September 24, 2007	Monday	Ramazan 11, 1428

Non-performing loans of both commercial and specialised banks rose to Rs184 billion at end-March 2007 from Rs173 billion at end-December 2006- a rise of Rs11 billion in just three months. The stock of non-performing loans net of provisioning also increased to Rs47 billion from Rs36.5 billion. And as a result, the ratio of net NPLs to net loans climbed to two per cent from 1.5 per cent.

Over this period, the gross NPLs of commercial banks rose to Rs142.8 billion from Rs134.5 billion, and that of specialised banks increased to Rs41.3 billion from about Rs38.7 billion.

The increase in NPLs indicates that the private sector is finding it difficult to service bank debt on time. And in their race for earning profits ,banks err while evaluating credit quality.

The volume of NPLs has shown an increasing trend after some years while banks’ profits have grown rapidly—thanks to low tax rates and high banking spread. The after-tax profit of the banking system zoomed to Rs84.1 billion in calendar year 2006 from just Rs2.9 billion in 2002. And in Q1 2007 it reached at Rs21.6 billion.

On the other hand, the cost of production and trading has risen sharply due to high inflation and high cost of water, gas and electricity plus a substantial increase in the bank interest rates. Bankers say that this has forced even their prime borrowers to defer debt repayments.

“Besides, banks have developed a sort of herd mentality in credit making which too is responsible for increasing NPLs,” says head of credit division of a large commercial bank.

Most banks are too focused on consumer lending without ensuring whether, “it is their cup of tea.” Resultantly, many are accumulating bad loans as they lack the expertise needed to manage such assets.

Although the loan infection ratio of consumer loans remained low at 3.2 per cent at end-March 2007, it saw a full percentage point increase during the quarter. From borrowers point of view, a big jump in mark-up was responsible for this situation.

Within the consumer loans portfolio, the highest rate of default was seen in credit cards. Bankers say they received a lot of cases of credit card payment problems during January-March 2007. “After close scrutiny we found that an increase in the mark up rate had created these problems,” said the head of a consumer finance at a local bank. “Besides, our staff who verified credentials of credit card seekers had not done their homework well,” he admitted.

At end-December 2006, credit cards had a loan infection ratio of 1.4 per cent which jumped to 3.7 per cent at end-March 2007.

In January-March 2007, corporate loans also came under NPLs as some seasonal loans issued earlier and due for repayment in July-September 2006 remained unpaid for next six months. Top bankers say corporate loans became infected partly because of the private sector’s financial woes and partly due to the banks’ inability to supervise these loans prudently.

This fits well into the much talked-about theory that part of the Rs402 billion private sector loans disbursed in FY06 was used for investment in stocks and in the real estate. And as the real estate prices slumped by the end of 2006, the borrowers began to defer debt payments.

The rise in corporate NPLs also suggests a co-relation between credit growth/NPLs and between NPLs and corporate leverage.

It has been observed that when the private sector credit grows strongly in a particular year, the stock NPLs shows a build up in the following year.

For example, when in FY05 private sector credit grew to an all time high of Rs438 billion, the gross NPLs of commercial banks also increased by Rs4 billion.

Since the private sector credit of Rs402 billion in FY06 was in excess of the target of Rs330 billion, an increase in NPLs of commercial banks in FY07 may be explained by the quality of credit.

Similarly, studies suggest that the banking sector asset quality is dependent on the financial health of the corporate sector. As the corporate sector’s profitability in calendar year 2006 was weaker than in 2005, it also increased NPLs till the end of March 2007.

Bankers involved in credit disbursement say that NPLs for April –June 2007 might also show further increase. They say that the agriculture sector would see repayment problems as the monsoon rains and floods have stripped farmers of cash. Textile spinning sector is also facing liquidity problems and is unlikely to repay bank loans on time. And higher interest rates on consumer loans would continue to create payment problems.

Agricultural loans show the highest loan infection ratio because loan recovery in rural areas dominated by powerful feudal lords is not a simple task. At end-March, 23.7 per cent of all agricultural loans were non-performing.

Bankers say non-performing loans are likely to increase further in April-June 2007 due to not-very-tight credit policies of banks during calendar year 2006. But as banks became more prudent in lending with the start of 2007, “you’d see its impact on NPLs after six months and I’m sure from July 2007 onwards there will be some regression in NPLs,” predicted a senior official of state-run National Bank of Pakistan.

An SBP official said, the SBP views the growing trend in NPLs with concern “but we are certainly not alarmed.” The reason is that the bulk of NPLs upto March 2007 are concentrated mostly in initial categories i.e. where the principal or interest or both remained unpaid for three months or six months. A State Bank report, however, showed that a portion of total NPLs was also liable to be treated as “Loss”.

Going forward, “banks will have to further tighten their credit appraisal and monitoring standards to stem increase in their NPLs portfolio and re-assess their exposures in relatively high risk areas,” says the report.

Bankers involved in credit disbursement and recovery say that a fast-paced mergers and acquisitions in the banking industry had also contributed to growth in NPLs. While mergers and acquisitions go on, many bankers switch over jobs and newcomers take time in having a grip on their new assignments. As a result banking operations suffer including in the areas of credit quality assessment and recovery.

(During January-March 2007 banks’ cash recovery fell slightly to Rs7.15 billion from Rs7.25 billion during October-December 2006).

“Generally speaking, banking industry is facing human resource scarcity, particularly at the middle and low levels,” says Raza Fatimi, himself a mid-level official in credit department of a local bank. “We hire new boys on contract and train them in different disciplines but it is just too difficult to get the best out of them,” he said and admitted that banks often do not pay them enough.

Earlier this month, the SBP sent a draft circular to all banks proposing that they make 100 per cent provisioning against all NPLs instead of following different slabs currently in practice.

It also proposed that the time period of one year should be reduced to six months for classifying non-performing personal and consumer loans as “Loss.” After having input from banks the central bank is likely to implement new standards from next year to stimulate loan recoveries. But banks fear a big decline in profits in case of implementing these measures.

An executive member of Pakistan Banks Association said making 100 per cent provisioning against all categories of NPLs could be very difficult. “The proposal about reducing the time period for treatment of non-performing personal and consumer loans as loss, merits consideration.”