or placements the non-banking financial sector’s assets. Despite
under the National Savings Scheme (PKR 3.0 large number of players, concentration of business is
trillion in FY15). evident as seven companies represent 80 percent of
Dipping DFI profitability has effected sector’s bottom-line… the sector’s assets, 70 percent of sector’s equity and
86 percent of sector’s income.
Asset quality of the DFI’s has remained within the
satisfactory limits owing to growing advances and Modarabas, however, remained the investment
reducing NPLs stock. Funding profile has remained choice for other modaraba management companies
tilted towards borrowings; while growth of deposits and Islamic banking branches of commercial banks
remains subdued. The DFIs profitability indicators looking for a Shariah compliant counter-party to
have dwindled a bit due to abridged spreads and their transactions. Bank controlled modarabas, with
higher non-mark up expenses. The industry is well their ability to mobilize deposits have focused on
capitalized; though CAR has exhibited a downward generating income from the provision of Shariah-
trend. compliant financing facilities; while the others,
depending on funds generated via IPOs and
DFIs profitability has dragged down NBFI’s accumulated profits, have focused on trading,
performance, as a whole, as it declined by 15 leasing and investment portfolios.
percent - largest fall among all the sub-sectors of
NBFIs (Table 5.2). This has largely been due to The diversity that the sector’s business model
increase in provision charge and other non-markup affords is still promising as it attracted two new
expenses incurred during FY15 by DFIs. entrants in FY15 with a total paid-up capital of PKR
1.45 billion. Some of the weak modarabas are also in
Leasing business: contrasting trends for leasing companies and talks with textile and food companies for
modarabas… acquisitions and collaborative projects; should that
occur it could change the face of the sector.
Both leasing companies and modarabas are active in
leasing business. However, leasing companies and Investment banks continue to fade…
modarabas have exhibited mixed business results in
FY15 due to their exposures in different segments In the absence of funding sources from commercial
of the economy. banks and limited equity, investment banks have
slowly been waning. The sector is unprofitable and
The leasing sector with its focus on transportation has been operating on the sidelines owing to their
and logistical fleet has witnessed YoY asset growth inability to compete with the investment banking
of 10 percent in FY15. Profits have also increased wings of commercial banks.
by 14 percent- the maximum growth witnessed
among the profit making entities of NBFIs. The much awaited road-map for the NBFIs
introduced by SECP is expected to pull the

71
 companies out of the difficult situation of losses Figure 5.2
(with their inability to generate income sufficient to Conventional Equity-based funds offered superior yields
cover operational expenses) and regulatory non- Yields on Mutual Funds vs KSE-100 Index and Average Deposit Rate

compliance (Minimum Equity Requirements (MER) (Percent)

and exposure limits due to weak equity profile). It Equity

Money Market
Income
Avergae Deposit Rate
has given the investment banks the choice of opting 60.00
KSE Returns

out of the deposit-taking category which attracts

lesser MER. Capital Adequacy Ratio has also been 50.00

introduced for the deposit-taking category of 40.00

investment banks.
30.00
The regulations while offering depositor protection
20.00
will further limit the funding avenues for the sector
which, given its resource constraints, has already 10.00
shifted its focus towards non-fund based activities
0.00
for income generation. They are restructuring their FY12 FY13 FY14 FY15
operations and balance sheets while focusing on Source: MUFAP, FSD,SBP and S&DWHD,SBP
NPL recoveries.
Figure 5.3
Mutual Funds130 Net Redemptions from Money Market Funds
Top Fund-wise Net Sales
Mutual funds continue to remain an important (PKR million)
alternate avenue for investments due to their Equity Income Money Market
comprehensive suite of products with multiple
100,000
investments classes like equity, money market and
income funds. 50,000

In FY15, the NAV of equity funds observed a

-
growth of PKR 44 billion followed by CPPI with a
growth of PKR 11 billion and pension funds with (50,000)
growth of PKR 5.4 billion. This growth in NAV,
mostly due to revaluation, has helped mutual funds (100,000)
retain 62 percent share in the NBFI’s sector (Table
5.1). (150,000)
FY12 FY13 FY14 FY15

Equity funds despite being volatile and risky, have Source: MUFAP

received net inflows of PKR 2.69 billion; yielding

maximum returns of 21.73 percent relative to 16.01 Interest rate trajectory has manifested itself in net redemptions
percent return on the KSE 100 Index in FY15. The in money market funds…
excess return is indicative of fund managers’ better
The mutual fund industry is no exception to the
sector and script selection (Figure 5.2).
effects of easing of monetary policy. As the interest
rates started to decline, money market instruments
Mutual Fund data has been obtained from MUFAP. The data is
became less and less attractive for the investors.
130

inclusive of pension fund statistics.

72
Consequently, in FY15, net redemptions of PKR 59 making them more attractive.131 The corporates and
billion have been witnessed in the conventional retail investors (individuals) can then tap the
money market category (Figure 5.3). revaluation gains of their balance sheets (or increase
in wealth) to borrow more and invest in productive
The outflow from money market funds has been avenues. Higher investment activity could then lead
large enough to more than offset the inflows to higher production. So, the first leg of the asset
observed in the rest of the funds categories. price transmission channel i.e. increase in equity
Consequently, the sector has observed overall net prices, appears to be working in Pakistan as well.
redemptions of PKR 22 billion in FY15.
…while Shariah compliant modes gained allegiance
Asset price channel of monetary transmission seems
operative… Behavioral factors usually have a strong bearing in
investment discipline. If we divide the fund industry
The asset wise composition of the funds is also between conventional and Islamic categories, there
indicative of their returns. Downward trajectory of is a clear inclination towards Islamic funds. The
the interest rate has worked towards a reversal in the conventional funds position in net assets regressed
composition of the funds; placing equity funds with by 15 percentage points bringing their share from 86
highest returns at the top, followed by fixed income percent in FY12 to 71 percent in FY15. While the
and money market funds in FY15. This is in stark share in net assets value of faith based open end
contrast to the state of affairs in FY12 when money mutual funds jumped to 29 percent in FY15 from
market funds maintained highest NAV (Figure 5.4). 14 percent in FY12 with an average YoY growth of
35 percent during this period.
Figure 5.4
NAV growth decelerated while equity-based funds took the lead
Figure 5.5
NAV of Fund categories
Increasing popularity of shariah-compliant funds
(PKR billion ) (Percent)
Composition of Islamic and Conventional Fund categories
Equity Income
Money Market Fund of Funds - CPPI (PKR billion) (percent)
Pension Funds Others
Growth in NAV(RHS) Conventional Funds Islamic Funds
450 20 Growth-Conventional(RHS) Growth-Islamic(RHS)
400
15 450.0
350 45
400.0
300
10
350.0 35
250 5 300.0 25
200
0 250.0
15
150
200.0
100
-5 5
150.0
50 -10 100.0 (5)
FY12 FY13 FY14 FY15
Source: MUFAP 50.0 (15)
FY12 FY13 FY14 FY15
Source: MUFAP
This compositional change is, however, as per
expectations. Monetary easing usually has a positive
For details please see “The Transmission Mechanism and the Role
impact on asset prices (equities, real estate, etc.)
131

of Asset Prices”, Frederic S. Mishkin, NBER Working Paper No.

8617, 2001.

73
 Shariah-compliant equity funds remained the most Table 5.3
popular category, witnessing net inflows of PKR 16 Shifts in Investor Base of Conventional Equity Funds
billion despite a return which was 71 bps lower than FY14 FY15
that offered by their conventional counterparts PKR million
during FY15 (Figure 5.5). Banking & FIs (2,161.0) 3,416.0
Provident & Pension Funds (196.0) 1,345.0
Shifts in the investor anatomy prevailed…… Individuals (982.0) 484.0
Others (1,571.0) (2,555.0)
Increasing popularity of the funds, especially among Total Net Sales (4,910.0) 2,690.0
retail investors, is evident from the expanding Source:MUFAP.
investor base due to higher yield and tax advantage.
The number of investment accounts has grown by Table 5.4
10 percent over the period FY12-15 with shifts in Shifts in Investor Base of Conventional Income Funds
investor category. Institutional investment funds FY14 FY15
went down from 83 percent to 66 percent probably PKR million
due to the waning of tax advantage for banks.132 Banking & FIs (109.0) (7,341.0)
While share of individuals in total NAV increased to Provident & Pension Funds 211.0 900.0
34 percent from 17 percent in FY12. Individuals 419.0 8,647.0
Others (883.0) 2,297.0
Despite rising share of retail investors in funds Total Net Sales (362.0) 4,503.0
market, their share is still low by international Source:MUFAP.
standards where retail participation is, generally, to
the tune of 80 percent. Mutual funds are, therefore, Table 5.5
a long way away from establishing themselves as a Shifts in Investor Base of Conventional Money
worthwhile alternate savings avenue in Pakistan as is Market Funds
the case internationally. FY14 FY15
PKR million
Sales and redemption pattern of mutual funds also Banking & FIs (9,062.0) (34,588.0)
provide an interesting insight. Net redemptions Provident & Pension Funds 377.0 (1,758.0)
from money market funds were observed for all Individuals (8,118.0) (8,793.0)
investment categories with a marked increase in Others (2,076.0) (13,483.0)
equity funds by the Provident & Pension funds. Total Net Sales (18,879.0) (58,622.0)
Source:MUFAP.
Banks, driven by the tax motives were also inclined
towards the equity funds. Driven by higher returns The sector has also graduated itself as a recipient of
but wary of the riskier equity funds, individuals took idle pension and other retirement funds largely due
the mid-way of replacing their money market funds to tax incentive133 and increased awareness among
with the income funds. the investor and public regarding this attractive
avenue for long-term savings, particularly for their

133Under section 63 of income tax ordinance 2015, pension fund

investments are eligible for tax credit up to 20% of one’s taxable
income. Additional catch-up incentives are provided to participants
132Previously under Finance Act of 2012, the income generated by over 40 years, with a maximum tax credit on 50% of taxable income.
banks from investment in mutual funds was taxed at 10%.

74
old age. Investments in the offered pension schemes Development Financial Institutions (DFIs)
in FY15 are five times the level observed in FY12.
The growing popularity of such funds resulted in 12 The DFIs continue to grow with a conservative
new fund offerings during the year (Table 5.3, 5.4 pace in CY15134 undermining the development role
and 5.5). of the sector. The size of the industry remains
limited to 8 DFIs with insignificant (3 percent)
Mutual funds facing stiff competition despite better returns… contribution to gross fixed capital formation.

Apart from direct competition from commercial The asset base of the DFIs has expanded by 8.7
banks and NSS instruments, returns offered by percent in CY15; mainly driven by growth in
mutual funds is also effected by indirect cost of advances and investment portfolio. Investments as
taxes and fees levied at the fund level. Banking compared to advances occupied significant share in
sector further presents a challenging competitor not total assets and remained the major source of
only in terms of funds mobilized but also with earnings for the DFIs (Figure 5.6).
regards to outreach to the general public through
their extended branch network. Figure 5.6
Investments occupied significant share in Total Assets
NAV of mutual funds industry is only 4 percent of Composition of Earning Assets

the funds parked in deposits with commercial banks (PKR billion)

Lending to FIs Advances - Net
offering an average return of 6.2 percent over the Investments - Net Balances with Banks

year when the money market mutual funds presently

200

180
offer 8.8 percent on average. The investor base of
160
around 236,000 investor accounts is meager as 140
compared to the 38 million CASA accounts. 120

Expectations of a thriving stock market may prolong the

100

current trend …
80

60

In light of the prevailing low interest rate scenario, 40

investor interest is expected to move further 20

towards high yielding equity funds. Some volatility 0

CY1 2 CY13 CY14 CY15
may persist in the equity market in the near term but Source: FSD,SBP

equities are expected to perform better relative to

money market over the medium term. Investors Advances grew handsomely but the share of SMEs squeezed
with relevant risk profiles and investment horizons further…
may profit from investing in the equity funds
category. While yield on debt instruments are In CY15, advances (gross) increased by a notable
expected to remain subdued due to soft inflation 14.0 percent over the last year, significantly higher in
outlook. comparison to growth of 8.1 percent in the banking
sector. The main contributing factor in advances’
growth during the year can be traced to a

For DFIs the calendar year (CY) is the same as the Financial Year
134

(FY).

75
 remarkable 13.6 percent growth in corporate sector investments have almost doubled in line with the
lending. Private sector lending increased as the capital market’s remarkable performance.
macro economic conditions improved. An analysis
of advances’ flow displays the same pattern of Figure 5.8

growth in fixed loans as observed in the banking Investment composition skewed towards Government Securities
Investment Portfolio of DFIs
sector (Figure 5.7). (PKR billion)

Under Consumer finance, flow of funds surged

Federal Government Securities Fully paid up ordinary shares
mainly in mortgage loans category. However, the TFCs, Debentures, Bonds, & PTCs Other investments
growth was limited to only one DFI. SME sector 140

shrank further with a net retirement of PKR 27 120

million. A prominent 75 percent decline was 100

observed in the overall lending to Financial 80
Institutions (FIs). Except one DFI, lending to FIs 60
witnessed a downward trend. 40

20
Figure 5. 7
Major share of funds flew to Fixed Investments 0
Advances Composition (Flows) CY12 CY13 CY14 CY15

(PKR billion) (percent) Source: FSD,SBP

Fixed investment Working Capital

others
advances growth-RHS
Consumer Finance
Investment composition skewed towards government
10 16 securities…
14
8
6
12 Investment composition is skewed towards
10
4 8 government securities followed by equity
6 instruments. In order to manage their liquidity and
2
gain benefit from interest rate movements, DFIs
4
- 2
0 kept their investment strategy flexible by parking
(2)
-2 major chunk of their investments under AFS
(4) -4
CY12 CY13 CY14 CY15 category (Figure 5.9). As of CY15, DFIs hold 50
percent of PIBs and 17 percent of T-bills under
Source: FSD,SBP
AFS category.

Share of investments in total assets remains large… Growth in deposits receded…

Investments, despite a decline in their share by 140 On the funding side, borrowings and equity
bps, occupy almost two-thirds share in total assets remained the main sources of funding for the DFIs.
of the DFIs during 2015. A growth of 7 percent in Borrowings grew by 16 percent YoY largely on
investments is observed during the period owing to account of increase in call borrowings and loans
a notable increase of 9 percent in government from SBP. This increase in borrowings is mainly
securities (Figure 5.8). Investment in stock market attributable to low cost of borrowings compared to
also observed rising trend. Since CY13, equity that of deposits. Equity, which on average funds 41

76
percent of the total balance sheet footing, grew on in CY15 compared to 9 percent in CY14) (Figure
the back of healthy growth in retained earnings. 5.10).

Figure 5.9 Assets quality of the DFIs shows improvements…

Major chunk of investments parked under AFS category
Investment Anatomy The infection ratio of DFIs has dipped due to
(PKR billion) (percent) marginal decline in NPLs stock and growth in
HFT AFS advances, leading to improved asset quality (Figure
HTM S&A
Share in Earning Assets (RHS) 5.11). NPLs declined across the board except for
140 68 two DFIs that showed an upward trend. More than
120 66 80 percent of the NPLs were parked under loss
100 category having remote chances of recovery.
64
80
Further, provision coverage ratio reached to a
62 marginally higher level of 76.5 percent in CY15 in
60
60 comparison to last year’s level of 74.5 percent,
demonstrating somewhat improved resilience of the
40
58
20 sector.
0 56
CY12 CY13 CY14 CY15
Figure 5.11
Source: FSD,SBP
NPLR showing a downward trend
Non Performing Loans & Provisions
(percent)
Figure 5.10 Provisions to NPLs NPLR (RHS)
Growth in deposits receded 90 35
Funding Structure 80
30
(PKR billion)
70
Equity Borrowing Deposits Others 25
60
200
50 20
180
160 40 15
140 30
10
120 20
100 5
10
80 0 0
60 CY12 CY13 CY14 CY15
40 Source: FSD,SBP
20
0
CY12 CY13 CY14 CY15 ROE and ROA of the sector dipped…
Source: FSD,SBP
Operating performance of DFIs has been modest
The share of deposits in total funding, on the other
during CY15. The sector has posted pretax profit of
hand, has receded due to higher cost135 (11 percent
PKR 8.8 billion, 1.1 percent higher over the last
year. However, after tax profitability has
135 DFIs as per their mandate can only raise term deposits.

77
 significantly declined relative to CY14 (a fall of 15 percent is still at a level higher than the regulatory
percent). requirement evidencing strong solvency of the
sector. All, but two, DFIs are compliant with
Though, the low interest rate environment has minimum capital requirements.
squeezed the return on advances, interest earned on
large investment portfolio supported the overall net Positive economic outlook, energy sector reforms,
interest income which has also been complimented improved law & order situation, developments on
by a 16 percent growth in non-interest income. The CPEC and low interest rate environment may lead
major increase in non-interest income came from to increased growth opportunities for this sector as
gains on sale of securities and dividend income. well.

Nevertheless, ROA and ROE has dipped mostly Figure 5.13

due to increase in provisions and administrative CRWAs inched up
expenses, and expanding asset base of largely low Solvency Profile of DFIs

yielding assets (Figure 5.12). (PKR billion)

CRWAs MRWAs
ORWAs CAR(RHS)
Figure 5.12 160 60
ROE & ROA dipped 140 58
Performance of DFIs 56
120
(PKR billion) 54
(percent) 100 52
Net Markup Income Non-Markup Income
ROA (RHS) ROE (RHS)
80 50
14 16 60 48

14 46
12 40
44
12
10 20 42
10
8 - 40
CY12 CY13 CY14 CY15
8
6
6 Source: FSD,SBP
4
4
2 2
Leasing Sector
0 0
CY12 CY13 CY14 CY15
With a miniscule share in the financial sector, leasing
sector poses limited concerns for the stability of the
Source: FSD,SBP

overall financial sector. However, their positive

Capital Adequacy Ratio (CAR) is declining… contribution in spurring economic activities via
provision of alternative financing source is well
Credit risk weighted assets have grown on the back
desired for the development of the financial
of growth in advances. Operational risks weighted
markets. Also, the focus of the leasing business in
assets (ORWAs) also inched up due to higher gross
Pakistan is, generally, on SME segment and
income. Eligible total capital increased as well but
consumer finance, with most of the disbursements
proportionately less than the increase in RWAs;
for machinery, equipment and vehicle leasing, which
pulling the CAR downwards (Figure 5.13).
makes it even more attractive for equitable
However, the overall CAR of the industry at 43.6
economic growth purposes.

