Financial Stability Review 2018 State Bank of Pakistan Table of Contents Governor’s Message ........................................................................................................................................................... i Acknowledgements ........................................................................................................................................................... ii FSR Team ........................................................................................................................................................................... iii Data Convention and Coverage ...................................................................................................................................... iv Overview ............................................................................................................................................................................. 1 Box 1: SBP’s Systemic Risk Survey-3rd Wave (January, 2019) ..................................................................... 8 Box 2: SBP’s Initiatives to Strengthen the Stability of the Financial Sector ............................................... 10 Chapter 1: Global and Domestic Macro-financial Environment ............................................................................... 17 Chapter 2: Financial Markets Risk Analysis................................................................................................................. 27 Box 3: US Dollar Liquidity Remains an Important Aspect of Inter-Connectedness and Financial Markets Behavior during CY18 .............................................................................................................................. 36 Section A: Banking Sector ............................................................................................................................................... 37 Chapter 3.1: Performance and Risk Analysis of the Banking Sector ........................................................................ 39 Box 4: FATF and AML/CFT Regime in Pakistan ......................................................................................... 53 Chapter 3.2: Performance and Risk Analysis of the Islamic Banking Industry ...................................................... 57 Chapter 3.3: Resilience of the Banking Sector under Stress Scenarios ...................................................................... 65 Section B: Non-Banking Financial Sector ...................................................................................................................... 75 Chapter 4.1: Performance & Risk Analysis of Development Finance Institutions (DFIs) ...................................... 77 Box 5: Brief History of DFIs in Pakistan ........................................................................................................ 82 Chapter 4.2: Performance & Risk Analysis of Non-Bank Financial Institutions ..................................................... 83 Chapter 4.3: Insurance Sector Performance and Risk Analysis ................................................................................. 91 Chapter 4.4: Performance and Risk Analysis of Exchange Companies.................................................................. 101 Section C: Non-Financial Sector ................................................................................................................................... 105 Chapter 5: Performance and Risk Analysis of the Corporate Sector ...................................................................... 107 Box 6: Altman Z-score – Measure of distress .............................................................................................. 115 Chapter 6: Performance and Soundness of Financial Market Infrastructures ....................................................... 117 Chapter 7: Financial Inclusion and Financial Stability ............................................................................................. 127 Box 7: Financial Inclusion .............................................................................................................................. 132 Appendix A .................................................................................................................................................................... 135 Acronyms ........................................................................................................................................................................ 139 Annexures ....................................................................................................................................................................... 145 Governor’s Message The year 2018 remained quite eventful from both global and domestic perspectives. The global economic momentum softened, amid increasing trade tensions and tightening financial conditions. The domestic economy faced various idiosyncratic challenges. The country had to go through uncertainties associated with the political transition in the first half. Afterwards, the widening twin deficits and elevated inflationary pressures necessitated policy measures for stabilization, which, as expected, slowed down the economic momentum. Resultantly, the investors’ sentiments remained subdued and financial markets, particularly the foreign exchange and equity markets, observed increased volatility. In response to the market dynamics, the local currency depreciated and the KSE-100 index dipped. The money market, however, operated smoothly by virtue of the interest rate corridor mechanism and improved liquidity conditions. Amid these challenges, the financial institutions, however, remained sound and facilitated the improvement in financial intermediation. Banks, the key player in the financial sector, carried forward the rising momentum in total loans with 22 percent growth, while maintaining strong solvency and liquidity profiles. Their capital adequacy ratio at 16.2 percent stood well above the international benchmark and the non- performing loans ratio decreased to 8 percent, despite some increase in NPLs during 2018. Moreover, the financial inclusion broadened due to joint efforts of the SBP and its regulated financial institutions. Particularly, to pursue the National Financial Inclusion Strategy, SBP introduced policy measures to enhance financial access to priority areas of SME, Housing and Agriculture, and to promote cross cutting themes of Islamic Banking and Digital Financial Services. State Bank, in line with its strategic objective of ensuring financial system stability, under “Vision 2020”, is closely monitoring global and domestic developments and responding appropriately where necessary. The current Financial Stability Review provides a detailed assessment of the emerging risks and highlights measures taken to beef up the financial sector stability. Among the emerging challenges, SBP stepped up its efforts to strengthen the overall AML/CFT regime and fortified the cyber resilience. In addition, SBP progressed towards Macro-Prudential Policy Framework by introducing regulatory guidelines for the designation of Domestic Systemically Important Banks (DSIBs), improving coordination among financial sector regulators and stepping up efforts for the establishment of an overarching National Financial Stability Council (NFSC). I hope that the stakeholders would find this report helpful and informative. Any suggestions, comments and feedback are welcome. Dr. Reza Baqir Financial Stability Review, 2018 i Acknowledgements The Financial Stability Review (FSR) team is highly indebted to Mr. Tariq Bajwa, Ex-Governor and Dr. Reza Baqir, Governor, State Bank of Pakistan (SBP) for their encouragement and guidance. The team is also grateful to members of Publications Review Committee (PRC) of the Management for providing invaluable feedback on the report. We are also thankful to Mr. Jameel Ahmad, Deputy Governor (Banking and FMRM) and Dr. Inayat Hussain, Executive Director, Banking Supervision Group, for their continuous support and supervision in the preparation of this report. The team would also like to thank various departments of SBP, especially Research Department (RD), Banking Policy and Regulations Department (BPRD), Offsite Supervision & Enforcement Department (OSED), Exchange Policy Department (EPD), Agricultural Credit & Microfinance Department (AC&MFD), 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) for their valuable support and feedback. We are also grateful to the Securities & Exchange Commission of Pakistan (SECP), National Clearing Company of Pakistan (NCCPL), Mutual Funds Association of Pakistan (MUFAP) and Pakistan Stock Exchange (PSX) for providing relevant data, technical information and comments on the relevant chapters/sections of the report. Publication Review Committee of the Management Dr. Saeed Ahmed (Chairman) Dr. Inayat Hussain Syed Irfan Ali Syed Samar Hasnain Mr. Muhammad Ali Malik Mr. Ali Choudhary Dr. M. Farooq Arby Dr. Omar Farooq Saqib Dr. Azizullah Khattak Mr. Muhammad Javaid Ismail ii Financial Stability Review, 2018 FSR Team Team Leaders Muhammad Javaid Ismail, Director – Financial Stability Department Dr. Asif Ali, Additional Director – Financial Stability Department Team Members Amer Hassan Anum Naeem Aqeel Ahmed Dr.