Written-off loans

Scheduled banks enjoy a unique position in the economy Pakistan. As of August 10, 2010, total deposits held with them aggregated to Rs 4.63 trillion. Advances given by above banks as of the above date amounted to Rs 3.32 trillion. This unique position is not enjoyed by any other institution in Pakistan.
It may be interesting to note that the total Federal budget for 2010-11 is Rs 2.77 trillion (current expenditure: 2.0 trillion + ADP Rs 0.77 trillion). As against this amount net Federal Revenue is forecasted at Rs 1.38 trillion - leaving a shortfall of Rs 1.39 trillion to be financed by several sources including external and internal debt and bank borrowing etc.
Consequently, it is high time that the financial sector of Pakistan is well protected against all risks, particularly against bank advances to be written off. The Supreme Court of Pakistan is ceased with this financial grim situation of write off of advances from 1972 - 2007 for Rs 256 billion and during the current democratic regime for Rs 51 billion in two years. A suo motto action has been initiated in this respect by the Supreme Court and the State Bank of Pakistan has been asked to provide significant information in this respect.
Banking in Pakistan: All types of banking services are being provided in the country. Data are available in respect of formal banking system. However, authentic data in respect of informal banking system is not credibly available. Agri finance has a great element of informal banking - to the detriment of the small farmers, as loans are available at exorbitant rate of interest. Out of total advances of scheduled banks of Rs 3.32 trillion, one quarter of a trillion is available for formal advances to agri financing, which is ridiculously low.
Agriculture, being the backbone of the economy of Pakistan, deserves a better deal rather than living with the above situation. However, a survey was carried out in the year 2009 relating to banking practices in Pakistan. Presentation was given to the State Bank of Pakistan. A summary of the survey results was published in the print media last year and is an eye opener for the banking system in the country.
Only 11% Pakistanis have bank accounts - leaving a potential of 89% to be tapped. The position in this respect is Azad Kashmir is 30%, Punjab 12%, Sindh 11%, Khyber Pakhtunkhwa 11% and Balochistan 4%. Only 4% women maintain bank accounts. Thirty-two percent are said to use formal banking.
It is surprising to note that 71% of adult population of Pakistan has a perception that there is no need to maintain bank account. In this backdrop, the whole banking system must use out of box solution with a breakthrough to change the landscape of Pakistan on the financial front. The foregoing figures as a wake up call for all of us. New breed of bankers is the crying need with an innovative approach to increase the spread of banking network in the country to pave the way for documentation.
Written off bank loans: A bank earns its revenue from three major sources namely; (1) Advances given to borrowers (2) investments made in various avenues and (3) services rendered by the banks.
Ordinarily, incomes earned from advances is called mark-up/interest. It constitutes significant segment as a revenue driver. It serves as a lifeline for the solvency of banking, if greater amount of bank advances become either bad or doubtful of recovery, the probability of a bank becoming insolvent becomes greater and greater.
No wonder, there is a great interest on global and domestic fronts for ensuring that Prudential Regulations are followed and implemented properly. Together with this, supervision by central banks as well as by commercial banks should continue to be on vigilant lines.
Monitoring is the name of the game. Every bank is expected to undertake risk analysis and ensure that the probability of risk is as low as is possible. For this, the globally known model of risk management namely, RMMM (Risk Mitigation, Monitoring and Management) should be religiously implemented. However, all types of risk exist. There are genuine risks where a borrower has an intention to pay, but less capacity to repay.
This may be due to slow down in the economy, recession, internal catastrophe, floods etc. In such a situation, several options exist with the bank. First option is to re-schedule the recovery over a longer period rather than ask the borrower to immediately settle the amount borrowed for which the borrower may not have financial capacity to settle his/her loan, despite his/her best intention to do so.
As a last resort, if the amount involved is a small one and the probability of recovery is low. The bank has a better choice to write it off as a normal business loss by treating it as bad debt. However, there are situations where a borrower has capacity to re-pay but no intention to do so. Such a situation is exploited to one's advantage by vested interest due to several clouts, eg political, influential, coercive, undue influence and such other factors.