78
Steady growth funded by deposits and borrowing… larger firm whose market share will further increase
concentration risk.136
The leasing sector has registered a steady growth for
the last couple of years. The sector added another Credit and liquidity are major risks faced by the
10 percent to its assets base during FY15. Most of it leasing companies. In terms of severity, liquidity
was funded by a reasonable increase in deposits and remains a major impediment in the growth of this
borrowings from financial institutions. The fresh sector. As large number of these firms are
funds were largely disbursed for financing core dependent on bank funds to finance their business,
business of leasing. Despite increase in loan loss their growth remains largely affected by availability
provisioning charge, the operating performance of funding lines from the banking sector.
showed significant improvement as ROE increased
by 130 bps to 13.5 percent (Figure 5.14). Changes in the regulatory framework…

Leasing sector is governed by NBFCs and NE

Figure 5.14
Steady asset growth funded by deposits and borrowings
(Non-Bank Finance Companies and Notified
Asset Growth & Profitability Ratio Entities) regulations 2008 which were amended in
(PKR billion) (percent) November 2015 (See Box 5.1). One of the major
Total Assets ROE(RHS) ROA(RHS)
changes in these regulations is in capital requirement
50.00 16
for deposit raising leasing firms.
14 As a result capital standards for new leasing
40.00
12 companies which can raise deposits has been set at
30.00 10 PKR 1 billion while existing leasing companies with
8 deposit raising status can operate with a capital base
20.00 6
of PKR 500 million. Further non-deposit taking
leasing firms can operate with a nominal capital base
4
10.00 of PKR 50 million.
2

- 0 Changes in the regulatory environment will help to

FY12 FY13 FY14 FY15
solve the long standing solvency issues plaguing the
Source: Annual Audited accounts of Leasing Companies
sector. Further it will add to overall financial stability
as only strong players remain in the market.
The ownership structure of leasing industry shows
that 6 of these companies are part of the local or Modarabas
foreign banking groups and are largely contributing
to the growth and performance of the sector during The Modaraba sector, despite 30 years of its
the last few years. The sector is quite concentrated operations, is far from actualizing the true potential
as the largest firm (asset-wise) in the sector accounts of its business model which encompasses diversity
for 69 percent of the sector’s assets and 82 percent in operations and maximum dividend payouts to its
of sector’s lease income. Market news suggest investors.
merger of two leasing companies which will create a In 2008, SECP introduced 12137 model financing
agreements both to bring the companies at a level-

136 For details of merger please visit www.psx.com.pk

79
 playing field with the conventional sector and to was largely contributed by investments138 which
provide new products for the Islamic financial grew by 13 percent in FY15 on the back of vibrant
market. Capitalizing on the model agreements, the equity market.
companies can undertake diverse activities including
leasing (Ijarah), financing, trading, manufacturing, On the other hand, lease rental receivable -the core
property development, project financing and equity business of modarabas showed a nominal growth of
investments. Yet the sector’s assets and income 2 percent. Reliance on lease rental services is evident
remains concentrated in leasing and only a few from the sector’s asset profile whereby lease assets,
players have attempted to venture into trading, while shrinking marginally, continued to make up a
manufacturing and other Shariah-compliant sizeable portion of total assets (48 percent in FY15
financing. down from 51percent in FY14) (Figure 5.15).

Although the bank sponsored modarabas drawing Figure 5.15

on the credibility of their parent companies are able

Sector Assets remain concentrated in Lease Assets
Composition of Assets
to mobilize funds in their investment schemes while (PKR billion)
also getting concessional credits at times, the rest of
Total Assets Total Advances Investments Lease Assets
the companies are facing funding constraints and
financing expenses.
35

30
Further, the Modaraba Management Companies
(MMC) akin to an Asset Management company,
25

were expected to float different types of Modarabas 20

exploiting their respective strengths but almost all of 15

the MMCs remained confined to the first offering.
10
Currently there are 33 licensed MMCs but only 24
are in operation. 5

0
The growing Islamic finance industry offers FY12 FY13 FY14 FY15
immense potential for profitable operations, but the Source: Audited financial statements of Modarabas

business strategies of the sector’s players and lack of

innovation in product offerings continues to Modest inclination towards advances can be gleaned
dampen the modaraba companies’ progress. from the trend in financing under the various
Shariah-compliant modes which grew by 2 percent
Moderate asset expansion amidst unchanged composition… in FY15. The growth, however, was concentrated in
the bank sponsored modaraba companies which
The 24-company sector’s asset base, while
witnessed a 4 percent increase while the rest saw a
expanding over the years at an average rate of 3
decline of 5 percent.
percent, has reached PKR 31 billion in FY15. It still
accounts for a meager 4 percent of the non-banking Performance is concentrated in asset rich and bank controlled
financial sector’s assets. The current asset growth companies…
137 Ijara, Modaraba, Musharika, Diminishing Musharika, Musawamah,
Istisna, Murabaha, Salam, Syndicate Modaraba, Syndicated Musharika, 138Investments include Listed /unlisted securities, Sukuk, certificate
Islamic CFS Murabaha and Sukuk. capital of other modarabas, subsidiaries/ associated companies and
mutual funds.

80
Much of the sector’s performance and assets Table 5.6
remained concentrated in the top seven modarabas. Modarabas under Management control of banks
These seven companies (asset-wise) represented 79 FY12 FY13 FY14 FY15
percent of the sector’s assets, 70 percent of sector’s percent
equity and 86 percent of sector’s income from Contribution in Sector Assets 58.0 55.0 53.0 51.0
operations in FY15 (Figure 5.16). Contribution in Sector Equity 18.0 16.0 17.0 19.0
Contribution in Core Income 28.0 48.0 32.0 34.0
Source: Audited financial statements of Modarabas.
Figure 5.16
Sector Assets remain concentrated in Top Seven Modaraba
Companies Equity financed a major portion of the sector’s assets…
Asset Concentration
(percent) Prudential regulations requiring transfer of 20-50
Top 3 Top 5 Top 7 Rest of firms percent of after tax profits to a statutory reserve
translated into an ever increasing contribution of
2015
equity in the sector’s funding mix which surpassed
21 51 percent in FY15. In FY15, 33 percent of the
21 57
56 2014 sector’s profits were transferred to statutory
reserves. Financing, predominantly from the
79 79
banking sector and other modaraba companies
shrank to 12 percent while deposit mobilization, via
69 non-interest bearing investment certificates, reached
71 21 percent (Table 5.7).

Table 5.7
Source: Audited financial statements of Modarabas
Funding Mix of Existing Modarabas
FY12 FY13 FY14 FY15
The modarabas under management control139 of the percent
banking sector seemed better positioned to take
Financing 17.0 14.9 16.4 12.2
advantage of the business model offered by the
Deposit Mobilization 23.2 25.6 20.8 21.3
sector as they made up 51 percent of total assets, 19
percent of equity and 34 percent of income from Equity 44.0 42.9 47.9 51.7

operations (Table 5.6). Source: Audited financial statements of Modarabas.

139Via direct ownership of the Modaraba Management Company or

shareholding by the bank’s associated companies.

81
 Figure 5.17 continued to pay the MMC fee at the maximum
Lease Income continues to dominate Sector Earnings prescribed threshold of 10 percent of annual profits.
Composition of Income from Operations
(percent) Tax exemption benefits continued to drive payouts
Lease Income Income from Trade/manufacturing to certificate holders. Cash dividends ranging from
Income from Advances Income from Maintenance Services
100
0.9 percent to 90 percent of paid-up-capital were
90
paid out by 20 of the companies in FY15 but many
80 of the companies offered rates which were still not
70 competitive.
60
50 Table 5.8
40 Performance Indicators of Modarabas
30 (PKR in billions and ratios in percentage)
20 FY12 FY13 FY14 FY15
10 Profit After Tax 1.2 2.0 1.4 1.3
0
FY14 FY15 FY14 FY15 Total Income 10.2 11.8 10.6 10.7
Source: Audited financial statements of Modarabas Operating and Finance Cost 6.3 7.1 6.7 6.9
ROA (After Tax) 4.3 6.4 4.7 4.4
Lease income dominated sector’s earnings… ROE (After Tax) 9.8 15.0 9.8 8.5
Source: Audited financial statements of Modarabas.
The sector’s income remained concentrated in lease
rentals which accounted for 59 percent (down from SECP in March-2016 carried out a comprehensive
61 percent in FY14) of total income generated from financial review of the modaraba companies to
operations in FY15. While income from initiate action against the ones with unsatisfactory
trading/sales grew on average at 7 percent over track record of dividend payouts, excessive
FY12-15, more than 70 percent of that income was bookings of non-earning assets and imprudent risk
attributable to a single manufacturing modaraba management framework. In the process, SECP has
(Figure 5.17). identified 13 underperforming modarabas and has
vowed to chalk out business plans for their
Profitability declined marginally… performance improvement.
Profitability of the sector fraught with operating and SECP invited stakeholder comments on proposed
financing costs, declined over the year by 4 percent regulations…
to reach PKR 1.4 billion with four companies
landing in red. 61 percent of the income from The proposed draft of Modaraba Regulations-2015,
operations was expensed in operating costs while much in-line with the sector’s current funding
another 10 percent went towards payment of status, seeks to confine issuance of certificates of
finance costs (Table 5.8). investment to the financial services modarabas. The
change, if approved, would likely result in increased
Depreciation on Lease Assets and Modaraba secondary offerings of securities by non-financial
Management Company (MMC) fee further dragged modarabas or alternatively padding-up of reserves
down the profitability as most of the modarabas via profitable operations in an attempt to maintain
funding level. The proposed regulations further seek

82
to link deposit mobilization with minimum equity NBFC categories such as commercial and retail
and proposed CAR methodology along with more leasing subject to additional minimum equity
stringent credit rating requirements envisaging requirements as defined by the SECP.
stronger depositor protection.
The sector has seven140 operative companies as of
The resilience that Islamic financial system FY15 but the licenses for six of these companies
components bring to the financial sector due to are pending renewal by SECP which is in the
their real asset backed nature advocates for their process of devising a road-map for the NBFC sector
stronger presence in our financial system. Lacking along with a new set of regulations.
the ability to mobilize funds via investment
schemes/deposits on the level of bank sponsored Repercussions of the liquidity crisis persisted while competitive
modarabas/Islamic banks which enjoy public environment threatened viability of operations...
confidence, the non-bank sponsored modaraba The liquidity crunch after the stock market crisis of
companies may venture into small-ticket businesses. 2008 was especially intense for the investment
By offering short and medium term financing in finance companies because of their excessive
areas like agriculture, livestock, tailor-made reliance on the unsecured credit lines from banks
financing, small-scale businesses, the companies can and huge provision expense on their infected
better position themselves to cater to the unbanked investments in stock market.
segments of the economy promoting financial The repercussions of the crisis still persist as the
inclusion on the one hand and avoiding sector is yet to post a profit. The companies
overwhelming competition on the other. continue to struggle with recoveries, accumulated
While the sector is devoid of posing a worthwhile losses and inability to raise financing. Lack of level-
threat to the stability of the country’s financial playing field and competition emanating from the
system, the resource contribution by the banking presence of the much resourceful investment
sector, both as a financier and as an investor, points banking desks of commercial banks add to the
to a relatively vulnerable position of the sector itself adversity being faced by the sector as they continue
in instances of operational threats to the banking to rely on their very competitors for their business
sector. funds.

Investment Finance Companies (IFCs) …… wiping out sector assets……

Investment Finance companies licensed as such by The business of IFCs is stagnant. The companies
the SECP can undertake a wide range of activities have been operating on the side-lines focusing on
from the very basic fee-based investment advisory, settling outstanding liabilities via disposal of non-
FX trading and brokerage to the much intensive core/non-earning assets and maximization of
portfolio/ wealth management and corporate recoveries from NPLs; thereby shrinking their
/consumer financing. The companies are meant to balance sheets.
serve the investment and financing needs of a
diverse clientele of financial institutions, general
public, private sector corporations and high net
worth individuals and can also venture into other 140LSE Financial Services, formerly the Lahore Stock Exchange,
exchange has been licensed as an IFC.

83
 Figure 5.18 Figure 5.19
Declining Balance Sheet Size of all but one company in the Sector Sector Earnings shift towards non-fund based sources
Balance Sheet Composition Composition of Income from Operations
(PKR million) (PKR million)

Assets Liabilities Equity Income from Lease operations Income from Investments
Income from financing Income from placements
Fee and Commission
16,000.00
800.00
14,000.00
700.00
12,000.00
600.00
10,000.00 500.00
8,000.00 400.00
6,000.00 300.00
4,000.00 200.00
2,000.00 100.00

- -
FY12 FY13 FY14 FY15 FY12 FY15 FY14 FY15
Source: Audited financial statements of Investment Finance Companies Source: Audited financial statements of Investment Finance Companies

The receding balance sheets of majority of players In FY15, five companies posted after-tax profits
diluted the sector’s asset base which reached PKR capitalizing on mark-up waivers on settlement of
10.5 billion in FY15 registering a 33 percent liabilities, reduction in financing costs brought on by
reduction over the four year period (FY12-15). a reduction in borrowings, net reversals in
Funding side (both liabilities and equity) followed provisions (registered by 5 companies in FY15) and
suit, decreasing by 28 percent and 31 percent, rationalization of administrative expenses (Table
respectively. All of the companies continue to report 5.9).
deferred tax assets which remained unutilized owing
to their limited taxable income. Deferred tax assets Table 5.9

accounted for 10 percent of the sector’s asset base Performance Indicators of Investment Finance Companies
in FY-15 (Figure 5.18). FY12 FY13 FY14 FY15
(PKR billions )

Mixed profitability results and tax losses overwhelm the

Income from Core Operations 1.46 0.76 0.67 0.57
sector’s bottom line…
Admin & Operating Cost (0.67) (0.56) (0.48) (0.46)

Most of the companies, due to non-availability of Finance Cost (1.50) (0.48) (0.30) (0.21)

liquidity for fresh business, have been focusing on Operating Profit (0.71) (0.28) (0.99) (0.72)
non-fund based activities to remain afloat. Non- Equity (1.69) (0.78) (0.13) (0.16)
fund based income (Fee and Commission) took the Source: Audited financial statements of Investment Finance Companies

lead witnessing YoY growth of 17 percent in FY15

Over the four year period (FY12 to FY15), funding
accommodating a 26 percent share in income (up
(borrowings, COIs, CDs) went down by 31 percent
from 4 percent in FY12). The contribution in total
which resulted in a reduction of 86 percent in the
income from financing, investments and placements
mark-up costs. During FY15, finance costs posted a
reduced from 78 percent to 62 percent over the
30 percent decline coming from a 12 percent
period FY12-15 (Figure 5.19).

84
reduction in funds; net provisions of PKR 156 face the need to re-structure their present
million in FY14 turned into net reversals against obligations or draw on funds from disposals of non-
provisions of PKR 96 million in FY15; while earning assets to meet impending commitments.
administrative and operating expenses decreased by
32 percent over the year. Non-compliance under NBFC regulations continues…

While both the operating and financing costs have Unfavorable business environment over the years
reduced over the years, the progressively declining coupled with accumulated losses has eroded net
income from operations remains insufficient to worth of most of the companies; as a result, six of
cover these costs. In FY15, operating expenses the companies remained non-compliant under the
wiped out 77 percent of Income generated from Non-Banking Finance Companies and Notified
operations and another 35 percent was expensed in Entities Regulations 2008 regarding Minimum
finance costs (28 percent for mark-up on COIs and Equity Requirement. The non-compliance further
CDs and 7 percent for borrowing). extends to fund and non-fund based exposure limits
which have been linked to equity.
Reversals in provisions of PKR 96 million were
enough to offset the operating loss of the sector SECP, under the new regulations has linked the
which managed to achieve nominal profits before Minimum Equity Requirement (MER) with deposit
tax of PKR 45 million- the first positive figure since taking and has given a year to the existing deposit
FY12. However, reversal of deferred tax asset of taking investment finance companies for
PKR 220 million by a single company overwhelmed compliance with the new MER or opt out of the
the sector’s after-tax performance landing it in red deposit taking category while freezing the deposits
(negative PKR 163 million). at the existing level.

The fund and non-fund-based exposures have been

Re-emergence of positive yet insufficient cash flows from revised downwards141, further constraining the limits
operations… for IFCs which opt out of the non-deposit taking
status. Deposit taking finance companies have
Cash flows from operations, a primary determinant further been required to maintain a Capital
of debt-servicing ability and one of the decisive Adequacy Ratio of 8 percent for the first two years
factors in credit analysis, seems to be a constraining and 10 percent thereafter.
factor in the companies’ ability to raise financing. This while being challenging for those investing in
The sector is facing serious problems in terms of unlisted equity, risky debt securities and unsecured
liquidity based on the cash flow generated from financing (highest capital charge category of 150
operations. Cash flows of PKR 239 million percent) would provide for additional capital
generated from operations in FY15 were only 25 cushion adding to immunity from adverse business
percent of the maturing liabilities of PKR 942 outcomes.
million. Should the expected outlook of the equity markets
Inability of the core income to cover the maturing materialize, the companies capitalizing on the
liabilities will present liquidity constraints over the
coming year as well. The companies will continue to 141Fund and non-funds from 30 percent to 20 percent and fund-
based from 20 percent to 15 percent of equity.

85
 generated business opportunities for investment
banking services may generate funds enough to
cover at least their operational costs.

86
Box 5.1: Revamped Regulatory Framework for Management Services i.e. Asset Management, Investment
NBFCs Advisory, Private Equity & Venture Capital Fund
Management Services and REIT Management Services
SECP introduced major amendments to the regulatory
under a single entity. In order to encourage private fund
framework for NBFCs in November, 2015. The
management, the eligibility criteria for Fund Management
amendments seek to improve on the risk management
Company has been redefined and now a company other
practices of NBFCs, link Minimum Equity Requirements
than a public limited company may also obtain license
(MER) with the respective business activities of the
for private fund management. In addition, a new type of
NBFCs and enable SECP to regulate the non-bank micro
fund i.e. Private Fund has been introduced. Now, the
finance institutions.
fund management company may launch private funds
The amendments categorize NBFCs as lending NBFCs with varied objectives of investing in wide range of
and Fund management NBFCs. Lending NBFC i.e. financial assets including equity securities, debt securities
Leasing Companies, IFCs, HFCs, Discount Houses and etc.
Non-Bank Microfinance Companies. NBFCs have been
For mutual fund industry, expense ratio has been capped
further segregated into non-deposit taking and deposit-
according to the type of fund. Management fee has
taking entities with distinct regulatory requirements. The
further been reduced to limit the maximum expenses that
definition of NBFC has been broadened to include
can be charged to a mutual fund to improve investors’
Discount Houses and Non-Bank Micro Finance
return.
Companies (NBMFCs). With the addition of new
entrants, NBFIs are expected to play an important role in
mobilizing investments to the sectors that need special
attention such as micro finance, SME financing, housing
and infrastructure development.

The concept of small and mid-sized non-deposit taking

NBFCs has been introduced with significantly reduced
equity requirements. MER for non-deposit taking leasing
companies and housing finance companies has been
reduced to PKR 50 million from PKR 700 million and
that of non-deposit taking investment finance services
has been reduced from PKR 1,000 million to PKR 100
million. Moreover, housing finance companies, in
addition to the consumer financing, have been permitted
to undertake commercial housing finance activities.

Lending NBFCs can apply for permission to raise

deposits after complying with the prescribed criteria
related to MER, CAR (initially at 8 percent), credit rating
etc. However, leasing companies, discount houses and
house finance companies are required to invest 70
percent of its total assets in its licensed form of business.

