Bank loans are becoming cleaner than before as recoveries are up and repayments are more regular — thanks to stable interest rates that fell fast in the last fiscal year, as well as sizable corporate earnings and greater prudence being exercised by banks.

Net non-performing loans (NPLs) of all commercial banks made up just 3.12 per cent of their total net loans in December 2013. In September, their net loan-to-net-NPLs ratio stood at 3.79 per cent.

This improvement in just one quarter of 2013 is not a one-time thing: It is in line with a trend that set in much earlier. Net loans to net NPLs of banks had started falling from Q2 of 2013, from a height of 4.6 per cent in Q1.

“So, what we see today has been achieved gradually and consistently over several quarters,” recalls a senior executive of state-run National Bank of Pakistan.

A proactive judicial review of loan defaults before the May 2013 elections had also alerted both banks and borrowers, which led to faster cleaning up of bad loans. Besides, corporate earnings were strong in FY12, which helped with recoveries later on. “These earnings somewhat tapered in FY13, but that didn’t stop the momentum.”

This happened primarily because banks continued making money by investing excessively in government securities. “And that made it possible for them to be overly cautious in meeting credit demands of the private sector,” remarks a central banker.

The fact that instead of making any fresh lending to the private sector, banks witnessed a net retirement of Rs19 billion of private sector loans in FY13 against their net lending of Rs235 billion in FY12, lends credence to this view. In contrast, banks’ investment in government securities totalled Rs1,029 billion, up 36.8 per cent over the year.

According to a Topline Securities sample of 27 companies that represent 64 per cent of the KSE-100 Index’s market capitalisation, corporate earnings totalled Rs337.6 billion in FY12 and only slightly fell to Rs326.5 billion in FY13.

Bankers say these levels of corporate earnings helped in regularisation of bad loans and led to debt recoveries, which shot up from Rs16.4 billion in Q1 of 2013 to about Rs23.9 billion in Q4. In 2012 too, cash recoveries had risen from Rs13.9 billion in the first quarter to Rs26.3 billion in the last quarter.

Central bankers say monetary easing and more vigilant monitoring of bad loans by the SBP also led to contraction in their volumes and improvement in banks’ loans-to-NPL ratios. The central bank’s key policy rate came down from 12 per cent in June 2012 to just nine per cent in June 2013 — a decline of 300bps within a year.

From then onwards, the rate has been raised by 100bps in two equal instalments to 10 per cent, but this came along with an increase in private sector credit demand. Therefore it did not decelerate the process of bad loan regularisation and debt recoveries.

“Stricter monitoring of bad loans is going on. We have developed a new, more revealing template for bad loans reporting for banks,” says a SBP official.

“Now, we have information on a monthly basis not only about bad loans as a whole, but also their due classification and how banks have been dealing with borrowers’ requests to regularise these loans,” he says, while referring to a particular circular for banks issued in June 2013.

Its also important to see movements in banks’ lending rates and contraction in bad loans. Faster transmission of monetary signals has had a more judicious and prompter impact on banks’ lending rates. And due to linking of banks’ minimum deposit rate to the central bank’s repo rate, the gap between lending and deposit rates has narrowed down.

“This has given companies both room and justification to retire expensive bank loans quicker than before, and even regularise payments on non-performing loans,” says another central banker. Banks’ average lending rate on fresh loans (minus zero-rated and interbank transactions) fell to 11.13 per cent in June 2013, from 13.58 per cent in June 2012.

The rupee’s depreciation — of eight per cent and 8.4 per cent respectively in 2012 and 2013 — created surplus local currency liquidity for exporters, multinational companies and others, which maintain foreign currency deposits with banks. Some bankers guess this additional liquidity also facilitated debt recoveries.

In the last two years, foreign currency deposits of all banks increased by one billion dollars to $6.2 billion. The weaker rupee was also responsible for this rise, among other factors like the rise in external trade and remittances.

Contraction in volumes of NPLs in the past two years has minimised banks’ provisioning requirements as well.

The overall stock of net NPLs fell from Rs182 billion in December 2011 to Rs126 billion in December 2013 — down Rs56 billion in two years. Consequently, provisioning charges declined from Rs50 billion to Rs36 billion during this period.