SBP proposes 100 percent cash provisioning for NPLs: 40 percent drop in banks profitability feared
The State Bank of Pakistan has floated a proposal for 100 percent cash provisioning for Non-Performing Loans (NPLs), which could reduce the profitability of banks by 40 percent if it is applied from current financial year.
A draft circular sent by SBP to the heads of all banks and DFIs, proposes to completely withdraw the facility of Forced Sales Value (FSV) against all NPLs for calculating provisioning requirements with effect from December 31, 2007. Furthermore, the time period for classifying Personal Loans and Consumer Loans as 'Loss' is proposed to be reduced from 360 to 180 days.
Scheduled Banks are expected to make a combined profit of Rs 100 billion in 2007. In case the banks have to allocate Rs 40 billion or more towards provisioning alone, some weak banks would be hard pressed to meet the SBP capital requirement of Rs 4 billion in 2007.
The total impact on leading banks of adopting 100 percent provisioning - without taking into account the sub-standard and doubtful categorisation presently in vogue shows: At present, banks make full provisioning against overdue loans of less than Rs 10 million. For NPLs above Rs 10 million, banks classify them in three categories, ie substandard; doubtful and loss.
Where the collateral provided by the borrower is in securities or bonds or Certificates of Investments (CoIs), ie liquid banks can encash them on default without recourse to a court of law.
In cases where collateral is land, building or machinery, banks need to classify them as substandard if the mark-up/interest or principal is overdue by 90 days or more - banks first subtract the value of liquid security from the overdue amount and on the balance, they take 25 percent of FSV amount into provisioning.
When 180 days have elapsed on the overdue loan, then 50 percent of FSV amount has to be allocated towards provisioning. After one year has elapsed the full amount of FSV goes towards provisioning.
Now SBP wants the banks not to take advantage of FSV in provisioning and treat it as nil value and instead provide 100 percent cash in provisioning. And, only when the machinery or land or building is sold (after due court process) only then take the realisable amount into their income. The court proceedings in Pakistan, unlike the developed countries takes four to five years.
Knowledgeable bankers while agreeing with the basic thrust of the SBP directive, strongly feel that pragmatism demands that the changes in provisioning requirement sought by the SBP need to be phased out over a three to four years period instead of applying them in one go from the current year. They point out, that in the past, SBP did give three years, to scheduled banks to adjust this substandard, doubtful and loss categorises.
It is also suggested that asset quality needs to be differentiated. Normally the land value (in case of clear title) increases over time; building value depreciates slowly and it can be valued at, say, 50 percent of the original cost even though construction cost is going up, and machinery value can be kept between 25 to 40 percent.
It is also pointed out that banks lend only 70 percent against the value of fixed assets. Therefore, there is sufficient cushion available to them prior to disbursement of loan.
The following Draft Circular has been issued: "Amendments in prudential regulations - provisioning for loans and advances: Please refer to BSD Circular No 7 dated November 01, 2005 on the above subject.
2. In terms of Para 2(ii) of the above-referred circular, banks / DFIs were advised that separate instructions for withdrawal of the benefit of Forced Sale Value (FSV) of collateral shall be issued in due course. The matter has been revisited and it has been decided to completely withdraw the benefit of FSV against all NPLs for calculating provisioning requirement with effect from December 31, 2007.
3. Accordingly, the following Prudential Regulations (PRs) stand amended and are attached herewith:
i) Annexure-IV of Regulation R-8 of PRs for Corporate/Commercial Banking.
ii) Annexure-III of Regulation R-11 of PRs for Small and Medium Enterprises Financing.
iii) Regulation R-22 (Housing Finance) of PRs for Consumer Financing.
4. Furthermore, the time period for classifying Personal Loans as "Loss" has been reduced from one year to 180 days. Accordingly, the amended Regulation R-27 (Personal Loans) of PRs for Consumer Financing is also enclosed."
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Amounts in PKR Mn; Per share in PKR
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Banks NPLs NPL Provisions Incremental Shares Per Share
June-07 Specific General Provisioning Million Impact
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National 37,395 (28,741) (2,086) 8,654 815.43 6.90
Habib 31,580 (18,462) (1,094) 13,118 690.00 12.36
United 17,900 (12,175) (1,368) 5,725 809.38 4.60
MCB 9,404 (6,633) (2,772) 2,771 628.28 2.87
Allied 10,619 (7,489) (159) 3,130 538.64 3.78
AlFalah 3,532 (1,727) (1,116) 1,805 650.00 1.81
BOP 2,352 (1,159) (150) 1,193 384.58 2.02
Askari 5,942 (3,440) (810) 2,502 300.65 5.41
Faysal 3,095 (1,190) (382) 1,905 423.72 2.92
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ANNEXURE-IV
GUIDELINES IN THE MATTER OF CLASSIFICATION
AND PROVISIONING FOR ASSETS (REGULATION R-8)
All Financing Facilities (including Short, Medium and Long Term)
=============================================================================================================
CLASSIFICATION DETERMINANT TREATMENT PROVISIONS TO
(1) (2) OF INCOME BE MADE
(3) (4)
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1. Substandard. Where mark-up/ interest Unrealised mark Provision of 25% of the
or principal is overdue up/interest to be kept difference resulting from
by 90 days or more from Memorandum Account the outstanding balance
the due date. and not to be credited of principal less the
Income Account except amount of liquid assets
when realised in cash realisable without
Unrealised mark recourse to a Court of
up/interest already taken Law.