Measures have also been adopted to support sustainable

growth of fund management industry. In order to reduce
the cost of setting up a company, Fund Management
NBFCs have been allowed to undertake different Fund

87
 Box 5.2: Real Estate Investment Trusts (REITs) in similar legislation. From the late 1990s Asian
Pakistan governments started passing legislation allowing for
establishment of REITs. The earliest Asian markets to
Real Estate Investment Trust (REITs) is a mutual fund adopt the structure were Japan and Singapore, later
that invests in a pool of properties/mortgages bundled followed by Hong Kong, Malaysia, Thailand, Taiwan,
together and offered as a security in the form of unit and South Korea.
investment trusts. These units can then be traded on
stock markets. Each unit in a REIT represents a Benefits and Risks
proportionate fraction of ownership in each of the
underlying properties/mortgages providing its holders a REITs under a product offering that derives value from
simple way to invest in real estate without the cost or both the real estate and trading components is expected
illiquidity associated with owning a property directly. to simultaneously promote the development of the real
There are two main types of REITs: equity REITs and estate and capital markets. A new product’s trading while
mortgage REITs (mREITs). Equity REITs invest in real adding depth to the capital market will build professional
estate by acquiring properties and developing or renting capacities in the areas of valuation, fund management
them. Mortgage REITs invest in the debt required to and trusteeship. The disclosure requirements of a REIT
finance real estate, including mortgage loans and (which equate those of a public limited company) and the
Mortgage Backed Securities (MBS). improved price discovery for rental and sale transactions
of properties are further expected to bring the much
Global perspective needed transparency in the current murky real estate
The global real estate securities market has seen a major market.
transformation with the adoption of REITs and similar
structures as countries sought to encourage broader Equity REITs are subject to the location-specific risks of
public investment in commercial real estate. The market their properties including any negative developments in
grew to approximately US $1.5 trillion in March 2016142 the nearby locations which may depress REIT valuations.
with more than sixty six percent of investment in REITs. Phases of boom and bust, typical of the property market,
may introduce further volatility in valuations.
REIT legislation was first introduced in 1960 in the
United States, followed by the Netherlands (1969) and In the mortgage REITs, the Global Financial Crisis has
Australia (1971). In the early 1990s, faced with a already demonstrated the potential hazards of leverage,
downturn in the commercial real estate and the savings- maturity transformation and repo borrowings. These
and-loan crisis, private real estate companies began to risks are typical of the mREIT model which borrows in
adopt the REIT structure thereby accessing capital from the repo market to invest in the longer-term MBS-
public markets. As a result, more than 100 U.S. earning the yield differential. Despite that, the US
companies formed as REITs and became public between mREIT market capitalization has grown significantly in
1991 and 1997. recent years to reach US$ 52 billion. The policymakers
seem to go soft on this asset class given the desirability
Encouraged by the positive impact REITs had on the of an active and liquid market for MBS and its favorable
investment landscape, real estate industry, capital markets effects on the housing market development.
and real economy, other countries began to implement
Regulatory environment in Pakistan

FTSE EPRA/NAREIT Global & Global ex US Indices as at

142 Globally, REITs are open-end structures. But in
March 31, 2016.
Pakistan, REITs have been initially introduced as closed

88
end funds to avoid high redemptions thereby safe borrowing for capital expenditures and to meet cost
guarding against systemic risk. overruns has been permitted to the extent of 30 percent
of land/real estate value. This resulting reliance on
The three types of REIT schemes introduced by SECP capital market for liquidity is expected to deepen capital
in Pakistan are the Developmental, Rental and Hybrid markets and protect unit holder’s right on the underlying
REITs. Developmental REIT schemes focus on property as it avoids excessive leveraging of a high-ticket
developing acquired properties for Industrial, business.
Commercial or Residential purposes through
construction or refurbishment and then selling it for REITs investments have been encouraged further by
providing tax benefits. As per finance bill 2015-16, the
profit. Rental schemes invest in commercial or residential
capital gains of a person who sold property to a REIT
Real Estate to generate rental income. Hybrids are a
development scheme have been exempted from Income
combination of the two.
Tax till June 30, 2020. Further, income tax chargeable on
SECP initially notified the REIT Regulations in 2008 dividend income from a REIT scheme set up by June 30,
2018 for the development of a housing sector has been
licensing two REIT Management Companies (RMCs),
reduced by 50 percent for the first three years.
Arif Habib REIT Management Company Limited and
AKD REIT Management Company Limited. However,
State Bank of Pakistan also took an initiative to develop
sufficient interest was induced after the launch of fresh
REIT market by relaxing its concentration limits for
REIT regulations in 2015143. The specified parameters
banks’ exposure in equity market. Previously, banks
for REIT schemes under the previous regulations tended were allowed to hold aggregate equity investment up to
to encourage developmental REITs and large-sized rental 30 percent of their own equity. However, for REITs
REIT schemes. The new regulations tend to encompass investment, they can add another 10 percent exposure.
the whole spectrum of schemes. This measure will help to develop the REIT market by
creating demand from the banking sector.
Entry barriers have been lowered whereby capital
requirements for starting an RMC have been revised Current status of REITs in Pakistan
downwards from PKR 200 million to PKR 50 million.
Limits on single investor ownership of fund units (IPOs Pakistan’s first Real Estate Investment Trust fund was
capped at 5 percent and Pre-IPOs at 10 percent of fund launched on June 12, 2015 which was oversubscribed;
units) has been done way with to facilitate admission of indicating huge interest of investors in indirect real estate
large-scale REIT projects. Concept of strategic investor market. Bringing together the strengths of the Arif Habib
group and the Dolmen Group, the “Dolmen City REIT”
has been introduced making RMC and the strategic
floated 25 percent of its fund size of 22.237 billion. The
investors the fall-back entities which are to hold the
Dolmen City REIT is close-end, listed, Shariah
specified investments units in blocked accounts until the
compliant Rental REIT offering investors to become
winding up of the scheme. The scheme’s fund size has
unit holders of two components of the Dolmen City
been linked with the listing regulations of the relevant
project, the Dolmen Mall Clifton and The Harbor Front.
exchange. The fund management paid its first month’s profit of
PKR 169.612 million as dividends, yielding 9.6 percent
Utilization of customer advances has been capped to a return to its investors in only a month.
percentage of construction cost as specified in the
business plan and offering document. Unsecured Outlook

Traded equity characteristics of the REIT structure may

143Currently four RMCs have been licensed under the new
regulations- AKD, Arif Habib Dolmen, Orange and ISE Towers. make them vulnerable to swings of the stock market.

89
 However, backing of a real asset as the fall-back value
coupled with the structure’s currently small share in the
NBFI sector assets (3 percent) points towards its relative
insignificance in terms of posing financial instability
threats to the financial system.

90
 6 Insurance

The trend of improved premiums and strengthening of asset base prevailed in the insurance sector during the last two years which
are reflected in comfortable stability indicators. Growth in gross premiums helped in improving asset base of life insurance, which
now constitutes more than 80 percent of the overall insurance sector of Pakistan. This also resulted in an increase in insurance
penetration in the country to 0.8 percent. Despite rise in management expenses, deceleration in net claims and growth in
investment income improved the profitability of life insurance. The non-life insurance sub-sector and the takaful business, in
general, are also growing. Growth in assets of insurance sector has remained consistent for the last two years.

The insurance sector144 has considerably prospered during H1CY14 (Figure 6.2). Around two-third of
in recent years (Figure 6.1). Life insurance these premiums were contributed by life insurance
continues to dominate the sector with over 80 business. Gross premiums of life insurance grew by
percent share as of H1CY15. Since H1CY13, the 32 percent, while that of non-life insurance
growth in life insurance has consistently remained increased by 11.8 percent for the half-year ended
around 21 percent (YoY). On the other hand, non- Jun-15.
life insurance grew by only 6.2 percent (YoY) as of
H1CY15 compared to 12 percent (YoY) as of Figure 6.1

H1CY14.
Steady growth in size of insurance sector
Assets of insurance sector

Family takaful grew by another 35.6 percent (YoY) (PKR billion)

in H1CY15 compared to 44 percent (YoY) in H1CY

Life Family Takaful Non-Life General Takaful

14. Similarly, there was an increase of 29.3 percent 900

(YoY) in general takaful business during H1CY15 800

(9.0 percent (YoY) growth in H1CY14). Overall,

700
600
both family and general takaful business only
500
comprised 1.9 percent of the total assets of the
400
insurance sector in H1CY15 against 1.6 percent in 300
H1CY14. 200

…as gross premiums of conventional insurance sector have

100
-
flourished H1CY13 H2CY13 H1CY14 H2CY14 H1CY15

During H1CY15, gross premiums of conventional Source: Unaudited/Audited published financial statements of life
insurers, non-life insurers, family takaful and general takaful companies.
insurance grew by PKR 18.3 billion (or 24.9 percent
(YoY)) to reach PKR 91.8 billion as compared to an Domestic sector fared well when compared with international
increase of PKR 9.5 billion (or 14.8 percent (YoY)) emerging markets

In comparison with other emerging markets and rest

The analysis is based on the data of 5 life insurers and 22 non-life
of the world, the domestic conventional insurance
144

insurers covering 98 percent and 83 percent of the life and non-life

insurance sectors, respectively. The analysis covers data up to half- market performed reasonably well as the growth in
year ending June 2015. The financial close for insurers is December
of the corresponding year. All growth ratios are on year-on-year basis.

91
 real premiums was well beyond other markets 0.3 percent in CY12146. As a result, Pakistan was
(Table 6.1). ranked 80th among sample of countries.

Figure 6.2 Life Insurance

Consistent rise in gross premiums of insurance sector
Gross premiums (flows) of the insurance sector Figure 6.3
(PKR billion) Government securities continue to be the main investment avenue
Non Life Premiums Life Premiums Structure of Life Insurance
(percent)
120
Current Assets Loans Government Bonds
100 Equities and Sukuks Other Assets

80 7.5 3.6
7.6 6.6
3.7
60 10.9 6.6
9.8 6.7
10.2 7.7
40 6.3
H1CY13
20

-
H1CY13 H2CY13 H1CY14 H2CY14 H1CY15 68.1
H1CY15 H1CY14
Source: Unaudited/Audited published financial statements of life and 71.5
non-life insurers. 70.7
Source: Unaudited published financial statements of life insurance
companies.
Table 6.1
Real Premium Growth Rates in 2014 Life insurance business continues to grow during last two
Life Non-life Total years…
percent
The life insurance segment has performed well
Advanced Countries 3.8 1.8 2.9
during the last two years in terms of strengthening
Emerging Countries 6.9 8.0 7.4
of asset base and rising premiums. The asset base
Pakistan 12.7 18.0 16.6
further increased by 21.5 percent (YoY) during
World 4.3 2.9 3.7
H1CY15 as the companies kept on building
Source: Swiss Re Sigma http://www.swissre.com/sigma/ investments largely in long-term risk free
and unaudited/audited published financial statements of insurance
companies.
government securities funded by rising premiums
and accumulated profits. As a result, 70.7 percent of
However, despite higher growth in the domestic assets of life insurance constituted of government
sector, the insurance penetration still remained one securities while 10.9 percent of investments were
of the lowest in the world. During CY14, the made in other avenues such as listed shares, mutual
insurance penetration was 0.8 percent145 which did funds and Sukuks (Figure 6.3).
manage to increase from 0.5 percent in CY13 and
146The Securities and Exchange Commission of Pakistan (SECP) has
given different penetration ratios: 0.67 percent for 2011-12; 0.73
percent for 2012-13; and 0.77 percent for 2013-14. For further
information, please see:
http://www.secp.gov.pk/annualreport/2015/Annual-Report-
145 For further information, please see: http://www.swissre.com/ 2015.pdf

92
Gross premiums significantly flourish… premiums to 15.3 percent in H1CY15 from 3.8
percent in H1CY14. One major company’s success
The gross premiums surged by 32 percent for the of a single premium product with a bank partner,
half year ending Jun-15 compared to 16.3 percent who has been very aggressive in its distribution
rise for the half year ending Jun-14. This was largely strategy, has been the major reason for the rise.
on account of attractive returns on unit-linked 147
policies and improved distribution channels Besides individual premiums, the group premiums
including bancassurance148. also witnessed 15.3 percent growth in H1CY15,
while its share declined to 11.4 percent owing to
The first year premiums showed a growth of 7.5 higher single premiums (Figure 6.4).
percent for the half year ending in June 2015;
however, its share in gross premiums declined to …while growth in net claims decelerated
19.4 percent from 23.8 percent in H1CY14.
Similarly, although subsequent premium (beyond The net claims witnessed significantly lower growth
two years) grew by 22.3 percent in H1CY15 (YoY), in H1CY15; 13.1 percent compared to 26.3 percent
its share in gross premiums declined in H1CY15. in H1CY14. Much of the claims were on account of
maturity (17.8 percent) and events of death (10.9
Figure 6.4 percent) of the insured. However, the share of
Life insurance premiums considerably grew claims incurred on account of surrender of policies
Life insurance premiums (flows) and claims ratio also increased to 48.1 percent.
(PKR billion)

First Year Second Subsequent Single Premium Group

The common reasons for cancelation of policy by
80
the insurers could be their inability to pay premiums
70
or expecting less benefit out of it. However, the
surrenders have also increased as investment-linked
60
policy holders tended to book immediate profits
50
from rising unit prices (possibly as the investments
40
were mostly made in long term government
30
securities whose prices increased as the interest rates
20
declined).
10
- Therefore, the down-side risk of unit-linked
H1CY13 H2CY13 H1CY14 H2CY14 H1CY15
insurance products is very high as it might affect the
Source: Unaudited/Audited published financial statements of life
insurance companies.
profitability of the life insurance providers.
However, the very same product has also increased
This was due to a significant increase in single the business of companies during the last few years.
premiums which increased its share in gross
Higher investment returns also supported life insurance
profitability…
147 “Unit-linked” in relation to life insurance means individual life
insurance contracts offering life insurance coverage coupled with Besides improvements in core underwriting
saving component where the saving component is managed through
operating unit-linked investment funds.
business, the life insurers also witnessed 14 percent
148 Bancassurance is an alternate distribution channel to sell life return on investments as of H1CY15 (Figure 6.5).
insurance products through banks. This line of insurance business
Specifically, the return on government securities
ensures wide coverage at lesser procurement cost.

93
 stood at 11.5 percent. Due to long-term nature of from 0.6 percent in H1CY14 to 0.7 percent in
investments, life insurance is not faced with an H1CY15.
immediate rollover risk. However, decline in
government yields during the last two years has Figure 6.6

started to impact investment returns. As a result,

Life insurance profitability
Life insurance profitability (flows)
insurers have moved some funds to more attractive (PKR billion)
yet riskier avenues of equity investments; the share Net Investment Income Management Expense
of fixed securities and equities investments to total Net Premiums Net Claims
PBT (RHS)
assets has increased from 9.8 percent in H1CY14 to 120 4.5
10.9 percent in H1CY15. 100 4.0
80 3.5
Figure 6.5 60 3.0
Return on investments continues to support reveneues 40 2.5
ROI of Life insurance companies 20 2.0
(percent) - 1.5
ROI Range Mean ROI (20) 1.0
(40) 0.5
35
(60) 0.0
30 H1CY13 H2CY13 H1CY14 H2CY14 H1CY15

25 Source: Unaudited/Audited published financial statements of life

insurance companies.
20

15 Table 6.2
10 Soundness of Life Insurance
5 H1CY13 H2CY13 H1CY14 H2CY14 H1CY15
percent
-
H1CY13 H2CY13 H1CY14 H2CY14 H1CY15 Capital to Assets 1.6 1.7 1.7 1.7 1.6
Claims to Capital 224.4 396.7 227.9 402.4 227.1
Source: Unaudited/Audited published financial statements of life
insurance companies. Claims Ratio 41.5 35.3 45.0 37.3 38.4
Expense Ratio 32.9 34.9 29.5 30.1 25.1
Overall profitability of life insurance considerably improved Combined Ratio 74.5 70.1 74.5 67.4 63.5
during the last two years… Premium Retention 98.0 98.3 98.2 98.5 98.6
Return on Investment 17.3 15.2 13.1 13.7 14.0
Given the aforementioned increase in premiums and ROA 0.5 0.8 0.6 0.8 0.7
investment income, and deceleration in claims, Source: Unaudited/Audited published financial statements of life insurance
profitability of the life insurance segment companies.

significantly improved over the last two years. Profit

before tax (PBT) has reached to PKR 2.4 billion (a Not surprisingly, the financial soundness indicators of life
surge of 42 percent (YoY)) during the half year insurance remained stable…
ending Jun-15 compared with profits of PKR 1.7 Solvency profile of the life insurance segment
billion (an increase of 33.9 percent (YoY)) during remains steady as claims to capital ratio slightly
the half year ending Jun-14 (Figure 6.6). As a declined, while capital to assets ratio also minutely
result, the ROA of the life segment also improved decreased as of H1CY15. Although, management

94
expenses rose during the half year ending June 2015, In the past, higher management expenses had
the expense ratio improved on account of higher significantly dented the profitability of family takaful
growth in gross premiums. By the same token, the companies. However, this trend changed in CY14 as
claims ratio came down to 38.4 percent during the family takaful business posted profit after
same period (Table 6.2). continuous losses in CY12 and CY13. This was
largely attributable to deceleration in expenses; 9.8
The life insurance segment carries concentration risk percent rise in CY14 compared to 29.2 percent
as it is dominated by a single public sector entity. increase in CY13. Overall, with improving share in
The company can be categorized as “too big to fail” insurance sector and opening of a number of family
i.e. its financial distress can have systemic takaful windows of conventional life insurance
implications and may require government companies, family takaful business shows a lot of
intervention. However, the risk of contagion promise in near future.
spreading across other insurance segments might be
limited; its subsidiary, a non-life insurer, has minimal Non-life Insurance150
market share in the non-life segment.
Figure 6.8
Figure 6.7 Non-life claims ratio remained steady
Profitability of LifeTakaful business improved Non-life net premium flows and claims ratio
Profitability of LifeTakaful Net Premiums (PKR billion) Claims Ratio (percent)
(PKR million) Fire and Property Marine, Aviation
Motor Miscellaneous
Net Contributions Net Claims
Health Claims Ratio (RHS)
Expenses Profitability 16 58
8,000 20 14 56

6,000 15 12 54
10 10 52
4,000
5 8 50
2,000
0 6 48
-
-5 4 46
(2,000) 2 44
-10
(4,000) -15 - 42
H1CY13 H2CY13 H1CY14 H2CY14 H1CY15
(6,000) -20
CY12 CY13 CY14 Source: Unaudited/Audited published financial statements of non-life
insurance companies.
Source: Unaudited/Audited published financial statements of family
takaful companies.
Non-life insurance business moves ahead…
Family takaful business shows promise…
The non-life insurance segment witnessed an 11.8
During CY14 , family (life) takaful companies also
149
percent (YoY) increase in gross premiums in
witnessed improvements in gross contributions and H1CY15; while premium net of reinsurance
asset buildup by 15.3 percent (YoY) and 37.6 registered an increase of 13.6 percent (YoY) with
percent (YoY), respectively (Figure 6.7).
150The data covers more than 83% of the general insurance industry
assets. The insurance industry data does not encompass National
Insurance Company Limited which has not published its annual
149 Analysis in this section is based on results up to CY14. accounts since 2009.

