Loan delinquency is not an entirely avoidable consequence of lending. Entrepreneurs and their financiers - most often bankers - take a view on the unfolding business opportunities and it is expected that they will take calculated risks in pursuing them.

At times their estimates prove inaccurate due to judgmental errors, unpredictable subsequent developments, managerial incompetence on the part of both entrepreneurs and their bankers, or sheer dishonesty of the entrepreneurs with or without the connivance of their bankers.

We have witnessed loan defaults rooted in all these causes and the cumulative damage it caused to the financial services sector as well as its spill-over effects that undermined the economy.

Without doubt, taxpayers eventually paid for losses suffered by NCBs. They paid for the deficiencies of the law, wayward policies of the state and bad business judgment of the borrowers that went unnoticed by lending bankers because of professional incompetence.

But the menace of bank loan defaults was neither the creation of entrepreneurs nor of their bankers. Until late 1960s, loan defaults were few and far between. Bankers tended to be conservative and businessmen maintained high standards of business ethics, particularly in meeting their commitments.

The first signs of fragility in the financial system appeared after the 1971 war when aid from donor countries and soft loans from IFIs began drying up - the backlash from the creation of Bangladesh through a bloodbath. Devaluation of the Rupee beyond the wildest estimates of business and industry compounded the miseries of the otherwise responsible borrowers.

Initially, these developments precipitated defaults on loans extended by DFIs. Later, businessmen who abhorred the idea of defaulting on loan repayments, fell into the habit of doing so signalling the beginning of the rot.

In spite of this dangerous change in borrower perception, in 1974 commercial banks were forced to delve into project financing without first putting in place the requisite risk evaluation and monitoring systems. As a consequence, it exposed them as well to loan delinquency, which continues to-date.

Defaults were most pronounced during the1980s. Distress suffered by the banking sector, and the dubious means resorted to redress it, gave rise to many self-damaging practices, which eventually proved more harmful than the financial losses banks suffered due to loan delinquency.

A side effect of the losses was a drastic reduction in outlay on up-dating IT infrastructure and employee training and skills development. Later, deficiencies in supervisory and control systems, and professional calibre of the bankers led them to commit graver errors in risk management.

Nationalization of banking was a mistake. Although it sought to weaken the emerging industrialist class (which had, allegedly, squandered away peoples' wealth) and achieve a quantum leap in industrial productivity, employment, and living standards but the core administrative capability therefor among the ranks of the bureaucracy, was both limited and lacked the temperament for managing industry with a bias for raising productivity.

In the 1970s, stretching branch networks to unmanageable limits was a recipe for disaster for developing country banks because computerization and modern telecommunication were a novelty even in the developed countries.

Yet, branch networks of NCBs were expanded frantically. During 1974-78, their branch network expanded from 4,400 to 7,183 and their manpower from around 51,000 to 79,200 rendering them unfit for supervision and control, and opening the door for their exploitation.

In spite of these weaknesses, however, banks could do more in the context of loan recovery but for the deficiencies of our legal system and the hardship banks faced in enforcement of court judgments.

In spite of the increase in the number of banking courts, the position had improved only marginally. Even today, thousands of recovery suits await decisions by courts indicating that improvements in the law on financed asset repossession remain inadequate, and continue to encourage defaults since loan defaulters still get enough time to misuse credit.

The reversal of the socialist policies in 1978 and a return to market-based economy, ostensibly to gain the sympathy of the estranged private sector was, in reality, a move to legitimize the regime's own existence.

To unburden NCBs of the slow moving loans they were saddled with by the previous regime, the new regime directed resources to "high" productivity sectors, and credit to private sector rose rapidly thereafter. Yet, until 1989, share of manufacturing stayed unchanged at 14 per cent while that of agriculture fell from 30.8 per cent to 25.7 per cent of the GNP.

There is a grain of truth in the allegations about the regime using NCBs for achieving political ends because, in spite of its claim about undoing nationalization, it did not privatize the NCBs.

Not surprisingly therefore, by early 1985, widespread concerns about the health of the risk asset portfolios of NCBs forced the SBP to conduct a special review of its quality, which confirmed the fears of policy makers. Statistics pertaining to the 14-year period beginning1974 show the extent of damage to Pakistan's banking sector.

1) By 1988, NPLs of the NCBs had risen from Rs558 million to Rs26.571 billion, or roughly 52 times, and

2) Under-provided NPLs had risen from Rs292 million to Rs17.6 billion, or roughly 59 times.

By 1997, NPLs rose to 28 per cent of NCB loan portfolios. Ironically, that year a Swiss banker told me that Swiss Monetary Authority had declared a state of emergency because banks' NPLs had risen to 2.5 per cent of their portfolios.

In Pakistan, in spite of the many remedial initiatives, NPL backlog from the 1980s continues to impact the viability of the banking sector. Latest estimate place NPLs at Rs220 billion, or roughly 20 per cent of the sector's loan portfolio.

This dismal scenario is a reflection of the policies pursued during 1980s and 1990s. Reluctance to re-capitalize NCBs in-time left them with one option: make up for the losses from politically inspired lending by whatever means available.

This encouraged lending to borrowers who were prepared to pay unrealistically high mark-up rates defying the axiom that "you can't charge high enough rate on a loan to compensate for its eventual delinquency". A lot of those loans still form part of the NPLs.

Professional imprudence was manifested in a variety of ways. During 1980s, some consultants developed patent project feasibility report formats. All that a sponsor had to do was to fill in the blanks and submit it to a DFI for obtaining project finance.

Easy credit encouraged borrowers to operate with low equity bases and no concern for profit retention. While lending to such borrowers, impliedly, banks assumed their bankruptcy risk by financing up to 80 per cent of the project cost. Another 10 per cent was provided in the guise of "bridge finance" adjustable against future equity inflows that often didn't materialize.

These ills promoted a culture of disregard for verifying the sustainability of product demand, validating technology cost and sourcing, and knowing about technology adoption trends in regional markets to establish the life cycle of a project and its product.

An example thereof was the setting up of yarn spinning units in mid-1980s based on identical technology that soon became obsolete as competitors in the regional markets switched over to newer technology. These loans account for the single largest chunk of defaulted loans.

The wayward behaviour of investment promotion and trade policies, and changes in tariff and tax rates and monetary and exchange rate policies contributed no less to loan delinquencies. These shocks killed many businesses, virtually overnight.

Ill-advised state policies impacted several economic sectors, and the fortunes of borrowers placed therein. A classic example thereof was the steep interest rate hike during 1990s leading to the closure of several thousand industrial units and enormous losses to their financing banks.

A more damaging aspect of this trend was that a handful of borrowers accounted for nearly two-thirds of the NPLs many of which were rolled-over because front-line bankers had little say therein.

The result: credit was not withdrawn from bad borrowers, and denied to good but non-influential borrowers. It also encouraged lower ranking bankers to adopt passive compliance as their survival mode. Finally, the preferential allocation of resources blunted economic growth and contributed to poverty, which is now our number one problem.