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Decline in bank credit

December 10, 2012

Advances of the banking sector saw the first-ever half-yearly dip of Rs17 billion in July-December 2011 over a decade, owing to decline in public sector borrowings.

The decline came from one-off conversion of public sector circular debt and unpaid subsidy on account of commodity operations of Rs78 billion into Treasury bills and Pakistan Investment Bonds in November 2011. This led to net retirements of Rs63 billion of commodity operations. Such retirements were significantly seen in three major commodities: wheat (Rs31 billion), sugar (Rs20 billion) and rice (Rs12 billion).

The bank-wise data reveals that major public sector exposure on account of commodity financing was concentrated in five big banks with cumulative share of 73 per cent in overall financing of Rs336 billion. The needs for public sector financing revolve around few commodities.

As of end 2011, public sector enterprises availed Rs271 billion (81 per cent) for wheat financing followed by Rs41 billion (12 per cent) for fertiliser and Rs22 billion (seven per cent) for sugar.

Government borrowing for commodity financing remained consistently high and rising during past few years due to escalating global commodity prices and increasing wheat support price. Now with the increase in wheat support price by Rs150 per 40 kg, its financing and procurement needs are expected to increase considerably.

Growth of private sector advances, though positive, remained subdued owing to credit risk and resultant non-competitive matrix vis-vis public sector credit. Low growth of 2.3 per cent in private sector advances resulted mainly from seasonal demand for advances in the last quarter of the year.

The domestic private credit off-take usually follows a seasonal pattern with net retirements in the third quarter followed by an overriding credit off-take in the fourth quarter. However, a high magnitude of net retirements during the third quarter of 2011 as compared to retirements in the corresponding periods of last two years, kept the flow of credit to private domestic sector depressed during second half of 2011.

The segment data reveals that most of the increase in credit came from decelerated working capital growth of Rs85 billion against off-take of Rs102 billion in the corresponding period last year. While fixed investment and trade finance observed negative credit off-take.

Continuously escalating global commodity prices especially the oil and raw material prices and domestic inflation kept the demand for working capital finance alive. The driving factors behind the decline in credit flows for trade finance were deceleration in overall exports especially the textile sector, owing to squeezed foreign demand in the US and euro zone, and domestic non-conducive business environment.

Further requirements also came from importers whereas demand for EFS loans remained low. However, demand for fixed investment declined due to already installed but underutilised industrial capacity.

The lacklustre demand for fresh fixed investment financing during the last few years is also translating into a drop in gross fixed capital formation to GDP ratio which exhibits an overall tendency towards consumption-led economy at the cost of potential investments. As empirical studies indicate, financial stability goes side by side with economic development and stability. The continuation of the existing trend may have significant ramifications for banking and financial sector stability.

Though overall credit off-take was sluggish, sector-wise credit demand varied. An exceptional retirement of Rs38 billion was seen in the sugar sector during the second half of 2011, much higher than the retirement of Rs8 billion in the same period the previous year. The inability of sugar mills to offload their inventories before the start of crushing season on account of lower domestic prices kept the advances demand low in this sector. However, government purchased sugar stock to stabilise prices, which facilitated the sugar sector to settle their dues. The low credit demand in the textile sectors (spinning, weaving, finishing etc) was driven by low raw material prices in domestic market and reduced global demand.

Cement sector also registered net retirements of Rs0.2 billion in the second half of 2011 due to squeezed construction activities. Other industries including electronics and electrical appliances and production and transmission of energy sectors also revealed negative credit demand. However, automobile and transportation sector somewhat recovered showing a net credit off-take of Rs2.8 billion in this period against the net retirement of Rs1 billion in the corresponding period of last year. For the same reason credit for agri-business, recovering from dismal performance of last year and chemical and pharmaceutical also showed a positive credit demand.

Credit risk emanating from the loan portfolio of the banks remain the most significant and immediate threat to financial stability of the banking sector. Despite credit contraction and recent trends of banks to park bulk of their incremental funds in safer assets, the credit risk remains the dominant component in the risk profile of the banking sector and has intensified since first half of 2011.

During second half in absolute terms, the risk weighted assets grew by three per cent to Rs118 billion. However a much robust growth in assets of six per cent on the back of investments in government papers markedly outpaced the relatively slower growth in credit risk weighted assets (CRWA). As a result, ratio of CRWA to total assets further regressed by 1.4, dropping to 46.35 per cent by the end of December 2011. However, falling CRWA to total assets over the last few years is not an indicator of lower credit risk, rather it simply suggest a strong flight to quality amid high non-performing loans. Banks have tried to manage higher infections by tightening their credit standards and significantly restricting their lending to riskier sectors, for e.g., small and medium size enterprises and consumer. At the same time, banks have liberally increased their investments in government debt.

The credit conditions appear to have tightened as evident from the decreasing credit risk weighted assets to total assets ratio. Any further tightening of credit conditions could intensify the adverse feedback loop of weak macro economic activity, which could ultimately harm the resilience of the financial system as well.