95
 motor vehicle and miscellaneous sub-sectors being net premium underwritten is sufficient to cover the
the main drivers for growth in net premium. claims and expenses.
Meanwhile, the motor vehicle sub-sector remained
the highest contributor towards premium Improved earnings due to an increase in net
accumulation with a share of 42 percent. (Figure premiums and investment income have led to an
6.8) increase in ROA to 11.7 percent. Return on
Investment has significantly increased to 16.6
During the same period, however, net claims percent as of H1CY15.
increased by 7.5 percent (YoY). As the net
Table 6.3
premiums increased more rapidly than the net
Soundness of Non-Life Insurance
claims, there is an overall decrease in the claims ratio H1CY13 H2CY13 H1CY14 H2CY14 H1CY15
(49.7 percent as of H1CY15 against 52.5 percent as percent
of H1CY14). This implies better underwriting Capital to Assets 11.1 12.7 13.4 13.6 13.8
performance by non-life insurers. Claims Ratio 53.9 55.5 52.5 50.9 49.7
Expense Ratio 26.8 26.7 26.3 25.9 24.3
Figure 6.9 Combined Ratio 80.7 82.2 78.8 76.9 74.0
Non-Life insurance profitability improved
Premium Retention 50.6 52.0 51.3 51.5 52.1
Non-Life insurance profitability (flows)
Return on Investment 13.3 11.0 10.8 10.5 16.6
(PKR billion)
Net Investment Income Management Expense ROA 8.1 6.7 7.4 7.6 11.7
Net Premiums Net Claims
Source: Unaudited/Audited published financial statements of non-life insurance
PBT (RHS) companies.
25 8.0
20 7.0
In order to improve financial soundness, the pubic
15 6.0
non-life insurer needs to publish its financials to
improve transparency. Pending litigation cases
10 5.0
5 4.0
pertaining to the company also need to be speedily
- 3.0
addressed to reduce systemic risk.
(5) 2.0
(10) 1.0
In order to expand the non-life insurance segment
(15)
H1CY13 H2CY13 H1CY14 H2CY14 H1CY15
0.0
further, the government needs to allow private non-
life insurers to provide general insurance coverage
Source: Unaudited/Audited published financial statements of non-life
insurance companies. to public property; the Insurance Ordinance, 2000
provides that all insurance business relating to any
The profit of the non-life segment grew by 68.6 public property or to any risk or liability pertaining
percent mainly due to an increase in investment to any public property, shall be placed with the
income of 66.2 percent; investment income is also pubic non-life insurer only and shall not be placed
the main component of gross revenue at 58.6 with any other insurer151.
percent. Overall, the Profit Margin has significantly
increased to 40.1 percent. (Figure 6.9)

The financial soundness indicators show that the

Government urged to end NICL ‘monopoly’ at
non-life insurance segment is relatively stable
151

http://www.dawn.com/news/1183000
(Table 6.3). The combined ratio indicates that the http://www.secp.gov.pk/corporatelaws/pdf/InsuranceOrdAmended
-Nov2011.pdf

96
General takaful asset base has significantly increased… …potential for further growth in insurance sector

General (non-life) takaful152 only comprises 2 Pakistan has a low insurance penetration rate which
percent of the non-life insurance business but is implies that there is a lot of potential for growth of
expected to grow rapidly due to the entry of non-life the insurance industry.
(conventional) insurers into the general takaful
segment. They are allowed to offer takaful services The future for the insurance sector looks stable.
through dedicated windows under Takaful Rules CPEC and Iran-Pakistan gas pipeline can provide
2012 as Window Takaful Operators. Accordingly, insurance companies an opportunity to underwrite
general takaful’s asset base has increased by 29.3 related developmental projects. However, the
percent as of H1CY15 (YoY). government may consider allowing local insurers to
underwrite such large developmental projects in
The general takaful segment witnessed an increase in conjunction with large international insurers. The
profitability by 11.8 percent (YoY) in the withdrawal of reinsurers may also deter the
shareholder’s fund, mainly due to an increase of 22.5 government from allowing local insurers to
percent in Wakala fee; the increase in profitability underwrite large developmental projects on their
was offset by increases in commission and own.
management expense. (Figure 6.10)
The lack of reinsurers has also contributed to
Figure 6.10 increased concentration risk. This has been slightly
Profitability of General Takaful business increased mitigated by insurers establishing reinsurance
Profitability of General Takaful contracts with international reinsurers. However, all
(PKR million)
insurers are mandated to offer 35 percent of their
surplus business to Pakistan Reinsurance
Wakala Fee Commission Expense
Management Expense Net Investment Income
Profitability (R.H.S.) Company154 in the form of cession; thus, limiting the
1,000 106.0 business which can be reinsured with international
800 104.0 reinsurers.
600 102.0
400
100.0 In order to strengthen the market infrastructure and
200
-
98.0 the regulatory regime, SECP, the insurance industry
(200)
96.0 regulator, is considering revising the insurance
(400) 94.0
regulatory framework, establishing an insurance
repository, issuing a Code of Corporate Governance
(600) 92.0
(800) 90.0
CY12 CY13 CY14 for the Insurance Sector155 etc.
Source: Unaudited/Audited published financial statements of general
takaful companies.
SECP is also considering policies to promote micro
insurance which may focus on lower capital
However, the Participants’ Takaful Fund (PTF) 153 of
requirements for dedicated micro insurance
general takaful is still reporting losses; it reported
companies, introduction of minimum quota for
losses of PKR 221 million for the year ended Dec-
14.
154 Pakistan Reinsurance Company Limited (PRCL) is a public sector
company under the administrative control of the Ministry of
Analysis in this section is based on results up to CY14.
152 Commerce.
The Participants’ Takaful Fund (PTF) is managed by the takaful
153 155 SECP has issued revised Code of Corporate Governance vide

operator; it is separate from the shareholders’ fund. SRO 160(i)/2016 dated February 26, 2016.

97
 micro insurance business, etc. Subsequently, (Bancassurance, mobiles, internet etc.) for
insurers, including State Life, are looking to launch distribution of their products.
micro insurance products like micro insurance
accidental cover and micro-health insurance,
specifically catering to this segment.

In order to reduce systemic risk in the insurance

industry, the issue of inadequately-capitalized
insurers needs to be resolved. Inactive and active
insurers which are inadequately capitalized may
consider mergers to meet the provisions of the
Insurance Ordinance, 2000 (which requires that
paid-up capital should be PKR 300 million for non-
life and PKR 500 million for life insurers,
respectively). The issue of inadequately capitalized
insurers will become more critical as the SECP
intends to increase the minimum paid-up capital
requirements to PKR 500 million and PKR 700
million for non-life and life insurers, respectively, by
the year end 2017.

Pending litigation cases pertaining to various

insurers also need to be expeditiously resolved.

Pakistan is also host to (at least) two global-

systemically important insurers (G-SIIs); Allianz SE
and AIG. However, due to their small marker share,
Pakistan is not particularly susceptible to global
market risks.

…expect acceleration in growth of general takaful assets

Recently, many conventional insurers have also been

allowed to undertake takaful business as Window
Takaful Operators under Takaful Rules, 2012. It is,
therefore, expected that the larger insurers will enter
the takaful segment to expand their business.

This may be disadvantageous for full-fledged takaful

companies which have limited outreach; Window
Takaful Operators will have greater outreach to
expand their takaful business through their larger
branch network and extensive agency arrangements

98
Section C: Financial Markets & Infrastructure

99
100
 7 Financial Markets

The financial markets showed strong resilience to external spillovers owing to improved economic conditions, effective policy
implementation, and positive sentiments of domestic and foreign investors. The overall stability of financial market strengthened;
PKR showed relative stability against US$ compared to most of the other regional currencies, though some volatility was
observed in equity market post Yuan devaluation period. More transparent and effective monetary policy implementation
mechanism complemented by prudent liquidity management by SBP helped in effective implementation of SBP’s monetary policy
stance in the financial markets. The positive prospects and adequate capacity on domestic front is expected to keep financial
markets running smoothly during CY16.

Global environment has been non-conducive for emerging Figure 7.1

markets in CY15… Net portfolio flows (debt) in emerging markets declerated
Net Portfolio Flows (debt) in emerging markets
The global financial markets were hit by bouts of (IIF debt index)
volatility in CY15 due to dull growth prospects of 35
the world economy and uncertainty about the future 30

direction of economic policies in major economies. 25

The currency and equity markets in majority of the 20

15
emerging economies remained under pressure as the
10
Chinese economy continued to slowdown, growth 5
in the European Union remained subpar and 0
commodity prices kept tumbling. -5
-10
The devaluation of Chinese Yuan in August 2015 -15
coupled with the – long anticipated - rise in policy
Jan-13

Jan-14

Jan-15

Jan-16
May-13

May-14

May-15
Mar-13

Mar-14

Mar-15
Nov-13

Nov-14

Nov-15
Sep-13

Sep-14

Sep-15
Jul-13

Jul-14

Jul-15
rate by the Federal Reserve (Fed) led to market
corrections and assets re-pricing in most emerging Source: Institute of International Finance (IIF) / Bloomberg
markets. The fears of global slowdown, deflation
and declining world trade further aggravated the Domestic financial markets exhibited strong resilience …
stress in the markets.
Despite the spillover of global environment
Owing to such non-conducive global environment, transmitting to the financial markets of Pakistan, the
investors’ risk appetite for emerging markets volatility in domestic markets remained relatively
dwindled and funds not only flew out of the equity low. Positive developments on domestic front and
markets but investments also decelerated in debt strong performance in few corporate sectors helped
markets (Figure 7.1). instill some stability in the Equity market.

The introduction of SBP policy rate which targets

the overnight money market repo rate in May 2015
coupled with prudent liquidity management that
kept the short-term market rates relatively stable and

101
 closer to the target rate, on average, succeeded in economic growth objective were some of the major
keeping the money markets calm. reasons that motivated the change in the direction
of the monetary policy.
Further, large accumulation of liquid foreign
exchange reserves and improvements in external The rate cut in the first half of CY15 was followed
accounts kept the domestic currency stable against by structural changes in SBP corridor in May 2015.
US$. A target rate for overnight interbank money market
repo rate (ONR) - set 50 bps below the SBP reverse
Overall the stability prevailed in the money, capital repo rate or ceiling rate – was introduced as the new
and foreign exchange markets in CY15 (Figure policy rate and the width of the Interest rate
7.2). corridor (ICR) was reduced to 200 bps from 250
bps156. The intension behind the former policy
Figure 7.2
change was to give unambiguous signal of SBP’s
Stability in financial makets have improved in CY15
Financial market stabiliyt map in Pakistan stance of monetary policy and the latter was to
CY14 curtail the dispersion in short-term rates in the
Money
CY15 Market money market157.

Introduction of SBP policy target rate curtailed volatility in

the money market…
Instability The initiatives paid off with the stronger
transmission mechanism leading to a marked
Stability reduction in the volatility in the money market
liquidity during the second half of CY15 (Figure
7.3). The weighted average ONR closely tracked the
Forex Capital
Market Market SBP target rate in comparison to last year158. The
Note: Volatility in respective markets calculated using Exponential Weighted regulatory induced discipline is expected to help
Moving Average (EWMA) method. Weekly ONR, daily KSE-100 index and
daily ER in the interbank have been used as the indicators in the money, market participants plan their liquidity operations in
capital and forex markets. For details please see Technical Appendix.
Source: SBP
a way so as to minimize disturbance of the market.

Money Market

Structural Changes in interest rate corridor initiated

concurrent with monetary easing …

After remaining flat at 10 percent throughout most

of the CY14, SBP slashed its policy rate,
cumulatively, by 400 bps since November CY14 to
bring it down to multi-decade low of 6 percent at 156 Besides, SBP also withdrew the penal rate on frequent access (7
the end of CY15. The reduction was aggressive times in a quarter) to SBP Reverse Repo and Repo facilities.
157 The unnecessary volatility in short-term rates creates disconnection
during the first half of CY15- down by 350 bps. between short-term and long-term rates which reduces the
Receding inflation and its benign outlook, effectiveness of monetary policy and weakens its power to effect
long-term rates.
improvement in balance of payment position, and 158 Standard deviation of weekly ONR reduced to 0.35 and 0.16 in Q3

& Q4 of CY15 compared to 0.60 and 0.50 in Q1 & Q2 of CY15.

102
 Figure 7.3 years) PIBs were the main attraction for the market
Volatiliyt in overnight repo rate (ONR) reduces after introduction (Figure 7.5). During CY15, banks offered aggregate
of SBP target rate
Trend in ONR
amount of PKR 2.2 trillion for PIBs with bid-cover
(Percent) ratio (i.e. offer to target ratio) of around 3 on
WA Overnight repo rate SBP reverse repo rate average.
SBP repo rate SBP Policy (Target) rate
11 Figure 7.4
SBP cononducted more OMOs in order to keep ONR close to the
10 targe rate
9 Average outstanding Open Market Operations (OMOs)
8 (PKR billion)
7 1400
6
1200
5
1000
4
3 800

600
Aug-13

Aug-14

Aug-15
Feb-13

Oct-13

Feb-14

Oct-14

Feb-15

Oct-15
Apr-13
Jun-13

Apr-14
Jun-14

Apr-15
Jun-15
Nov-13

Nov-14

Nov-15
Mar-13

Mar-14

Mar-15
Sep-13

Dec-13

Sep-14

Dec-14

Sep-15

Dec-15
Jan-13

May-13
Jul-13

Jan-14

May-14
Jul-14

Jan-15

May-15
Jul-15

400
Source: DMMD, SBP
200

0
Increased volume and frequency of OMOs were in line with Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
monetary policy objectives… CY14 CY15

Increased instances of liquidity injections via Source: DMMD, SBP

frequent OMOs were needed to align market Figure 7.5

interest rates with the target rate. Average Banks' offer to purchase PIBs remained overwhelming

outstanding OMOs injections of PKR 1.2 trillion Target, Offer and Acceptance of PIBs
(percent)
were recorded during Jul-Dec, 2015 (average Offer to Acceptance Ratio Acceptance to Target Ratio
acceptance to bid ratio of 0.94) compared to average 6
injections of PKR 0.71 trillion during the first half
5
of CY15159 (Figure 7.4). Liquidity injections in
CY15 were primarily in line with the easy monetary 4
policy stance of SBP which envisaged money supply
3
(M2 growth) to be consistent with keeping inflation
low and providing support to growth160. 2

Overwhelming banks’ interest in PIBs remains intact…

1

0
Investment in the Government securities, serves as Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
a credit risk free source of income stream, continued CY13 CY14 CY15

to drive market liquidity. Medium tenor (3 and 5 Source: DMMD, SBP

Besides, higher injections in second half of CY15 was also driven

The banks’ inclination to lock in their income
159

by high fiscal need and pick up in credit demand from private sector
160 For detail explanation, please see the press release at
stream through PIBs in CY15 might have been
http://www.sbp.org.pk/press/2015/Liquidity-13-Jan-15.pdf

103
 driven by an anticipation of expected lower interest Figure 7.7
rates (due to falling inflation in the short-run and T-Bills investment offers concentrated wihtin 3 & 6 months
easing-off on external front)161 (Figure 7.6). From
securities
T - Bill Tenure Offer
the supply side, government’s choice to raise longer- (Percent Share) 6M 3M
term debt might have been driven largely due to 100
maturity preference (to avoid roll-over risk) 90

80

Figure 7.6 70

PIBs yeild responded to easy monetary policy stance 60

Primary Yeild Pattern for PIBs 50

(percent) 40

30
3-y 5-y 10-y
20
12
10
11 0

Nov-14

Nov-15
Sep-14

Sep-15
Jan-14
Feb-14

Jul-14

Jan-15
Feb-15

Jul-15
Apr-14
May-14
May-14

Dec-14

Apr-15
Apr-15
May-15

Dec-15
Jun-14

Oct-14

Jun-15

Oct-15
Aug-14

Aug-15
Mar-14

Mar-15
10

9 Source: DMMD, SBP

8
Figure 7.8
7 Non-competitive bids' share rises in CY15
Share of Non-Competitive Bids
6
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 (PKR billion) (percent)

Note: Bids for10-year PIB tenor were rejected in both June and July 12-month 6-month 3-month share (RHS)
2015 Auctions. 180 14
Source: DMMD, SBP
160 12
MTB’s witness no compositional change… 140
10
120
Banks participation in MTBs remained strong and 100 8

was almost entirely distributed within 3 months and 80 6

6 months maturity buckets (Figure 7.7). Banks 60
4
subscription of 12 months MTBs during CY15 was 40
2
20
similar to their marginal participation in CY14.
0 0
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4

2011 2012 2013 2014 2015

Source: DMMD, SBP

NCB’s were also geared towards longer tenor …

Meanwhile, the participation of retail investors in

the Non-Competitive Bids (NCBs) also picked up
161The average monthly yield spread complement this fact as spread pace during CY15 (Figure 7.8). NCBs share in total
between 3 years and 6 months tenor significantly reduced during
CY15 (yearly average 53 bps) compared to CY14 (yearly average 191
acceptance increased to 8.2 percent, on average, in
bps).

