Private credit: a far cry from a boom!

We already discussed in this column that there is an up tick in bank lending to the private sector, with a healthy bump in lending to the energy sector recently. (Read: Corporate credit: Energy leads the way, published July 3, 2017). There are some interesting trends that need to be considered in detail.

One: long term loans have been increasing significantly to the corporate sector and in fact, fixed investment (FI) advances reached 47 percent in Mar-2017 as a share of all lending (38% in Mar-2014). This share has slowly been going up, against a fall in share of working capital (WC) lending. For SMEs too, this share has gone up since 2014 but in contrast to the corporate sector, this share has remained stagnant over the past year; and lags significantly behind the corporate sector. Working capital remains the prominent lending mode to SMEs.

The trend for greater fixed investment loans come at the back of higher demand for capital expenditure and are witnessed in many sectors ranging from textile to sugar to construction segments. SBP’s latest quarterly report relates it to the recovering economy: “Apart from being a direct outcome of low interest rates, this trend also reflected an improvement in the investment climate manifested in the country’s better risk perception and an improved energy outlook”.

Now partly the reason for low FI lending to SMEs could be the demand itself—larger firms are more likely to think about expanding or require long term financing terms whereas SMEs require more of the immediate day-to-day working capital finance, or trade finance for SME exporters. But it also comes down to the size of the loans and the higher risk factor associated with SMEs to which banks are still hesitant to lend.

This leads to our second point, that perhaps the high risk factor for SMEs, particularly in giving out long term loans, is more perceived rather than based on evidence. It is to note that the infection ratio for fixed investments to SMEs is much lower than that for working capital finance. In Mar-2017, nonperforming loan (NPL) ratio for FI was 13 percent against NPL ratio for WC at 26 percent for SMEs. Long term loans traditionally have lower infection ratios in the overall private sector.

Thirdly, overall credit up tick has been largely because banks have greater liquidity available given higher deposit generation, and lower government borrowing from banks. The SBP sites government’s financing facilities and schemes as additional reasons for the ability of banks to lend more—outstanding financing under Long-Term Financing Facility (LTFF) increased by Rs30 million during Jul-Mar FY17, according to the SBP quarterly report. Conversely, the share of SMEs utilizing these schemes is paltry.

It is also prudent to point out that the up tick in lending comes from the energy sector which is the greatest recipient from banks but this is because it carries very low credit risk as the projects are government guaranteed. Whereas there are now four private credit bureaus as well as the SBP- Credit Information Bureau (CIB) that creates credit reports of borrowers, the infection ratio is still much too high for the corporate sector and SMEs—11 percent and 22 percent respectively in Mar-2017 compared to 5 percent or less for most emerging economies. This will continue to affect banks’ ability to issue higher credit.

Greater lending is a positive sign, but we are far from done when it comes to expanding bank credit base while NPLs remain high. The growth today should be evaluated looking at various factors starting with how diversified the lending portfolio is for banks. SMEs still carry a small share despite recent targets set by SBP for banks and improved prudential regulations. The road ahead is long.