The quarterly performance review of the banking system, as reported by the State Bank of Pakistan (SBP), has revealed a massive rise in non-performing loans (NPLs) of the banking sector in the first quarter of 2009/10. The reason attributed to the rise in NPLs is the slow down in economic activity, sourced partly to declining exports due to global recession, and partly to declining domestic productivity due to load shedding and high interest rates.
This revelation should lay the accusation to rest that all NPLs are the outcome of unscrupulous influential borrowers, who effectively exerted tremendous pressure on financial institutions to not insist on providing realistic collateral and also, in time, to write off billions of rupees worth of loans. This is not to deny that some of the NPLs maybe sourced to such influence.
Examples of large NPLs in other countries that threatened the very fabric of their banking sector may provide the answer to what needs to be done in this country. In the late 1980s, the Japanese corporate sector began to embark on aggressive borrowing to purchase land as land prices soared and offered land as well as stocks as collateral.
When land prices fell in 1991, as did stock prices in 1992, the NPLs rose dramatically. In 1997, the rise in NPLs contributed to the depth of the South Korean financial crisis and the two factors, identified as being responsible for the rise in NPLs, were contagion (with a typical chaebol ownership spanning the corporate as well as the banking sector) as well as currency speculation. Short-term measures to strengthen the financial sector, in both Japan and South Korea, required the injection of public funds into major banks and financial institutions.
Reform, with the objective of reducing the likelihood of a rise of NPLs in the future, required long-term measures that included the following: (i) privatisation of state-run banks and development financial institutions to, not only mitigate charges of nepotism in extending loans, but to ensure that decisions are based on the risk assessment of a borrower; (ii) improving accounting, auditing and financial disclosures of the banks and the borrower; and (iii) modernisation of the insolvency system.
These measures, among others that were specific to the needs of these two countries, have ensured that NPLs sourced to nepotism declined. However, these measures alone cannot obviously guarantee that the NPLs sourced to economic performance would decline. In other words, there is an urgent need to distinguish between those NPLs that were written off due to an economic downswing and those that were written-off due to influence peddling in Pakistan.
It is acknowledged by all that the global recession has impacted on the ability of borrowers to pay back loans. Additionally, it is also known in Pakistani banking circles that the economic downswing has been even more acute here than in the economies of our competitors in the international marketplace.
In this context, it is critical for the government to determine a modus operandi that would be fair and in the country's long-term economic interests. This must include a plan to resuscitate the productive sectors to ensure that defaults are avoided.
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