104
CY15 against average 5.3 percent in CY14. finance. Perhaps, the lack of demand in the
Government papers of short term maturity (3- economy and the risk aversion of Islamic banks are
months T-bills) remained attractive for liquidity the driving factors behind buildup of liquidity with
purposes but longer term maturity papers (6 months the IBIs.
& 12 months T-bills) gained popularity due to
interest rate expectations. Secondary market for government securities is working
smoothly…
Ijarah Sukuk attracted IBIs…
An efficient and deep secondary market of
The much awaited Ijarah Sukuk of PKR 100 billion government securities is prerequisite for better price
was issued in the last quarter of CY15. High liquidity discovery, diversification of investor base, liquidity
parked with Islamic banks and limited avenues management, and reduction in cost of borrowings.
available to invest in Shariah compliant products Pakistan has a mature secondary market for
made each issue of Sukuk extremely appealing. marketable government debt securities (MTBs,
There is a consistent rising trend in offer to target PIBs, and Sukuks).
ratio of Sukuk since CY13 and in CY15 the offer
was 2.7 times the target of PKR 100 billion set by CY15 has observed an overall trade of around PKR
the government (Figure 7.9). 11.0 trillion of government securities (PKR 10.6
trillion in CY14). In addition, if repo borrowings of
Figure 7.9 PKR 13.4 trillion in the secondary market during
Ample liqudity resulted in high offer to target ratio for Ijarah Sukuk CY15 (PKR 15.5 trillion in CY14) are also included,
Offer to Targe Ratio of Ijarah Sukuk the overall trade volume reaches to PKR 24.4
(PKR billion) (percent)
trillion during CY15 (PKR 26.1 trillion in CY14). In
Target Offered Offer to target (R.H.S) recent years, SBP has taken several measures to
300 3.00 improve the efficiency and depth of trading in
secondary markets (e.g. online auction of
250 2.50
government securities, issuance of international
200 2.00 securities identification numbers, trading of
government securities at stock exchange etc).
150 1.50

100 1.00 Shape of the yield curve hints at rising inflation expectations
beyond CY16…
50 0.50
The 350 bps fall in the policy rate during CY15 has
led to a downward shift in the yield curve (Figure
0 -
CY11 CY12 CY13 CY14 CY15
7.10); indicating the effectiveness of SBP’s monetary
Source: DMMD, SBP
easing policy. The yield curve as of end Dec-15 is
The current behavior of market for Shariah quite flat till 1-year horizon and then rises
compliant investment products, on the one hand, afterwards. Also, in relation to Dec-14, the gap
implies that government can easily tap additional between the two yield curves is wider at the shorter
resources from this avenue. But, on the other hand, end but narrower at the longer end.
it also reveals that there are limited alternate avenues
available in the private sector for Islamic banks to

105
 Figure 7.10 Foreign Exchange Market
Yield curve depicts rising inflation expectations beyond CY16
Term Structure of Interest Rates Improved BOP position and accumulated reserves helped
(Percent) stabilize domestic currency…
Dec-13 Dec-14 Dec-15
14 PKR against US$ remained broadly stable, owing to
improvement in the external account as well as
12
favorable macroeconomic conditions163 (Figure
10
7.11).
8
Figure 7.11
6 BOP improved during CY15

4 Developments in External Accounts

(USD million) (PKR/USD*)
2 Capital Current PKR/USD (R.H.S)

0 111
1500
3M
4M
6M
9M
1Y
2Y
3Y
4Y
5Y
6Y
7Y
8Y
9Y
10Y
15Y
20Y

900 106
Source: DMMD, SBP 300
-300 101
The shape of the yield curve, therefore, suggests that -900
96
market is anticipating benign inflation in the short- -1500

term and no change in the policy interest rate. -2100

91
-2700
However, market expects bottoming out of inflation -3300 86
on account of foreseeable recovery in international -3900
commodity prices162 in the medium-term and likely -4500
CY13 CY14 CY15
81
rise in interest rates. * Monthly weighted average Mid buying-selling of interbank rate

Since the banking book, at the moment, is exposed

Source: S&DWHD, SBP

to market risk, any movement in interest rates

The low global commodity prices paid off in terms
against these market expectations would have
of low import bill, particularly, due to the reduced
adverse consequences for the profitability and
payments on oil products. This helped in narrowing
solvency of the banking sector.
the trade deficit down to USD 16.6 billion during
The pattern of government borrowing will also be a CY15 as against 17.9 billion during CY14. The
major factor driving the liquidity and volatility in the successful negotiations with IMF in each quarterly
money market. review mission under EFF program, consistent net
inflows through worker remittances, receipts against
coalition support funds (CSF) and issuance of
Pakistan sovereign Bonds helped country’s liquid
foreign exchange reserves touch the unprecedented
163Owing to continued strengthening of external payment position
and sustained progress in structural reforms under the government
program with IMF, Moody's Investors Service upgraded Pakistan's
foreign currency issuer and senior unsecured bond ratings to B3 from
Caa1, and assigned a stable outlook in June 2015.

106
peak in Dec 2015164covering almost 28 weeks165 of decelerated to 12.1 percent in CY15 from
imports. 17.9 percent during CY14169.
iv. To better negotiate with future contingency
Though strengthening external sector stabilized the on external front, permanent nature of
market sentiments which translated into relative foreign exchange inflows (e.g. exports, FDI
stability in the foreign exchange markets, few etc) are needed.
concerns are still worth considering: The favorable external position and positive market
i. The exports of Pakistan are consistently on sentiments complemented with SBP’s prudent
the declining path (export growth: CY15: polices helped stabilize the value of domestic
negative 8.2 percent, CY14: negative 1.2 currency against most foreign currencies despite
percent). The economic slowdown in china decline in exports receipts during CY15 (Table 7.1).
(one of Pakistan’s major trade partner) and PKR depreciation in CY15 is in line with trends in emerging
devaluation of Euro have had a dismal markets…
impact on the exports of many emerging
counties including Pakistan. The consistent Though domestic currency recorded depreciation
appreciation in Real Effective Exchange Rate against USD by 4.2 percent during CY15 (mostly in
(REER) over the last couple of years166 may second half of CY15), this was synchronized with
also have impacted the export accelerating exchange rate depreciation in many
competitiveness. emerging economies against USD. The capital flight
ii. Already low Foreign Direct Investment (FDI) from emerging markets in search-for yield since US
in CY14 reduced further in CY15. Though, in announced “tapering of quantitative easing” had
recent past, FDI flows have also declined started to build pressure on the currencies of these
globally due to fragility in the global economies. Further, the devaluation of Chinese
economy, policy uncertainty for investors and Yuan170 in August 2015, probably to restore its
elevated geopolitical risks, FDI decline in export competitiveness, followed by replica of the
Pakistan was much higher than the global same policy stance by many emerging economies -
trend167. to keep their global share in exports intact - even hit
iii. The recent dip in oil prices, if continues, may the value of these currencies harder.
impact the inflow of remittances coming
from the oil exporting countries,168 going
forward. The growth in remittances has

164 Further, Net International Reserves (NIR) also remained

comfortable meeting IMF performance criteria in most of its
quarterly review missions.
165 Source: http://www.sbp.org.pk/ecodata/FER/2016/Forex-11-

Mar-16.pdf
166 REER appreciated by 5.2 percent during CY15 and 16.0 percent in

CY14.
167 Source: United Nation Conference on Trade and Development

(UNCTD) 169Partially, this deceleration may also be due to high base effect.
168 Around more than 60 percent of worker remittances inflows are 170In August 2015, the china devalued its Yuan by 3 percent in order
coming from GCC countries. to gain export competitiveness. China observed negative growth in its
http://www.sbp.org.pk/ecodata/Homeremit.pdf exports during July 2015.

107
 Table 7.1 up to 0.78 PKR/USD from 0.59 PKR/USD during
PKR Apr/Dep (-) against other currencies - CY15 CY14 (Figure 7.13). The deviation was more
pronounced in the second half of CY15.
(Percent)
South Africa 29.3 Figure 7.12
Malaysia 17.8 Volatility in foreign exchange market curtailed
Canada 15.0 Exponetial Weighted Moving Average of PKR/USD
Australia 7.4
Mid Weighted Interbank Mid Kerb Rate
Euro 6.7
1.4
Thailand 5.2
1.2
Sweden 4.3
Singapore 2.5 1
UK 0.8
0.8
India 0.4
0.6
China 0.4
Kuwait -0.5 0.4
Japan -3.4 0.2
Switzerland -4.0
0
UAE -4.1
Dec-05

Jan-10

Dec-12
May-12
Feb-07

Oct-11

Feb-14
Apr-08

Jun-09

Apr-15
Nov-08

Nov-15
Sep-07

Mar-11

Sep-14
Jul-06

Aug-10

Jul-13
USA -4.2
Saudi Arabia -4.1
Source: DMMD, SBP
Hong Kong -4.1
Figure 7.13
Source: Bloomberg
KERB premium escalated post Yuan devaluatoin
KERB Exchange Rate and Premium
Pakistan did not opt for the herd prescription of (PKR/USD) (PKR)
manipulating exchange rates and instead relied on
Premium (RHS) KERB Rate
domestic interest rates to spur growth. Moreover, 114 2.5
the export growth in Pakistan, besides exchange 2.0
rate, is mainly dependent upon structural 109
1.5
bottlenecks which are beyond the control of any 104
1.0
central bank.
99 0.5

Volatility in currency market declines… 94

0.0
-0.5
The exchange rate both in the interbank and kerb 89
-1.0
markets remained stable171; though, some volatility 84 -1.5
was seen post Yuan devaluation after August, 2015
Dec-13

Dec-14

Dec-15
Oct-13

Feb-14

Oct-14

Feb-15

Oct-15
Apr-13
Jun-13

Apr-14
Jun-14

Apr-15
Jun-15
Aug-13

Aug-14

Aug-15

(Figure 7.12).
Source: DMMD, SBP
However, during CY15, daily average risk premium
on PKR/USD exchange rate in the KERB market During the reviewed year, the speculative sentiments
(over interbank market) slightly widened and moved in retail currency market slightly emerged, perhaps,
due to further depreciation of the local currency in

108
anticipation of rate rise by FED172. Further, the exports from Pakistan – more permanent sources of
average bid-ask spread in Kerb market moved up to foreign exchange inflows. However, worker
PKR 0.26 during CY15 (more so during the second remittance inflows may decelerate further from oil
half) compared to PKR 0.21 during CY14. producing countries if oil prices continue their
current declining trend and development spending
Foreign exchange reserves rise in CY15… in these countries subsides.
With the addition of USD 5.5 billion during CY15 Capital Market
(almost entirely in SBP), the liquid FX reserves of
the country touched unprecedented USD 20.8 Global Equity markets remained volatile in CY15…
billion as of end December 2015. Importantly, the
scheduled obligations maturing during the year are Marked with global uncertainty, the reviewed year
fully covered by reserves (Figure 7.14).173 observed accelerated pace of market corrections in
equity markets across the globe. The net selling and
Figure 7.14
capital flight from emerging economies prompted
Foreign Exchage (FX) Reserves reach unprecedented level
Foreign Exchange Reserves and Import Coverage
high scale of volatility as gauged by Chicago Board
(weeks) (USD billion) Options Exchange (CBOE) Volatility Index174
Banks SBP Coverage (weeks) (Figure 7.15).
30 22
28
Figure 7.15
26 17
CY15 observed large correction in global equity markets
24
22 Chicago Board Options Exchange (CBOE) Volatility Index
12
20
18 45
7
16 40
14
2 35
12
10 30
8 -3 25
Dec-14

Dec-15
Jan-14

Jan-15
May-14

May-15
Feb-14

Oct-14

Feb-15

Oct-15
Apr-14

Jun-14

Apr-15

Jun-15
Mar-14

Mar-15

20
Nov-14

Nov-15
Sep-14

Sep-15
Jul-14
Aug-14

Jul-15
Aug-15

15
Source: DMMD, SBP 10
5
Going forward, the stability in foreign exchange
0
market may keep on track keeping in view the
Dec-12

Dec-13

Dec-14

Dec-15
Feb-13

Oct-13

Feb-14

Oct-14

Feb-15

Oct-15
Apr-13
Jun-13

Apr-14
Jun-14

Apr-15
Jun-15
Aug-13

Aug-14

Aug-15

adequate buffer in the form of liquid foreign

exchange reserves held by SBP and depressed
outlook of commodity prices especially oil prices. Source: Chicago Board Optoin Exchange (CBOE)

Further, expected global recovery and developments

on the CPEC front will lift up the FDI as well as
172Finally, US Fed raised its policy rate by 25 bps in December 2015.
173As of end December 2015, foreign exchange reserves has import 174CBOE index is a popular measure of the implied volatility of S&P
coverage ratio to around 28 weeks; much higher than the 3 months 500 index options. VIX is a ticker symbol of CBOE index
which is considered the minimum bench mark for reserve adequacy. (https://en.wikipedia.org/wiki/VIX)

109
 Higher but manageable volatility in domestic equity in general and inflation in particular. On aggregate
market… basis, KSE-100 index moved up by 2.1 percent
during CY15 (27 percent in CY14) to reach 32,816
A little bit higher volatility in the equity market of as of end, December 2015.
Pakistan during CY15 compared to CY14 was a
natural outcome owing to spillover transmitted from Figure 7.17
the stress in international markets. However, it SCRA observed relatively higher outflows duirng CY15

remained within a range not threatening to the KSE-100 Index and Special Covertible Rupee Account (SCRA) Flows
(USD million) (Index)
stability of the market. In fact, the volatility was
Outflows Inflows KSE-100 (RHS)
significantly lesser than the extreme levels seen 1150 36000
during the 2008 and 2009 stressed years (Figure
34000
7.16).
950
32000
750
30000
Figure 7.16 550
28000
Volatility in capital market increased
350
Exponetial Weighted Moving Average of KSE-100 Index 26000
150
24000
3.5
In CY08, -50
capital market 22000
3.0 observed high -250 20000
volatility
2.5
Nov-14

Mar-15

Nov-15
Jul-14

Jul-15
Sep-14

Dec-14

Sep-15

Dec-15
Jan-15
Oct-14

Feb-15

Oct-15
May-15
Apr-15

Jun-15
Aug-14

Aug-15
2.0
Source: S&DWHD,SBP and Pakistan Stock Exchange
1.5

1.0 The overall market capitalization, however, declined

by 5.9 percent during CY15 to reach PKR 6.9
0.5
trillion as of end December, 2015 against PKR 7.4
0.0 trillion as of end December, 2014 (Table 7.2).
Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15

In comparison to trends in other emerging economies, equity

Source: Pakistan Stock Exchange market fared relatively better …

Positive sentiments of domestic investors shield the equity More fragility was seen in equity markets during
market… second half of CY15 (Table 7.3). However, the
post Yuan devaluation impact was lesser in Pakistan
Despite net selling by foreign investors in Pakistan than many other emerging economies. During this
in the second half of CY15 (Figure 7.17), a host of stressed period, KSE-100 index observed 5 percent
factors resisted freefall in equity markets: (a) decline as against 18 percent fall in MSCI index of
optimistic sentiments of domestic investors based emerging economies.
on positive economic outlook and improved
economic fundamentals, (b) corporate profitability
in fertilizer, auto and cement sectors and (c) positive
impacts of low commodity prices on the economy

110
Table 7.2 Table 7.3
Progress of Capital Markets in Pakistan during CY15 World Equity Market Indices
Million PKR except companies, index and bond data Dec-14 Jun-15 Dec-15 Change Change
31-12-2014 31-12-2015 in CY15 Jun-Dec,
Total No. of Listed Companies 557 554 2015
Total Listed Capital - PKR 1,168,485 1,269,703 indices percent

Total Market Capitalisation - PKR 7,380,532 6,928,497

USA (DJIA) 13,823 17,620 17,425 26.1 (1.1)
Euro (Euro Stoxx) 319 354 345 8.2 (2.5)
KSE-100™ Index 32,131 32,811
Japan (Nikkei) 17,451 20,236 19,034 9.1 (5.9)
KSE-30™ Index 20,772 19,309
France (CAC) 4,272 4,790 4,637 8.5 (3.2)
KSE Meezin Index (KMI-30) 50,735 55,647
Germany (DAX) 9,805 10,945 10,743 9.6 (1.8)
KSE All Share Index 23,398 22,868
China (SSEA) 3,234 4,273 3,539 9.4 (17.2)
New Companies Listed during the year 6 8
India (BSE) 27,499 27,781 26,118 (5.0) (6.0)
Listed Capital of New Companies - PKR 26,973 29,941 Pakistan (KSE) 32,131 34,399 32,816 2.1 (4.6)
New Debt Instruments Listed during the year 6 2 Britian (FTSE) 6,566 6,521 6,242 (4.9) (4.3)
Listed Capital of New Debt Instruments - PKR 15,000 25,000 Brazil (BVSP) 50,007 53,081 43,350 (13.3) (18.3)
Average Daily Turnover - Shares in million 219 258 MSCI World 417 423 399 (4.3) (5.7)
Average value of daily turnover - Rs. 9,402 11,465 MSCI Developed 1,709 1,735 1,662 (2.8) (4.2)
MSCI Emerging 954 972 794 (16.8) (18.3)
Average Daily Turnover (Future™) YTD 24 36
Source: Bloomberg
Average Value of Daily Turnover - YTD 2,205 3,142
Source: Pakistan Stock Exchange
Going forward, the overall improvement in
Shariah compliant equity instruments outperform the domestic economy is expected to reflect in terms of
market… resurgence in equity market.

The Shariah compliant equity instruments

performed relatively better than overall market as
reflected through 9.6 percent growth in KMI-30 (i.e.
KSE Meezan Index) during CY15 (though growth
decelerated compared to CY14: 19.6 percent).

KSE-100’s performance is being acknowledged globally…

Based on progress witnessed in market liquidity,

framework and regulations, recently, MSCI Inc. - a
US-based provider of equity, fixed income, and
hedge fund stock market indices – is considering to
reclassify the MSCI Pakistan Index from ‘Frontier
Markets’ to ‘Emerging Markets’ in 2016.

111
112
 8 Financial Market Infrastructure

In Pakistan, Payment System constitutes the major form of Financial Market Infrastructure (FMI) as it serves both large
value and retail transactions through established channels. The Pakistan Real Time Interbank Settlement System (PRISM)
observed a substantial hike in both the value and volume terms due to large securities settlement in the review period. Retail
payment by virtue of paper and e-transactions showed consistent growth relative to the preceding years. The unfolding demands
and challenges related to national payment systems are duly being taken into account by SBP in the form of various initiatives
taken on developmental and regulatory front.

FMI includes a spectrum of institutions… Parties179 (CCPs), and Trade Repositories180 (TRs).
Detail view of the FMI framework is given in
In Pakistan, there exists an effective and efficient Annexure A at the end of this chapter.
infrastructure of FMI which is spread across the
different entities and jurisdictions. Financial Market State Bank of Pakistan manages the securities
Infrastructure (FMI) of Pakistan largely consists of settlement system of government securities through
systemically important payments systems which PRISM on gross basis and in real time, which is
include large value transactions executed through secure, low cost and one window solution.
PRISM and retail transactions routed through the Government securities are settled using Delivery
paper based and e-transactions. Besides payment versus Payment (DvP) model. Additionally, SBP
systems, depository and clearing companies are also acts as a primary central securities depository for the
the key manifestations of the FMI which provide book based government securities. SBP also
effective and efficient platform for the market manages the issuance and recording of secondary
players of the financial infrastructure to execute market transactions including repos. The
their transactions in a safe and structured manner. government securities include Treasury Bills (T-bills)
– Market T-bills (issued to commercial banks) and
FMIs are centric to the clearance and settlement of Market Related T-bills (government borrowing
transactions in the financial institutions as well as directly from SBP), Government of Pakistan Ijarah
the flow of money and securities. As per BIS 175, Sukuk and Pakistan Investment Bonds. State Bank
FMI essentially covers the Payment Systems176, of Pakistan introduced an Electronic Bond Trading
Central Securities Depositories177 (CSDs), Securities platform (EBND) in January, 2010 with an objective
Settlement Systems178 (SSSs), Central Counter to bring efficiency in secondary market trading of
Government Securities. It provides a central
175 Committee on Payment and Settlement Systems, (2012). platform where investors can easily access
“Principles for Financial Market Infrastructure”, Bank of marketable securities i.e. Market Treasury Bills,
International Settlement.
176 A payment system is a set of instruments, procedures, and rules for Pakistan Investment Bonds and Ijara Sukuk.
the transfer of funds between or among participants; the system
includes the participants and the entity operating the arrangement.
177 A central securities depository provides securities accounts, central 179A central counterparty interposes itself between counterparties to
safekeeping services, and asset services, which may include the contracts traded in one or more financial markets, becoming the
administration of corporate actions and redemptions, and plays an buyer to every seller and the seller to every buyer and thereby
important role in helping to ensure the integrity of securities issues. ensuring the performance of open contracts.
178 A securities settlement system enables securities to be transferred 180A trade repository (TR) is an entity that maintains a centralized

and settled by book entry according to a set of predetermined electronic record (database) of transaction data. TRs have emerged as
multilateral rules. a new type of FMI particularly in the OTC derivatives market.