These people ultimately prove to be stronger than the strength of a bank to recover. Unfortunately, this is mostly due to lack of ethics and with the intention of taking loans and not to re-pay. In such a situation, banks will have disastrous effects not only on its bottom line, but also on affecting the position of the government in collecting lower income tax and the society in terms of growing default culture with a domino effect.
A crackdown by all stakeholders ought to be a positive response against these elements. The civil society must rise to this occasion. The courts must deliver their goods and the entire financial system must be geared up to tackle these elements and curb their negative attitudes for restoring the financial discipline in the country.
This is the crying need of the hour in the society. In the above backdrop, a quantitative analysis of the bank advances written off and as discussed in the press and as reported to the Parliament of Pakistan is now presented with a brief review.
From 1972 to 2007, it is reported that a sum of Rs 256 billion was written off as bad debts by banks in Pakistan. This gives an annual average of Rs 7.11 billion. The Supreme Court of Pakistan, in suo motu action, has taken a serious note of it and asked the State Bank of Pakistan to furnish complete details so that the cases of bank advances, written off to the extent of Rs 256 billion can be fairly and properly examined.
During Musharraf's regime (1999-2007), a sum of Rs 55 billion was written off as bad debt, representing write off advances with an annual average of Rs 7.8 billion. However, it was reported to the Parliament of Pakistan that during the current democratic regime, in two years, a sum of Rs 51 billion was written off as advances by the banks, involving an average of Rs 25.5 billion.
A total of 212,114 people and companies are reported to have benefited from this write off. The names of the banks and the beneficiaries have yet to be made publish. Consequently, the situation is getting from bad to worse. It is high time that this trend is arrested immediately, failing which banks will be heading towards low profitability in the short-run and insolvency in the long run. This financial debacle must be avoided with prudence and strong monitoring. The financial system must rise to the occasion and reverse the above adverse trend, notwithstanding, powerful vested interests.
Growing NPLs trends: NPLs stands for non-performing loans. The tested hypothesis is that with growing amount of NPLs, the financial health of the banks will continue to be deteriorating. Prudent banking requires declining trend of NPLs. It is unfortunate that from December 31, 2008 to March 31, 2010, NPLs have grown by Rs 112 billion as additional burden on the banks. In terms of time series, this NPLs amount as of 31st December 2008 was Rs 345 billion, which till March 31, 2010 was Rs 457 billion. This now represents 14.4% of banks advances.
Accordingly, there is a wake up call for banks and for the State Bank of Pakistan to arrest this unfavourable trend, failing which banking system will grow from a healthy position to a sick one with consequential adverse effects on banking system, lower taxes to the government and sad effects for the society as a whole. The sooner this growing adverse and unfavourable trend is arrested the bearer it will be for all the stakeholders.
Way forward: This piece has addressed only one theme namely, need to organise banking sector house in proper shape in the larger interest of strengthening Pakistan's financial front. The Supreme Court of Pakistan has already taken up this issue. Now, the Parliament is requested to get serious and earmark at least two days for a full-fledged debate for studying the root cause of growing NPLs and upward trend of write off of bank advances.
This piece has highlighted consequential domino effects of this situation and the democratic government will be strengthened. If our house has to stay in order, we must take serious note of the grim financial situation and rise to the occasion for a positive and productive solution to the challenges facing the country on the foregoing fronts with determination and will power.
The increase in NPLs and written off advances should be firstly grounded to zero level and later the trend should be reversed to the ultimate advantage to various stakeholders in the country. There is a need to have a fresh look at the existing laws and amend these to curb the unhealthy trends stated above.
The challenge is big, but our response should be bigger and by Allah's grace, we after exercising the willpower, can find solution to the foregoing problems. Let us get committed to the job and deliver the goods in a befitting manner. Time is on our side and we should translate it to our solid advantage.
(The writer is professor emeritus and founder Principal of Hailey College of Banking & Finance, University of the Punjab, Allama Iqbal Campus, Lahore) ([email protected])