to income account to
2. Doubtful. Where mark-up/ interest reversed and kept
or principal is overdue Memorandum Account. Provision of 50% of the
by 180 days or more As above. difference resulting from
from the due date. the outstanding balance
of principal less the
amount of liquid assets
realisable without
3. Loss. (a) Where mark-up/ recourse to a Court of
interest or principal is Law.
overdue by one year or As above. Provision of 100% of the
more from the due date difference resulting from
the outstanding balance
of principal less the
amount of liquid assets
(b) Where Trade Bills realisable without
(Import/Export or Inland recourse to a Court of
Bills) are not paid/adjust-As above Law.
ed within 180 days of the As above.
due date.
=============================================================================================================
NOTE: Classified loans / advances that have been guaranteed by the Government would not require provisioning, however, mark up / interest on such accounts to be taken to Memorandum Account instead of Income Account.
ANNEXURE-III
GUIDELINES IN THE MATTER OF CLASSIFICATION
AND PROVISIONING FOR ASSETS (REGULATION R-11)
All Financing Facilities (including Short, Medium and Long Term)
=============================================================================================
CLASSIFICATION DETERMINANT TREATMENT PROVISIONS TO
(1) (2) OF INCOME BE MADE
(3) (4)
=============================================================================================
4. Substandard. Where mark-up/ interest Unrealised mark- Provision of 25% of the
or principal is overdue up/interest to be kept in difference resulting from
by 90 days or more from Memorandum Account the outstanding balance
the due date. and not to be credited to of principal less the
Income Account except amount of liquid assets
when realised in cash. realisable without
Unrealised mark recourse to a Court of
up/interest already taken Law.
to income account to be
5. Doubtful. reversed and kept in
Where mark-up/ interest Memorandum Account.
or principal is overdue As above. Provision of 50% of the
by 180 days or more difference resulting from
from the due date. the outstanding balance
of principal less the
amount of liquid assets
6. Loss. realisable without
recourse to a Court of
(a) Where mark-up/ As above. Law.
interest or principal is
overdue by one year or Provision of 100% of the
more from the due date difference resulting from
the outstanding balance
of principal less the
amount of liquid assets
As above realisable without
(b) Where Trade Bills recourse to a Court of
(Import/Export or Inland Law.
Bills) are not paid/adjust-
ed within 180 days of the As above.
due date.
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NOTE:
Classified loans / advances that have been guaranteed by the Government would not require provisioning, however, mark up / interest on such accounts to be taken to Memorandum Account instead of Income Account.
REGULATION R-22 The mortgage loans shall be classified and provided for in the following manner:
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CLASSIFICATION DETERMINANT TREATMENT PROVISIONS TO
(1) (2) OF INCOME BE MADE*
(3) (4)
===========================================================================================================
1. Substandard. Where mark-up/ interest Unrealised mark- Provision of 25% of the
or principal is overdue up/interest to be kept in difference resulting from
by 90 days or more from Memorandum Account the outstanding balance
the due date. and not to be credited to of principal less the
Income Account except amount of liquid assets
when realised in cash. realisable without
Unrealised mark recourse to a Court of
up/interest already taken Law.
to income account to be
2. Doubtful. reversed and kept in
Where mark-up/ interest Memorandum Account.
or principal is overdue As above. Provision of 50% of the
by 180 days or more difference resulting from
from the due date. the outstanding balance
of principal less the
amount of liquid assets
3. Loss. realisable without
recourse to a Court of
Where mark-up/ interest As above. Law .
or principal is overdue
by one year or more Provision of 100% of the
from the due date difference resulting from
the outstanding balance
of principal less the
amount of liquid assets
realisable without
recourse to a Court of
Law.
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REGULATION R-27 The personal loans shall be classified and provided for in the following manner:
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CLASSIFICATION DETERMINANT TREATMENT PROVISIONS TO
-1 -2 OF INCOME BE MADE*
-3 -4
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4. Substandard Where mark-up/ interest Unrealised mark- Provision of 25% of the
or principal is overdue up/interest to be kept in difference resulting from
by 90 days or more from Memorandum Account the outstanding balance
the due date. and not to be credited to of principal less the
Income Account except amount of liquid assets.
when realised in cash.
Unrealised mark
up/interest already taken
to income account to be
5. Loss reversed and kept in
Where mark-up/ interest Memorandum Account. Provision of 100% of the
or principal is overdue As above. difference resulting from
by 180 days or more the outstanding balance
from the due date. of principal less the
amount of liquid assets.
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NOTE: These specific provisions will be in addition to general reserve maintained under Regulation R-4.
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