113
 EBND helps in improving price discovery and the main segments of PSX which are dealt in the
enhancing liquidity in the Government securities. NCCPL for clearing and settlement purposes:
Further, the availability of real-time information
about yields and turnover is beneficial for all  Regular/Cash Market
investors and corporate issuers as it facilitates  Odd-lot Market
benchmarking of their upcoming corporate bonds  Derivative Markets (Futures and Stock
Index)
or funding requirements. This system also provides
 Negotiated Deal Market
international investors an additional window to
 Debt Market
access the country’s financial markets.
 Margin Trading System (“MTS”)
Central Depository Company (CDC) serves as the  Margin Financing System (“MFS”)
sole securities depository in the country as far as the  Securities Lending and Borrowing System
capital market is concerned. CDC handles the (“SLB”)
transactions like deposit of securities, transfer of
Role of central counterparty (CCP) has not been
securities, pledging of securities, pledge release,
taken by any institution in the country. In most of
pledge call, withdrawal of securities and corporate
the countries, the clearing companies assume the
actions181. CDC handles the electronic (paperless)
function of CCP due to their very relevance and
settlement of transactions (both equity and bonds)
nature. In Pakistan, NCCPL intends to adopt the
carried out at the stock exchange of the country. As
charge of CCP. In doing so, multiple factors have to
of June 30, 2015, CDC has managed 117.7 billion
be premeditated, primarily on the account of
shares, with a total market capitalization of PKR
associated cost, default risk, systemic risk and
4,649.6 billion in central depository system 182.
oversights function.
CDC is also providing the securities settlement of
government securities Bond Automated Trading Trade repository (TR) is the emerging form of FMI
System (BATS).183 Above arrangement has enabled which has been trying to establish its position
the retail segment to participate in the trading of globally in the face of many legal and technical
government securities. hurdles185. In the local context, low OTC derivative
market has not inspired the formation of TR in the
Another significant FMI, National Clearing country.
Company of Pakistan Limited (NCCPL) provides
clearing and settlement services to the Pakistan In the wider sense, FMI also encompasses the
Stock Exchange Limited (PSX) through fully supporting entities such as credit bureaus, stock
automated National Clearing and Settlement exchanges and mercantile exchange etc. which
Services (NCSS)184. NCSS is the integrated system indirectly impact the FMIs. Thus, FMI plays a vital
which provides settlement mechanism on DvP role in the smooth functioning of the financial
basis, without the involvement of physical system and contributes towards the financial
instruments and manual intervention. Following are stability and, in the broader sense, economic growth.
At the same time it carries various FMI related risks
181 http://cdcpakistan.com/businesses/central-depository-system/ which if not managed properly can trigger a
182 http://cdcpakistan.com/downloads/
183 http://cdcpakistan.com/media-center/cdc-to-provide-settlement-

services-for-government-securities-traded-on-kses-bond-trading-
system/ 185https://www.bis.org/ifc/events/ifc_isi_2015/089_heitfield_presen
184 http://www.nccpl.com.pk/ tation.pdf

114
systemic distress in the financial market, a key payment transaction is by and large consistent with
concern for the regulators. the spike seen in the preceding years (Table 8.1).
PRISM transactions accounted for almost 56.3
Payment System landscape…. percent of the total value of the payment system in
Payment System, the most prominent form of FMI, CY15.
mainly accounts for large value transactions and Table 8.1
retail transactions facilitated through well- Profile of Payment System Mechanisms
established products and channels. An efficient and
effective payment system is the responsibility of the
CY13 CY14 CY15
Mechanism
stakeholders of the system and requires Volume Value Volume Value Volume Value

management of the ever evolving challenges and Volume in thousands and value in PKR trillion

risks. Smooth functioning of payment system is PRISM 483.0 134.0 636.0 144.0 809.0 213.0
critical not only for the stability of the financial Retail Payments 718,312.0 140.4 802,020.0 158.0 856,298.0 165.0
markets but also for the uninterrupted transmission
Paper based 357,800.0 109.0 365,219.0 123.0 348,797.0 129.0
of the monetary policy signals.
E-transaction 360,512.0 31.4 436,801.0 35.0 507,501.0 36.0

As one of its core objectives, SBP has included the Source: PSD, SBP

strategic goal on payment systems in its vision 2020.

It aims to extend the focused efforts on the Figure 8.1

developing, modernizing, regulating and maintaining PRISM shows hike in both value and volume terms

the modern and robust payment systems in the Growing trend of PRISM

country. Such efforts will complement the SBP (Volume in thousand) (Value in PKR trillion )

vision 2020 by facilitating the development of Value (RHS) Volume

900 250
efficient, effective and robust financial system of the
800
country. SBP has made concerted efforts to ensure 700 200
payment system’s safety, integrity, efficiency and 600
reliability. Such endeavors remained well cognizant 500
150

of market players’ investment in IT and core 400

100
banking solutions. 300
200
In recent times, Payment systems have migrated from the 100
50

backroom to the boardroom… 0 0

CY13 CY14 CY15
In CY15, payment system witnessed a robust
growth in its various components significantly Source: PSD, SBP
contributed by the large value transactions
conducted through PRISM186. Growth of retail PRISM transactions grow in volume and value…

In CY15, PRISM has shown a noticeable elevation

186PRISM started operations with the settlement of interbank money
market transactions and the domestic leg of FX market operations in in terms of value which reaches the figure of PKR
July 2008. Since then, the scope of PRISM has been enhanced over
time to provide a range of services such as; a) settlement of
213.0 trillion (Figure 8.1). Large value transactions
government securities, b) Intraday Liquidity Facility (ILF), c) SBP’s observed rising trend which was characterized by
internal transactions, e) bank’s own account transfer and f) access to
stock exchange member through their settlement bank.

115
 the high value transactions of government securities are settled in PRISM on multilateral net settlement
(PKR 151 trillion) (Figure 8.2). batch (MNSB).

The significant increase in value of Government Figure 8.3

Securities is basically due to increase in interbank Number of PRISM transactions shown uphill trend
Securities Settlement as well as Open Market Components of PRISM
Operations (OMOs) in CY15187. (Volume)
Securities Settlement (SS) IFT
900,000
800,000
Figure 8.2
PRISM transactions increased substantialy 700,000

Components of PRISM 600,000

(Values in PKR trillion) 500,000

Securities Settlement (SS) IFT 400,000

160 300,000

140 200,000
100,000
120
0
100 CY 13 CY 14 CY 15
80
Source: PSD, SBP
60

40 As against volume of transactions, the value of the

20 IFT transaction has shown a slight dip of 0.5
0 percent in CY15. This contradictory trend of
CY 13 CY 14 CY 15 volume versus value shows that banks have used
Source: PSD, SBP PRISM platform more frequently for relatively low
value transactions (Figure 8.2).
In terms of volume also, PRISM transactions are
growing steadily (Figure 8.3). Inter-bank Funds Since transactions in PRISM are settled on real time
Transfer (IFT) carry the major portion in the gross basis, this feature requires its participants to
PRISM transactions as far as the volume is have instant liquidity at the time of transaction
concerned. In CY15, IFT transactions grew by 28.8 settlement. To address the liquidity risk so that
percent as compared to CY14. Rise in IFT is shortages at one participant do not spread
rationalized by the elevated confidence on the throughout the system, various techniques like
PRISM by banks for the speedy transfers and queuing arrangements, prioritization algorithms,
settlement among themselves. netting arrangements (e.g. in hybrid systems),
intraday credit arrangements, and securities lending
Securities settlement transactions also kept growing arrangements are employed for better execution of
and recorded 69,433 transactions in CY15. the liquidity management.
However, the instruments of retail cheque clearing
SBP also provides certain facilities for efficient
settlement of transactions. For example, liquidity
187Securities are settled in PRISM system on DVP Model 1, because deficient participant may avail either (a) Intraday
of which settlement risk is totally eliminated.

116
Liquidity Facility (ILF)188 from SBP or (b) queue the growth pattern in line with previous years (Figure
pending transaction in PRISM till the availability of 8.4).
required funds. The ILF, generally, allows banks
smooth settlement of transactions and avoids large Within retail, paper based transactions remained
queues and gridlock situations189. dominant as they accounted for 78.1 percent of the
aggregate retail value of all transactions. E-
Figure 8.4 transactions also showed an improvement by
Retail payment growth trends consistent with previous years recording the value of PKR 36 trillion as compared
Retail payment trend to PKR 35 trillion in CY14 (Table 8.1).
(Volume in million) (Value in PKR trillion)

Volume Value Prevalence of paper based transactions shows that

900 180 the use of digital channels is limited and low due to
800 160 lack of customers’ (households and businesses)
700 140 trust, financial illiteracy, digital divide and habit
600 120 persistence etc.
500 100
400 80 Figure 8.5
Cheque transactions dominated the paper based transaction
300 60
Value-wise share of paper-based retail transactions during CY15
200 40
(percent)
100 20 Cheques Pay Orders Demand Draft Others
0 0
CY 12 CY 13 CY 14 CY 15 2% 6%
6%
Source: PSD, SBP

Retail Payment transactions continue to grow…

Retail transactions are usually described as the

transactions between consumers and the businesses.
Consumers generally use the retail payments in areas
like purchase of goods and services, bills payment, 86%

Person-to-Person payments (P2P) and cash

withdrawals. In a granular view, paper based and e-
Source: PSD, SBP
transactions accumulate to form the retail
transactions. Retail transactions of 856 million in Cheques still the dominant part of Paper-based
number with a worth of PKR 165 trillion were transactions…
executed in CY15; thus following the consistent
Historically, consumers have been using cheques
more often than any other retail payment
instruments other than cash. The spread out of
The ILF is a fully collateralized liquidity facilities extended by SBP
paper based transactions reveals that the dominance
188

against approved government securities to ensure the smooth

functioning of PRISM.
189 If one bank face funding shortfall, it may create the shortage of
of cheque based transactions persists as they
funds for the recipient bank. A system wide similar situation where comprised 85.6 percent share in value and 93.6
several banks’ transactions are stuck is called Gridlock situation. percent share in volume terms (Figures 8.5 & 8.6).

117
 Other paper based transactions such as pay orders Keeping in view the high share of chequing
and demand drafts are low in value and volume transactions in the overall retail payment structure,
depicting the limited but customized needs of the there runs a parallel risk of frauds associated with
customer. the financial instruments like cheques. To address
this important aspect, SBP has issued the
Figure 8.6 guidelines190 in 2014 on the standardization of
Cheque transactions remained highest in value
security features and layout of cheques prescribing
Volume-wise share of paper-based retail transactions during CY15
(percent)
minimum requirements in respect of security
Cheques Pay Orders Demand Draft Others features and printing techniques of cheques. This
1% initiative is intended to speed up the overall cheque
2%
3%
clearing process, facilitate truncation project and
minimize fraudulent activities. Similar steps have
been taken by SBP to standardize the layout and
security features of Pay Order (PO), Demand Draft
(DO) etc.

Clientele behavior, technology and regulation accelerating the

E-banking......
94%
Financial sector of Pakistan, with SBP’s
complementary efforts, has shown considerable
Source: PSD, SBP
growth in a wide spectrum of e-banking avenues,
Among cheque based transactions, cash based enabling customers to benefit from speedy,
transactions held the lead in volume terms by convenient and paperless ways of conducting
contributing 52.4 percent of the total chequing financial transactions. With more banks stepping
transactions, whereas cheque transfers were most into the e-banking infrastructure and offering
preferred mode in value terms– about 61.4 percent technology based banking services coupled with
of the total chequing transactions in CY15 (Table enhanced awareness among consumers; the e-
8.2). banking is flourishing in a consistent manner.

E-banking has been growing in recent years. In

Table 8.2
CY15, value and volume of e-banking has increased
Chequing Transactions in CY15 by 14.6 percent and 40.7 percent respectively, as
Amount Volume Value compared to CY13 (Table 8.1). The rising trend in
Number
(million)
(PKR share Share e-banking was duly supplemented by enriched
Billion) (percent) (percent) infrastructure such as ATMs, Real Time Online
Cash 172.0 18,354.0 52.4 16.5 Branches (RTOBs), credit cards, debit cards etc.
(Table 8.3).
Transfer 99.0 68,342.0 30.2 61.4

Clearing 57.0 24,444.0 17.4 22.0

Refund 0.0 210.0 0.0 0.2

Source: PSD, SBP
190 PSD’s Circular No.1 of 2014 and CPD’s Circular No.1 of 2014

118
Table 8.3 Delivery Channel (ADC) in e-banking which
Overview of e-Banking in Pakistan (June 30, 2015) comprises the value share of around 87.6 percent
Description Numbers compared to significantly low volume contribution
Infrastructure of 24.3 percent in e-banking repertoire (Figures 8.7
Online Branches per 100,000 population 6 & 8.8). With addition of 1,293 online branches in
Mannual Branches 622 the banking network of Pakistan, the total figure of
ATMs per 100,000 population 5 online branches reached 12,442 (around 95.6
Interoperable switches 2
percent of total branches) by the end of CY15.
Banks managing POSs 6
There is an addition of PKR 795 billion value in the
POS Machines 41,183
RTOB transactions.

Chart Title
Banks' Services Figure 8.8
Number of E-Banking transactions increased
Banks providing internet banking 21
Volume of E-Banking Transactions
Banks providing mobile banking 16
(In million)
Banks providing call center & IVR banking 16
RTOB ATM POS
Banks issuing credit cards 12 Call Center Internet Banking Mobile Banking
600
Banks issuing debit cards 27
Banks issuing prepaid cards 9 500
Banks having ATMs 28
400
Source: PSD, SBP
300

Figure 8.7 200

E-Banking transactions show slight improvment in value
Value of E-Banking Transactions 100
(PKR trillion)
Mobile Banking Internet Banking Call Center 0
POS ATM RTOB CY13 CY14 CY15
41
Source: PSD, SBP
36

31 ATM’s penetration has improved…

26 ATMs are one of the user friendly and convenient
21 tools of e-banking. SBP has endeavored to ensure
round the clock availability of ATMs with consistent
16
monitoring, resolving issues (like out of cash,
11 hardware/software issues, power outrages,
CY13 CY14 CY15
connectivity or network issues) in minimum
Source: PSD, SBP possible time and ATM penetration.

With a decent growth of 19.1 percent the

RTOB the lead component of e-banking in value terms… cumulative number of ATMs reached 10,736 in
CY15 (Table 8.4). Expansion of ATMs is spurred
Real Time Online Banking (RTOB) transactions are
relatively large value-low frequency Alternative

119
 by the business as well as regulatory reasons191. for the availability of working ATMs especially
Though overall penetrations of ATMs have during occasion days. The average downtime has
improved and on average 5 ATMs are available for reduced to 7 percent and 10 percent for the day and
100,000 people, it still lags behind the international night time, respectively from 10 percent and 14
standards of outreach.192 percent in CY14 (Figure 8.9).

In CY15, there were 325 million transactions routed Stats related to issuance of ATM cards has also
through ATMs out of a total of 507 million e- shown an unprecedented upheaval (419.9 percent)
banking transactions. The value shared by ATMs is due to the fact that for the first time ATM cards of
PKR 3.4 trillion which is almost 9.4 percent of the Microfinance banks have been included in the
total e-banking transaction value of PKR 36 trillion. reported e-banking infrastructure (Table 8.4).

Table 8.4
Figure 8.9
E-Banking Infrastrcture Position
ATM Effeciency has improved
ATM Downtime CY12 CY13 CY14 CY15 Growth

Day (9 am - 9 pm) (9 pm - 9 am) number percent

16% ATMs 6,232.0 7,684.0 9,018.0 10,736.0 19.1

14% Online Branches Network 9,896.0 10,596.0 11,149.0 12,442.0 11.6

12% POS 34,724.0 33,734.0 34,945.0 50,072.0 43.3

Credit Cards (000) 1,271.2 1,336.0 1,332.0 1,394.0 4.7

10%
Debit Cards (000) 18,571.5 20,048.1 23,727.0 26,489.0 11.6
8%
ATM Only Cards (000) 873.8 996.2 935.0 4,861.0 419.9
6%
Source: PSD, SBP
4%

2%
PoS, the other e-banking channel, also grow…
0%
CY 12 CY 13 CY 14 CY 15
Among other e-banking channels, Point of Sale
Source: PSD, SBP (PoS) was the most impressive channel of e-banking
in CY15 as far as the growth rate (43.3 percent) is
concerned. Elevated trust of customers
Keeping a check on the operational efficiency of the
accompanied with available PoS infrastructure has
ATMs, the downtime (time ATMs not operational)
improved the PoS based transactions.
serves as an important yardstick. The downtime of
the ATMs has reduced in CY15 when compared In consonance with the growth rate, PoS achieved
with the previous years. Enhanced regulatory efforts the splendid increment of 78.4 percent and 76.5
have been made and supervisory tools are exercised percent in value and volume terms, respectively, in
CY15 relative to the CY13. Though, proportionate
share of the PoS is not prevailing in terms of both
As per SBP’s instructions, banks are required to open at least one
value and volume terms, when compared to other e-
191

ATM with each new branch and bring number of ATMs at par with
number of branches in next five years w.e.f. end December 2013 such banking avenues, yet it has recorded improved
as covering 20 percent gap each year.
192 17 ATMs per 100,000 people is the average of (50 th percentile) 26 figures of volume (35 million) and value (PKR 182
countries sample as per analysis in the report of World Bank.
http://siteresources.worldbank.org/INTTOPACCFINSER/Resourc
billion) on standalone basis in CY15 (Figure 8.10).
es/Bnkoutrch.pdf

120
 Figure 8.10 acceptance from the market, which took quick
POS recorded spike in volume and value strides for its implementation. Seven years down the
POS Growth road, the experiment seems to strongly indicate that
(Value in PKR billion) (Volume in million) it has contributed positively in reaching the target
Value Volume audience.
200 40
180 35 The interest shown by the well-known banking
160
30
groups illustrates the viability of the BB from a
140
25
purely business development standpoint. There are
about 8 players in the BB business, five belonging to
120
100 20
80
main stream top private banks and three MFBs.
15

With the growing participation of banks in

60
10
40
20 5 branchless banking, the sector holds promise for
0 0 eliminating financial exclusion of the depressed
CY13 CY14 CY15 sections of society. Fast expanding BB network,
Source: PSD, SBP both due to entry of new players and increase in
number of agents offering BB remained the key to
Nonetheless, more efforts and investments are this extraordinary growth.
needed for the encompassing outreach of the e-
Table 8.5
banking services to the unbanked population of the Key Highlights of Branchless Banking
country. At the same time, such efforts are needed Growth
CY14 CY15
to be accompanied by sophisticated and prudent (percent)

risk management systems at bank level to minimize No. of Agents 204,073.0 301,823.0 47.9

the losses and frauds associated with e-transactions.

