With credit penetration currently at less than a fifth of the country’s gross domestic product (GDP), raw numbers paint a bleak picture of Pakistan’s banking sector.

Of course, the economy seems shaken by never-ending protests against the government, recurring floods and military operations. However, digging deeper into the data emerging from the banking sector reveals another story altogether.

Earnings of most of the banks operating in Pakistan are set to post a healthy increase in coming years as a direct result of “reviving business activities”.

“Due to improved banking fundamentals, we expect earnings of Topline Universe banks to grow by 21.9% in the next three years (2014-16) compared with 5.5% growth in the last three years (2011-13),” according to Topline Securities banking sector analyst Zeeshan Afzal.

In a detailed report covering all the listed banks operating in Pakistan, Afzal predicts that profits of the banks covered by Topline Securities will grow by as much as 35% in 2014.

These are positive signs for sure. The banking sector has seen some tough time in the recent past. But Afzal believes local banks will be the key beneficiaries of the impending economic recovery and uptick in business activities in coming years.

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Growth in deposits

Deposits of commercial banks increased at a compound annual growth rate (CAGR) of 14.6% in the last five years (2009-13). Banks’ deposits increased 13% on a year-on-year basis at the end of June.

This is slightly lower than the recent growth pattern, Afzal said, noting that the decline is mainly because of slow growth in money supply and revaluation of foreign currency deposits after the appreciation of the rupee against the dollar.

Among large banks that have assets exceeding Rs500 billion, the largest expansion in deposits took place in Bank Alfalah (15.9%) and Habib Bank (15.2%) over the 12-month period ended June 30, 2014.

Other large banks also recorded significant growth in their deposits with Allied Bank, United Bank and MCB Bank posting an increase of 13.3%, 13.1% and 12.4%, respectively.

National Bank was the only large bank whose deposits declined (0.6%) on a year-on-year basis.

Improving credit off-take

The later part of 2008 proved dreadful for Pakistan’s banking sector, as the financial meltdown scared away investors for many years to come. Slow economic growth and unfavourable business environment resulted in subdued demand for credit and banks’ overall unwillingness to lend.

Therefore, the banking sector’s advances grew at a CAGR of only 5% during 2009-13 to reach Rs3.9 trillion in December 2013. This was in sharp contrast to the 10-year average growth rate of 13.3%.

However, Afzal says an improvement in economic outlook and pickup of demand for credit by businesses resulted in 12.5% year-on-year growth in advances at the end of June this year. This was the highest growth rate in banks’ advances during the last six years.

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Sharp rise in investments

As an obvious consequence of economic slowdown, most commercial banks experience low private-sector demand for credit and high government borrowing needs. This is exactly what happened in Pakistan in the aftermath of the 2008 crisis.

“Risk-averse bankers started to park funds in risk-free investments with attractive yields,” Afzal said, referring to the years following the 2008 crisis. This resulted in a sudden increase in banks’ investments, which grew further during 2012 and 2013 when the equity market boomed.

Investments of commercial banks increased at a CAGR of 31.8% between 2009 and 2013 to Rs4.3 trillion. However, they have slowed down of late. Year-on-year growth in banks’ investment was only 5.4% by the end of the 12-month period in June 2014 as opposed to the three-year average of 26.9% during 2011-13.

“In the next three years, Topline Banking Universe deposits are estimated to grow at a CAGR of 12.9% compared to 15.6% in the last three years. Similarly, we estimate advances’ growth at a CAGR of 13.5% in the next three years versus 7.9% in the last three years,” Afzal noted.

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