Rising level of NPLs

It is a matter of grave concern that non-performing loans (NPLs) of country's banking system have been showing a continuously rising trend in the recent past. According to the latest data of the State Bank, NPLs of banks and DFIs registered a hefty increase of Rs 38.3 billion or 6.48 percent to reach Rs 629.6 billion during the quarter ended September, 2011. The increase was much higher than Rs 5.54 billion in the previous quarter and Rs 22 billion in the first quarter of CY11. A major boost in NPLs was recorded by banks. Their NPLs surged by Rs 37.4 billion to Rs 613.2 billion, while NPLs of DFIs rose by less than rupees one billion and stood at Rs 16.3 billion at the close of September, 2011. Among banks, NPLs of public sector banks went up by Rs 26.3 billion, local private sector banks by Rs 8.8 billion, foreign banks by Rs 0.5 billion and specialised banks by Rs 1.77 billion. Another indicator of surging NPLs was the ratio of NPLs to net loans which jumped to 6.53 percent by the end of September, 2011 as compared to 5.48 percent in the preceding quarter, depicting an alarming increase of 1.05 percent in just three months. It may be useful to clarify that NPLs are loans and advances whose mark-up/interest or principal is overdue by 90 days or more from the due date. The swelling of NPLs to such a high level could be attributed to a number of factors. A major reason for the low recovery rate was the difficulty faced by the bankers to recover agricultural loans from the flood-hit areas. According to certain estimates, NPLs of the banking system due to this reason alone could be in the range of Rs 40-Rs 50 billion. Other factors contributing to the decline in loan recoveries could be poor performance of the economy in the past few years, persistent high inflation, power outages, political uncertainty, poor law and order situation and higher cost of borrowed funds. Businessmen, in particular, have been insisting that high lending rates and tight monetary policy adopted by the State Bank have slowed down economic activity in the country and increased the cost of production, resulting in lower recoveries and high level of NPLs. While this may be partly true, the State Bank cannot substantially reduce the policy/lending rates in a situation where inflationary trends are entrenched and the external sector position is still not strong enough to allow the authorities to lower the guard. There is also a perception that banks themselves are to be partly blamed for the problem. They are sometimes accused of lending to parties under political pressure or to their own favourites that have ultimately defaulted. Taking notice of the possibility of such a situation, the Supreme Court had asked the State Bank to direct banks to issue notices to the main borrowers who had gotten their loans written off and present the relevant data. The fact that the Supreme Court had to take notice of the matter speaks a great deal about the seriousness of the situation prevalent in the financial system of the country. The surprising aspect of the rising NPLs is the slowdown in the private sector credit take-off and a considerable expansion in their investment in risk-free government papers in the recent past, which, though not very desirable from the growth perspective, was supposed to lower the ratio of NPLs. It appears that such an opportunity has either been squandered by the banks, or the recovery rate in the private sector has been abnormally dismal to aggravate the aggregate rate of the NPLs. However, whatever the reasons, the recovery rate of loans and advances cannot be allowed to deteriorate continuously due to its adverse impact on the economy. Increasing NPLs would hurt the banking system in the long run and reduce its ability of financial intermediation by lowering the deposit rate, decreasing the will to save and reducing its lending capacity. Some credit must be given to the State Bank for being quite vigilant to the issue recently by insisting upon higher provisioning requirements to contain the level of infected portfolios in order to keep the system more viable and solvent. Nonetheless, as the relevant data suggests, more needs to be done by the SBP to arrest the deteriorating trend in NPLs and force the banks to improve their balance sheets. On their part, the banks themselves also need to redouble their efforts to improve their credit appraisal and monitoring standards to ensure the quality of their assets. Fortunately, Pakistan has not faced the sort of financial crisis witnessed in a large number of other countries but it is better to be alert and erect the necessary safeguards before the issue becomes too hot to handle. Copyright Business Recorder, 2011