No. of Accounts (thousands) 5,414.0 15,322.0 183.0
No. of Transactions (millions) 278.0 375.0 34.9
Branchless Banking on the surge… Average No. of Transactions Per Day
772.0 1,041.0 34.8
(thousands)
The Branchless Banking (BB) regulations, first of its Deposits (PKR million) 6,668.0 8,827.0 32.4
kind and based on the spirit of financial inclusion, Value of Transactions (PKR billion) 1,353.0 1,872.0 38.4
were developed and issued by the State Bank way Average Size of Transactions (PKR) 4,867.0 4,992.0 2.6
back in 2008. Differing from the international Source: AC&MFD,SBP
models that were teleco-based, the central bank
owing to peculiar social settings opted for the bank- In CY15, number of accounts grew by 183.0 percent
led model; underlying themes being the as compared to CY14, thus showing the interest of
“responsibility viz–a-viz the depositor”, consumer the public in the branchless banking (Table 8.5).
protection and compliance with the AML/CFT. Furthermore, the telecom companies’ balance air
time network has also been instrumental in padding
Given the fact that the idea of financial inclusion up the agents’ network. Elevated market penetration
revolves around the dispossessed sections of the of BB network has duly impacted the value and
society and the bank-led model matched the volume, which hiked up to PKR 1,872 billion and
industries’ move towards technology based banking, 375 million, respectively, in CY15.
branchless banking initiative of the SBP gained early

121
 Risks, Challenges and Developments… risks and implementing internal controls and
security measures. Further, SBP is also working on
The host of risks associated with FMI includes other aspects like drafting regulations on card
major risks like systemic risk, credit risk, liquidity security etc.
risk, legal risk and operational risk (See Box: 8.1)
which are critical, especially in the context of Along with underlying risks, FMI also faces many
supervisory oversight. Failure to address these risks challenges related to infrastructure and market
can lead to sources of financial shocks such as discipline. Taking a stock of all these risks and
liquidity dislocations and credit fallouts. Failure of challenges, SBP has remained engaged with a
payment system has a negative impact on the number of important domestic and international
execution of the monetary policy and confidence of regulatory initiatives relevant to its mandate of
the public in the financial system at large. payment systems and related infrastructure. Major
developments in this connection include195:
SBP has largely eliminated the settlement risk in
large value payments by implementing PRISM  Real Time Gross Settlement System (RTGS)
system and its success is evident as it is not only implementation and encouraging Financial
used by institutions but also by high value Institutions to implement Straight Through
customers. Processing (STP)
 Enhancing access of PRISM for
With the growing landscape of e-banking
Microfinance Banks
worldwide, the probability of cyber attacks has also
increased. In 2015, there were 3 billion digital users  Interoperability of ATM Switches
and it is estimated that network traffic will be more  Branchless Banking Regulations
than double from 2015 to 2019193. Accordingly,  Collaborative launching of Pakistan
routes for exploitation and disruption will also Remittance Initiative (PRI)
augment. It is clear that the risks are on the rise and  Supporting government initiated social
a growing cause of concern to the industry and safety nets such as Benazir Income Support
regulators alike. Recent episode of cyber heist on Program (BISP) by waving off inter switch
Bangladesh bank has provoked the regulators and fee.
financial institutions globally to ramp up their  IBAN standard adoption.
efforts against cyber threats. SBP is aware of the  Introduction of cheque layout and security
recent cyber-attacks on various financial institutions standards.
and has reviewed its operational set-up and system  Introduction of Guidelines on
security infrastructure for cross border payments. Standardization of Payment Orders (POs)
Adequate measures have already been taken to and Demand Drafts (DDs),
secure the SBP systems.
 Introduction of domestic payment scheme
SBP has issued regulations for security of internet
194 i.e. PayPak.
banking that sets minimum benchmarks for
In order to establish an environment conducive for
financial institutions requiring the assessment of
competition and discipline among the payment
193https://www.ecb.europa.eu/press/key/date/2016/html/sp160113

_1.en.html 195Payment systems review 2014-15- PSD-SBP

194 http://www.sbp.org.pk/psd/2015/C3-Annexure-A.pdf http://sbpweb/payment/pdf/FY/FiscalYear-2014-15.pdf

122
system stakeholders, SBP has issued Rules for 8.1). These standards stress upon that FMIs be
Payment System Operators (PSOs) and Payment more resilient to financial crises, particularly, the
System Providers (PSPs) in 2014. One of the participant defaults to minimize likelihood of
objectives of these Rules is to encourage the systemic risk. Importantly, PFMI also set forth
participation of non bank entities in payment responsibilities of central banks, market regulators
industry to provide new products and services. and other relevant authorities for FMI related to the
Under these Rules, existing and new Payment regulation, supervision and oversight of FMI. These
System Operators/institutions would come under a responsibilities highlight that relevant authority;
formal regulatory ambit.
 should have adequate powers and resources
Payment System Oversight… to develop regulation, supervise and to carry
out oversight,
Payment system oversight is a critical function of a  should clearly define and disclose oversight
central bank which is carried out by developing policies,
regulatory framework, effectively monitoring the  should apply CPMI-IOSCO principles,
existing systems, ensuring compliance of systems  should cooperate with each other, both
with best domestic laws/regulations and best domestically and internationally, as
international practices and promoting cost effective appropriate, in promoting the safety and
e-banking technologies and cross-border efficiency of FMIs
connectivity in a safe way.
In Pakistan, SBP conducts the regulatory oversight
With the growing concern about financial stability,
of Payment System through a well established legal
the role of central banks oversight of payment and
and regulatory framework. In 2007, Payment System
settlement system has gained immense attention as
and Electronic Fund Transfer Act was passed which
one of the key policy objectives. The scope of
empowers SBP to conduct oversight of payment
oversight has broadened multifold in response to
system to ensure its safety, integrity, efficiency or
more direct and active role of the private sector in
reliability. The Act covers all areas related to
providing payment and settlement systems.
payment system including RTGS, payment
Furthermore, other oversight demanding factors instruments, clearing, and electronic fund transfers,
include significantly large increase in the value of e-banking / ATMs, fines and penalties, etc.
transfers cleared and settled, centralized channeling
Way Forward…
of activities through smaller number of key systems,
and enhanced technological interconnectedness of In the backdrop of ever evolving challenges and
many systems. Besides ensuring efficiency with risks, efforts are being made to protect all FMI
safety, payment system oversight helps in stakeholders. SBP has given guidance to banking
maintaining public confidence on money as a mean industry on various aspects like efficiency and
of exchange and performing the monetary policy in automation of payment systems. In the same vein,
smooth and efficient way. regulations for Electronic Funds Transfers are also
under considerations at SBP which shall help in
Quite cognizant of the importance of payment
achieving the stable and uninterrupted payment
system oversight, CPMI introduced Principles of
system structure in the country.
Financial Market Infrastructure (PFMI) (See Box

123
 On the part of PRISM participants, core banking developing the Guidance on cyber resilience for
and PRISM systems are not integrated, thus financial market infrastructures196.
requiring manual feeding of the payment
instructions which is inefficient and error prone. In
order to improve efficiency and minimize errors in
payment processing, SBP has instructed the
participants of PRISM to implement “Straight
Through Processing (STP)”. It ensures automated
processing of transactions through PRISM system
by integrating it with their core banking systems.

Designation and oversight of payment system is

important and in this realization, SBP is working on
the framework of payment system oversight, which
is in line with the related international best practices
including CPMI & IOSCO supervisory & oversight
principles.

Cybercrime risks emanating from the ever rising

landscape of e-banking requires due attention of all
market players as well as regulators. To circumvent
cyber related risks, cyber resilience mechanism
needs to be formulated and executed. Proactive
steps are required to be taken on account of
improved legislation, market awareness and program
formulation to counter the cyber related risks. Part
of this actualization has been translated into the
legislation and approval of law on cyber crime titled
as “Prevention of Electronic Crime Act 2015” by
National Assembly of Pakistan. Enforcement of this
law will extend the legal shelter for the market
players of the industry against the cyber crimes.

In relation to global recognition on cyber threats, it

is pertinent to mention that international
“Committee on Payments and Market
Infrastructures” (CPMI) and the “Board of the
International Organization of Securities
Commissions” (IOSCO) have joined their efforts in

196
CPMI-IOSCO consultative paper "Guidance on cyber resilience
for financial market infrastructures", November 2015,
https://www.bis.org/press/p151124.htm

124
Box 8.1 7. Liquidity risk: An FMI should effectively measure,
CPMI & IOSCO Supervisory & Oversight Principles monitor, and manage its liquidity risk. An FMI
for FMIs197: should maintain sufficient liquid resources in all
relevant currencies.
Committee on Payment and Market Infrastructure 8. Settlement finality: An FMI should provide clear
(CPMI) and Technical Committee of the International and certain final settlement, at a minimum by the
Organization of Securities Commissions (IOSCO) have end of the value date. Where necessary or preferable,
jointly published 24 principles for financial market an FMI should provide final settlement intraday or in
infrastructures (FMIs). FMIs are systemically important real time.
payment systems, securities settlement systems, central 9. Money settlement: An FMI should conduct its
securities depositories, central counter parties and trade money settlements in central bank money where
repositories. Some of the principles are applicable to all practical and available. If central bank money is not
types of FMIs, while most of the principles are only used, an FMI should minimize and strictly control
relevant for specific FMIs. Key issues covered by the the credit and liquidity risk arising from the use of
principles encompass financial risk, participant default commercial bank money.
rules and organization. A brief overview of the principles 10. Physical deliveries: An FMI should clearly state its
is listed below: obligations with respect to the physical deliveries and
should identify, monitor, and manage the associated
1. Legal basis: An FMI should have a well-founded, risks.
clear, transparent, and enforceable legal basis for 11. Central securities depositories (CSDs): A CSD
each material aspect of its activities in all relevant should have appropriate rules and procedures to
jurisdictions. help ensure the integrity of securities issues.
2. Governance: An FMI should have clear and 12. Exchange-of-value settlement systems:
transparent governance arrangements aimed to Sometimes FMIs settle transactions that involve the
promote the safety and efficiency of the FMI. settlement of two linked obligations. Settlement of
3. Framework for the comprehensive management one obligation should take place if, and only if, the
of risks: An FMI should have a robust and associated liability is settled. This is called “delivery
overarching risk management framework for versus delivery” in foreign exchange settlement and
managing legal, credit, liquidity, operational, and “delivery versus payment” in securities settlement.
other risks. 13. Participant-default rules and procedures: An
4. Credit risk: An FMI should measure, monitor, and FMI should have effective and clearly defined rules
manage its credit exposures to participants and those and procedures to manage a participant default.
arising from its payment, clearing, and settlement 14. Segregation and portability: This principle
processes. concerns the protection of CCP members’
5. Collateral: An FMI that requires collateral to customers. In the case of a member default, the
manage its or its participants’ credit exposure should member’s customer should be able to move their
accept collateral with low credit, liquidity, and market positions and the relevant collateral to an account in
risks. another institution.
6. Margin: A central counter parties should cover its 15. General business risk: An FMI should identify,
credit exposures to its participants for all products monitor, and manage its general business risk.
through an effective margin system that is risk-based 16. Custody and investment risks: An FMI should
and regularly reviewed. safeguard its own and its participants’ assets and
minimize the risk of loss on and delay in access to
197Committee on Payment and Settlement Systems, (2012). these assets.
“Principles for Financial Market Infrastructure”, Bank of
International Settlement.

125
 17. Operational risk: An FMI should identify the
plausible sources of operational risk and mitigate
their impact through the use of appropriate systems,
policies, procedures, and controls.
18. Access and participation requirements: An FMI
should have objective, risk-based, and publicly
disclosed criteria for participation, which permit fair
and open access.
19. Tiered participation arrangements: An FMI
should identify, monitor, and manage the material
risks to the FMI arising from tiered participation
arrangements.
20. FMI links: An FMI that establishes a link with one
or more FMIs should identify, monitor, and manage
ink-related risks.
21. Efficiency and effectiveness: An FMI should be
efficient and effective in meeting the requirements of
its participants and the markets it serves.
22. Communication procedures and standards: An
FMI should use, or at a minimum accommodate,
relevant internationally accepted communication
procedures and standards for communication
23. Disclosure of rules, key procedures, and market
data: An FMI should have clear and comprehensive
rules and procedures and should provide sufficient
information to participants to have an exact
understanding of the risks and related costs.
24. Disclosure of market data by trade repositories:
A trade repository should provide timely and
accurate data to relevant authorities and the public in
line with their respective needs.

126
Annexure: A

Framework
Financial Market
Infrastructure

Key legal and regulatory Key FMIs Payment systems

framework

Payment System Electronic Fund Act Key Participants

2007 Payment Systems. Payment systems
Central Depositories Act, 1997 Securities Settlement System.
Central Depository Company of Central Securities Depositaries.
Pakistan Limited Regulations Central Counterparties.
PRISM (RTGS) Operating Rules Trade Repositories
Stock Exchanges (Corporatization, PRISM ( large value
Demutualization and Integration) Act, SBP
transactions)
2012 Financial instituions
Securities Settlement
The National Clearing Company of NIFT
Pakistan limited regulations, 2003 Interbank fund transfer
SWIFT
The Financial Services Ordinance E- banking
SBP-PRISM Payment system operators
2001. Real Time Online
Central Depository Banking
Company
Internet banking
National Clearing
Company of Pakistan ATMs
Limited PoS
Mobile banking
Call centre
Paper based
Cheques
Pay orders
Demand Drafts

127
128
Technical Appendix

A. Banking Sector Stability Map (BSSM)

Based on the methodology described by the IMF198, the BSSM covers the risks faced by the banking sector in seven
dimensions listed in Table 1. To gauge the magnitude of risk in each dimension, relevant indicators have been used.
Table 1: BSSM Dimensions and Corresponding Risk Indicators
Sr Risk Dimension Subcomponents Judgment Impact on
No. based Financial
Weights Stability
1 Capital Adequacy Capital Adequacy Ratio 40% Positive
Tier I CAR 30% Positive
Capital to Total Assets 30% Positive
2 Asset Quality NPLs to Total Loans 30% Negative
Provision to NPLs 30% Positive
Net NPLs to Capital 30% Negative
Loss to NPLs 10% Negative
3 Exposure to Public Sector Public Sector Exposure/Total Assets 50% Negative
4 Residual Growth Growth in Investments 25% Negative
(growth financed by non- Growth in Advances 25% Negative
core liabilities)
Growth in Borrowings 25% Negative
Growth in Deposits 25% Positive
5 Interconnectedness Call Lending and Borrowings/Total Assets 50% Negative
Financial Liabilities(SBP exclusive)/Total Liabilities 50% Negative
6 Earnings Return on Assets (Before Tax) 20% Positive
ROE (Avg. Equity& Surplus) (Before Tax) 20% Positive
NIM 20% Positive
NII/Gross Income 15% Positive
Cost / Income Ratio 15% Negative
Trading Income to Total Income 10% Negative
7 Liquidity Liquid Assets/Total Assets 33% Positive
Liquid Assets/Total Deposits 33% Positive
Earning Assets/Deposits 33% Negative

In each dimension, historical annual series of selected indicator ratios (up to 20 years), as listed in Table 1, have been
collected. Based on each series, percentile rank for the year under consideration is computed. The ranks are then

For methodology please see Dattels, P., McCaughrin, R., Miyajima, K., & Puig, J. (2010). “Can you map global financial stability?” IMF
198

Working Papers, 1-42.

129
 normalized on a scale of 1 to 10; indicators with positive impact are subtracted from 10 since lower values indicate
more stability, while indicators having negative impact are simply normalized. Based on the weights of each series, as
given in Table 1, an average summary measure having a single value of risk is arrived at for each dimension. Lower
value of the summary measure indicates lower risk to the banking sector stability while higher values signify higher
risk in that dimension.

B. Financial Markets Stability Map (FMSM)

The FMSM measures risks in three dimensions i.e. Equity Market, Money Market and Foreign Exchange Market.
Historical daily series of KSE-100 index since August 9, 2000, daily series of mid average interbank selling-buying
PKR/USD exchange rate since June 23, 2005, and weekly series of weighted average overnight repo rates since July
15, 2005 are used to compute Exponential Weighted Moving Average (EWMA) volatility 199 for each series. The
smoothing factor, , is taken to be 0.94 and initial volatility, , of 0.01 is used.200,201
Based on daily or weekly values (as the case may be), average volatility was computed for each completed calendar
year since CY06. The percentile rank of a particular year’s volatility (say CY14), in each of the three dimensions, is
then computed relative to their respective history (since CY06). Higher ranking in a dimension represents higher
riskiness. The percentiles were subsequently rescaled from 1 to 10 so as to make them presentable in the map.

Table X
C. CPV Model Results
Regression Results of CPV Model
Dependent Variable: Gross Non-Performing Loans
The variant of the CPV model used for the macro-stress (GNPLR)
testing exercise is reproduced below: Variables Coefficents
GLSM(-1) -0.3584
[0.0005]
= + + GLSM(-3) -0.4538
[0.0000]
GEXP(-4) -0.1623
+ + + [0.0103]
PSE(-2) -0.2237
[0.0062]
DR(-1) 0.6074
The estimation results202 of the model are, generally, in line [0.0000]
with prior expectations (Table X). All variables have the DR(-2) -0.7912
expected signs except discount rate at second lag. However, [0.0024]
DR(-3) 0.3250
the combined effect of discount rate implies a positive [0.0351]
relationship with the dependent variable, GNPLR. Model fit Intercept -0.2984
is also reasonable. The Durbin-Watson statistics is in the [0.0018]
Observations 51
satisfactory range (above 2.0). R-squared 0.72
Adj R-sqaured 0.67
Durbin Watson stat 2.29

199 The formula for computing EWMA volatility is: = ∗ + 1 − ∗ , where, , is the standard deviation, , is the smoothing
factor and , is the return.
200 Riskmetrics (1996), J. P. Morgan Technical Document, 4th Edition, New York, J.P. Morgan.
201 Chang, C. L., Jiménez-Martín, J. Á., McAleer, M., & Pérez-Amaral, T. (2011). Risk management of risk under the Basel Accord: Forecasting

value-at-risk of VIX futures. Managerial Finance, 37(11), 1088-1106.

202 Since we estimated the model using step-wise OLS regression, lags of explanatory variables which are insignificant are dropped.

130
Acronyms
AC&MFD Agricultural Credit & Microfinance FSV Forced Sale Value
Department FX Foreign Exchange
ADR Advances Deposit Ratio G-SIIs Global-Systemically Important Insurers
AFS Available for Sale GDP Gross Domestic Product
AML AML: Anti Money Laundering HFCs House Finance Companies
ATM ATM: Automated Teller Machine HFT Held for Trading
BB Branchless Banking HTM Held-To-Maturity
BIS Bank for international settlement IBBs Islamic Banking Branches
BPRD Banking Policy & Regulations IBIs Islamic Banking Institutions
Department IFC Investment Finance Company
bps basis points
IFSB Islamic Financial Services Board
CAR Capital Adequacy Ratio IFT Interbank Fund Transfer
CASA Current Account - Saving Account IPO Initial Public Offering
CBs Commercial Banks IRR Interest Rate Risk
CCP Central Counter Parties KAP Knowledge, Attitude and Practices
CD Certificate of Deposit KIBOR Karachi Interbank Offer Rate
CDC Central Depository Company KSE Karachi Stock Exchange
CDNS Central Directorate of National Savings LCR Liquidity Coverage Ratio
CDR Currency in Circulation to Deposits Ratio LPBs Local Private Banks
CEIFE Center of Excellence in Islamic Finance LSM Large Scale Manufacturing
Education MBS Mortgage Backed Securities
CF Consumer Finance
MCR Minimum Capital Requirement
CFT Combating the financing of terrorism
MER Minimum Equity Requirements
CiC Currency in Circulation
MMC Modaraba Management Company
COI Certificate of Investment
mREIT Mortgage Real Estate Investment Trust
CPEC China Pakistan Economic Corridor
MRWAs Market Risk Weighted Assets
CPMI Committee on Payment & Market
Infrastructure MSR Minimum Saving Rate
CPPI Constant Proportions Portfolio Insurance MTB Market Treasury Bill
CRR Cash Reserve Requirement MUFAP Mutual Funds Association of Pakistan
CRWA Credit Risk Weighted Assets NAV Net Asset Value
CSD Central Securities Depository NBFC Non-Bank Financial Companies
CY Calendar Year NBFC Non-Bank Finance Companies and
DFI Development Finance Institution &NE Notified Entities
NBFIs Non-Banking Financial Institutions
DMMD Domestic Markets & Monetary
Management Department NBMFC Non-Bank Micro Finance Companies
FBs Foreign Banks NII Net Interest Income
FCY Foreign Currency NIM Net Interest Margin
FDR Financing to deposit ratio NPAs Non Performing Assets
FI Financial Institution NPFs Non Performing Financings
FMI Financial Market Infrastructure NPL Non-Performing Loan
FSD Financial Stability Department NPLR Non Performing Loans Ratio

131
 NSS National Savings Scheme RSL Risk Sensitive Liabilities
OAEM Other Assets Especially Mentioned RTGS Real Time Gross Settlement
OICCI Chamber of Commerce and Industry RTOB Real Time Online Banking
OMOs Open Market Operations RWA Risk Weighed Assets
ONR Overnight Rate S&A Subsidiaries and Associated undertakings
ORWAs Operational Risk Weighted Assets SBP State Bank of Pakistan
PBT Profit Before Tax SBs Specialized banks
PIB Pakistan Investment Bond S&DWHD Statistics and Data Ware House
PKR Pakistani Rupee Department
PoS Point of Sale SECP Securities and Exchange Commission of
Pakistan
PRISM Pakistan Real-time Interbank Settlement SLR Statutory Liquidity Requirement
Mechanism
PSCBs Public Sector Commercial Banks SME Small & Medium Enterprise
PSD Payment Systems Department SSS Securities Settlement System
PSEs Public Sector Entities TCP Trade Corporation of Pakistan
PSO Payment System Operators TR Trade Repositories
PSP Payment System Providers USD US Dollar
PTF Participants’ Takaful Fund WADR Weighted Average Deposit Rate
RCOA Reporting Chart of Accounts WALR Weighted Average Lending Rate
REITS Real Estate Investment Trust WPI Wholesale Price Index
RMC REIT Management Company YoY Year on Year
ROA Return on Assets
ROE Return on Equity
RSA Risk Sensitive Assets

132
Annexures

133
134
 Annexure I - Balance Sheet and Profit & Loss Statement of Banks
PKR million
BALANCE SHEET Dec-12 Dec-13 Dec-14 Dec-15
ASSETS
Cash & Balances With Treasury Banks 805,672 840,233 723,664 909,429
Balances With Other Banks 191,599 186,221 149,631 198,395
Lending To Financial Institutions 169,630 273,991 429,380 360,772
Investments - Net 4,009,213 4,305,484 5,309,630 6,880,765
Advances - Net 3,760,289 4,046,587 4,447,300 4,815,827
Operating Fixed Assets 247,678 259,405 277,030 310,102
Deferred Tax Assets 75,542 78,855 67,077 65,644
Other Assets 501,219 546,214 702,550 602,301
TOTAL ASSETS 9,760,842 10,536,989 12,106,261 14,143,234
LIABILITIES -
Bills Payable 110,077 122,707 137,651 145,089
Borrowings From Financial Institution 1,035,671 723,828 1,001,447 1,766,145
Deposits And Other Accounts 7,300,687 8,318,058 9,229,773 10,389,260
Sub-ordinated Loans 55,160 40,070 44,329 51,366
Liabilities Against Assets Subject To Finance Lease 52 34 33 50
Deferred Tax Liabilities 17,924 18,288 37,149 47,622
Other Liabilities 359,444 375,374 448,432 420,935
TOTAL LIABILITIES 8,879,016 9,598,360 10,898,816 12,820,468
NET ASSETS 881,826 938,629 1,207,445 1,322,767
NET ASSETS REPRESENTED BY: -
Share Capital 463,647 481,250 587,053 619,862
Reserves 155,287 175,593 189,242 192,039
Unappropriated Profit 154,610 164,440 227,151 290,908
Share Holders' Equity 773,544 821,283 1,003,446 1,102,809
Surplus/Deficit On Revaluation Of Assets 108,281 117,346 203,999 219,958
TOTAL 881,826 938,629 1,207,445 1,322,767

PROFIT AND LOSS STATEMENT Dec-12 Dec-13 Dec-14* Dec-15*

Mark-Up/ Return/Interest Earned 800,800 776,653 919,821 981,760

Mark-Up/ Return/Interest Expenses 460,918 444,431 504,990 485,575
Net Mark-Up / Interest Income 339,882 332,222 414,830 496,185
Provisions & Bad Debts Written Off Directly/(Reversals) 32,492 36,252 25,323 38,874
Net Mark-Up / Interest Income After Provision 307,390 295,970 389,507 457,311
Fees, Commission & Brokerage Income 54,002 62,337 70,421 82,640
Dividend Income 21,686 14,606 14,098 16,910
Income From Dealing In Foreign Currencies 21,745 21,431 28,396 22,824
Other Income 40,559 42,036 54,434 86,369
Total Non - Markup / Interest Income 137,993 140,409 167,349 208,743
445,383 436,379 556,856 666,053
Administrative Expenses 252,861 267,990 304,588 330,006
Other Expenses 4,813 3,237 5,726 7,231
Total Non-Markup/Interest Expenses 257,674 271,227 310,313 337,237
Profit before Tax and Extra ordinary Items 187,709 165,153 246,543 328,817
Extra ordinary/unusual Items - Gain/(Loss) 848.99 2.01 3.79 0.51
PROFIT/ (LOSS) BEFORE TAXATION 186,860 165,151 246,539 328,816
Less: Taxation 65,480 54,176 83,171 129,811
PROFIT/ (LOSS) AFTER TAX 121,380 110,975 163,368 199,006

135
 Annexure II - Financial Soundness Indicators of the Banking Sector
percent
Indicators Dec-12 Dec-13 14-Dec Dec-15
CAPITAL ADEQUACY
Risk Weighted CAR^ 15.4 14.9 17.1 17.3
Tier 1 Capital to RWA 12.8 12.6 14.3 14.4
Capital to Total Assets 9.0 8.9 10.0 8.4
ASSET QUALITY
NPLs to Total Loans 14.5 13.0 12.3 11.4
Provision to NPLs 71.8 78.4 79.8 84.9
Net NPLs to Net Loans 4.6 3.1 2.7 1.9
Net NPLs to Capital^^ 19.4 13.4 10.1 7.7
EARNINGS
Return on Assets (Before Tax) 2.1 1.7 2.2 2.5
Return on Assets (After Tax) 1.4 1.1 1.5 1.5
ROE (Avg. Equity& Surplus) (Before Tax) 22.7 18.4 24.3 25.8
ROE (Avg. Equity &Surplus) (After Tax) 14.7 12.4 16.1 15.6
NII/Gross Income 71.1 70.3 71.3 70.4
Cost / Income Ratio 53.9 57.4 53.3 47.8
LIQUIDITY
Liquid Assets/Total Assets 47.4 47.3 49.2 53.8
Liquid Assets/Total Deposits 63.3 60.0 64.5 73.3
Advances/Deposits 51.5 48.6 48.2 46.4
^ Data for Dec-13 and onwards is based on Basel III, and data from CY08 to Sep-13 is based on Basel II with the exception of
IDBL,PPCBL, and SME Bank, which is based on Basel I.
^^ Effective from June 30, 2015, Regulatory Capital, as defined under Basel requirements, has been used to calculate Net NPLs to Capital
Ratio. Prior to Jun-15, Balance Sheet Capital was used for calculation of this ratio.

136
 Annexure III - List of Banks
Dec-14 Dec-15
A. Public Sector Com. Banks (5) A. Public Sector Com. Banks (5)
First Women Bank Ltd. First Women Bank Ltd.
National Bank of Pakistan National Bank of Pakistan
Sindh Bank Ltd. Sindh Bank Ltd.
The Bank of Khyber The Bank of Khyber
The Bank of Punjab The Bank of Punjab
B. Local Private Banks (22) B. Local Private Banks (22)
AlBaraka Bank (Pakistan) Ltd. AlBaraka Bank (Pakistan) Ltd.
Allied Bank Ltd. Allied Bank Ltd.
Askari Bank Ltd. Askari Bank Ltd.
Bank AL Habib Ltd. Bank AL Habib Ltd.
Bank Alfalah Ltd. Bank Alfalah Ltd.
BankIslami Pakistan Ltd. BankIslami Pakistan Ltd.
Burj Bank Ltd. Burj Bank Ltd.
Dubai Islamic Bank Pakistan Ltd. Dubai Islamic Bank Pakistan Ltd.
Faysal Bank Ltd. Faysal Bank Ltd.
Habib Bank Ltd. Habib Bank Ltd.
Habib Metropolitan Bank Ltd. Habib Metropolitan Bank Ltd.
JS Bank Ltd. JS Bank Ltd.
KASB Bank Ltd.* MCB Bank Ltd.
MCB Bank Ltd. MCB Islamic Bank Ltd.***
Meezan Bank Ltd. Meezan Bank Ltd.
NIB Bank Ltd. NIB Bank Ltd.
SAMBA Bank Ltd. SAMBA Bank Ltd.
Silk Bank Ltd Silk Bank Ltd
Soneri Bank Ltd. Soneri Bank Ltd.
Standard Chartered Bank (Pakistan) Ltd. Standard Chartered Bank (Pakistan) Ltd.
Summit Bank Ltd Summit Bank Ltd
United Bank Ltd. United Bank Ltd.
C. Foreign Banks (6) C. Foreign Banks (4)
Bank of Tokyo - Mitsubishi UFJ, Ltd. Bank of Tokyo - Mitsubishi UFJ, Ltd.
Barclays Bank PLC** Citibank N.A.
Citibank N.A. Deutsche Bank AG
Deutsche Bank AG Industrial and Commercial Bank of China Ltd.
Industrial and Commercial Bank of China Ltd.
HSBC Bank Oman S.A.O.G. #
D. Specialized Banks (4) D. Specialized Banks (4)
Industrial Development Bank Ltd. Industrial Development Bank Ltd.
Punjab Provincial Co-operative Bank Ltd. Punjab Provincial Co-operative Bank Ltd.
SME Bank Ltd. SME Bank Ltd.
Zarai Taraqiati Bank Ltd. Zarai Taraqiati Bank Ltd.
All Commercial Banks (33) All Commercial Banks (31)
Include A + B + C Include A + B + C
All Banks (37) All Banks (35)
Include A + B + C + D Include A + B + C + D
* KASB Bank Limited was de-scheduled on May 7, 2015, on account of its amalgamation with and into BankIslami Pakistan Limited, under Section 47 of the Banking
Companies Ordinance, 1962.
**Barclays Bank PLC (Pakistan Branch Business) was de-scheduled on June 11, 2015, on account of its merger with and into Habib Bank Limited.
*** “MCB Islamic Bank Limited” was declared as a Scheduled Bank with effect from September 14, 2015.
#
HSBC Bank Oman S.A.O.G. was de-scheduled on November 04, 2015, on account of its merger with and into Meezan Bank Limited.

137
 Annexure IV - Composition of Islamic Banking Institutions
Dec-14 Dec-15
Islamic Banks Islamic Banks
1 AlBaraka Bank (Pakistan) Ltd. 1 AlBaraka Bank (Pakistan) Ltd.
2 BankIslami Pakistan Ltd. 2 BankIslami Pakistan Ltd.
3 Burj Bank Ltd. 3 Burj Bank Ltd.
4 Dubai Islamic Bank Pakistan Ltd 4 Dubai Islamic Bank Pakistan Ltd
5 Meezan Bank Ltd 5 MCB Islamic Bank Ltd.
6 Meezan Bank Ltd
Conventional Banks having Islamic Conventional Banks having Islamic
Banking Branches Banking Branches
1 Askari Bank Ltd. 1 Askari Bank Ltd.
2 Allied Bank Ltd. 2 Allied Bank Ltd.
3 Bank Al Habib Ltd 3 Bank Al Habib Ltd
4 Bank Alfalah Ltd 4 Bank Alfalah Ltd
5 Faysal Bank Ltd. 5 Faysal Bank Ltd.
6 Habib Bank Ltd 6 Habib Bank Ltd
7 Habib Metropolitan Bank 7 Habib Metropolitan Bank
8 MCB Bank Ltd 8 MCB Bank Ltd
9 National Bank of Pakistan 9 National Bank of Pakistan
10 Silk Bank Ltd 10 Silk Bank Ltd
11 Sindh Bank Ltd 11 Sindh Bank Ltd
12 Soneri Bank Ltd 12 Soneri Bank Ltd
13 Standard Chartered Bank 13 Standard Chartered Bank
14 Summit Bank Ltd. 14 Summit Bank Ltd.
15 The Bank of Khyber 15 The Bank of Khyber
16 The Bank of Punjab 16 The Bank of Punjab
17 United Bank Ltd. 17 United Bank Ltd.
Grand Total 22 (5+17) Grand Total 23 (6+17)

138
 Annexure V - List of Non-Banking Financial Institutions
Development Finance Institutions
1 House Building Finance Company Ltd.
2 PAIR Investment Company Ltd.
3 Pak Brunei Investment Company Ltd.
4 Pak Libya Holding Company Ltd.
5 Pak Oman Investment Company Ltd.
6 Pak-China Investment Company Ltd.
7 Pakistan Kuwait Investment Company Ltd.
8 Saudi Pak Industrial & Agricultural Investment Company Ltd.
Leasing Companies
1 Grays Leasing Limited
2 NBP Leasing Limited
3 Orix Leasing Pakistan Limited
4 Pak-Gulf Leasing Company Limited
5 Saudi Pak Leasing
6 Security Leasing Corporation Limited
7 Sindh Leasing
8 SME Leasing Limited
9 Standard Chartered Leasing Limited
Investment Finance Companies
1 Escorts Investment Bank
2 First Credit and Investment Bank Ltd.
3 First Dawood Investment Bank Limited
4 IGI Investment Bank
5 Invest Capital Investment Bank Limited
6 Security Investment Bank Ltd.
7 Trust Investment Bank Limited

139
 Annexure V - List of Non-Banking Financial Institutions
Modarabas
1 Allied Rental Modaraba
2 B.F. Modaraba
3 B.R.R. Guardian Modaraba
4 Crescent Standarad Modaraba
5 First Al-Noor Modaraba
6 First Elite Capital Modaraba
7 First Equity Modaraba
8 First Fidelity Leasing Modaraba
9 First Habib Modaraba
10 First IBL Modaraba
11 First Imrooz Modaraba
12 First Islamic Modaraba
13 First National Bank Modaraba
14 First Pak Modaraba
15 First Paramount Modaraba
16 First Prudential Modaraba
17 First Punjab Modaraba
18 First Treet Manufacturing Modaraba
19 First UDL Modaraba
20 KASB Modaraba
21 Modaraba AL-Mali
22 Sindh Modaraba
23 Standard Chartered Modaraba
24 Trust Modaraba

140
 Annexure VI - List of Insurance Companies
Non-Life Insurance Companies
1 ACE Insurance Ltd.
2 Adamjee Insurance Company Ltd.
3 Alfalah Insurance Company Ltd.
4 Allianz EFU Health Insurance Ltd.
5 Alpha Insurance Company Ltd.
6 Asia Insurance Company Ltd.
7 Askari General Insurance
8 Atlas Insurance Ltd.
9 Capital Insurance Company Ltd.
10 Century Insurance Company Ltd.
11 Continental Insurance Company Ltd.
12 East West Insurance Company Ltd.
13 EFU General Insurance Ltd.
14 Excel Insurance Company Ltd.
15 Habib Insurance Company Ltd.
16 IGI Insurance Ltd.
17 Jubilee General Insurance Company Ltd.
18 National Insurance Company Ltd.
19 New Hampshire Insurance Company Ltd.
20 PICIC Insurance Ltd.
21 Premier Insurance Ltd.
22 Reliance Insurance Company Ltd.
23 Sahara Insurance Company Ltd.**
24 Saudi Pak Insurance Company Ltd.
25 Security General. Insurance Company Ltd.
26 Shaheen Insurance Company Ltd.
27 Silver Star Insurance Company Ltd.
28 Sindh Insurance Ltd.
29 The Asian Mutual Insurance Company (Guarantee) Ltd.*
30 The Co-operative Insurance Society of Pakistan Ltd.*
31 The Credit Insurance Company Ltd.*
32 The Crescent Star Insurance Company Ltd.
33 The Pakistan General Insurance Company Ltd.
34 The Pakistan Mutual Insurance Company(Guarantee) Ltd.*
35 The United Insurance Company of Pakistan Ltd.
36 The Universal Insurance Company Ltd.
37 TPL Direct Insurance Ltd.
38 UBL Insurers Ltd.

141
 Annexure VI - List of Insurance Companies
General Takaful Companies
1 Pak-Kuwait Takaful Company Ltd.
2 Pak Qatar General Takaful Ltd.
3 Takaful Pakistan Ltd.
Life Insurance Companies
1 Adamjee Life Assurance Company Ltd.
2 Asia Care Health & Life Insurance. Company Ltd.
3 East West Life Assurance Company Ltd.
4 EFU Life Assurance Ltd.
5 IGI Life Insurance Ltd.
6 Jubilee Life Insurance Company Ltd.
7 State Life Insurance Corporation of Pakistan
Family Takaful Companies
1 Dawood Family Takaful
2 Pak Qatar Family Takaful
Reinsurance Companies
1 Pakistan Reinsurance Company Ltd.
* Stay Order from the Competent Court has been obtained by the insurer against the Directive issued by the Commission under Section 63(1) of the Insurance
Ordinance 2000, prohibiting the insurer to enter into any new insurance contract.
** The proceedings seeking sanction under Section 309 (b) of the Companies Ordinance, 1984 for winding up of the Company are underway.
Source: Securities & Exchange Commission of Pakistan (SECP)

142