Recent unprecedented floods and torrential rains in the country to some extent intensified the effects of an already fragile macro environment as the non-performing loans (NPLs) of the banking system grew at a faster rate during July-September 2010 quarter.
The asset base of the system also contracted over the quarter, conforming to an established pattern for the third calendar quarter that is marked with slow growth and the end of operating cycle of major Kharif crop-based industries. The macro-environment is already tenuous for the last two years or so. A host of factors ie slackened economic activities, power shortages, security concerns, and higher inflation have squeezed profit margins as well as the repayment capacity of borrowers.
Moreover, the fiscal situation also deteriorated and the public sector borrowed heavily from banks for budgetary support, financing needs of Public Sector Enterprises (PSEs) and commodity operations. Accordingly, there was a shift in banks' asset-mix towards credit to the public sector along with increased preference for top rated corporations- over Small and Medium Enterprises (SME) and consumer that are generally less resilient to economic slowdown and fragility in the operating environment. The heightened credit risk is reflected in a noticeable and persistent increase in NPLs - doubling over two years by the end of CY09 (see Figure 1.1 & Table 1.1).
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Table 1.1: Selected numbers of Balance Sheet and Profit & Loss
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(billion Rupees)
CYO4 CYO7 CYO8 Sep-09 CY-09 Jun-10 Sep-10
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Total Assets 3,043 5,172 5,628 6,105 6,516 6,782 6,626
Investments (net) 679 1,276 1,087 1,593 1,737 1,893 1,873
Advances (net) 1,574 2,688 3,173 3,119 3,240 3,231 3,167
Deposits 2,393 3,854 4,218 4,483 4,786 5,128 5,021
Equity 202 544 563 641 660 668 656
Profit before Tax (ytd) 52 107 63 70 81 59 80
Profit after Tax (ytd) 35 73 43 42 54 36 49
Provisioning Charges 11 60 106 64 97 30 50
Non-Performing Loans 200 218 359 422 446 460 494
Non-Performing Loans 59 30 109 128 134 123 143
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Note: The statistics of profits and provision charges are on year-to-date (ytd)
The growth in NPLs, which decelerated during the first two quarters of CY10, grew by 7.4% during the quarter under review reaching Rs 494 billion (see Table 1.1). This coupled with over-the-quarter decline in lending portfolio amplified the deterioration in infection ratios. However, since these fresh NPLs required only partial provisioning coverage, the system's baseline earning indicators remained positive (see Table 1.2).
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Table 1.2: Highlights of the quarter ended Sep-10
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(in percent)
CY04 CY07 CY08 Sep-09 CY09 Jun-10 Sep-10
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Asset Growth 19.7 18.8 8.8 0.3 15.8 5.4 (2.3)
Loans Growth 42.1 10.7 18.0 (1.8) 2.1 1.9 (2.0)
Deposit Growth 21.9 18.4 9.4 (1.7) 13.5 7.4 (2.1)
Investments Growth (13.6) 53.1 (14.8) 13.1 59.9 5.9 (1.0)
Equity Growth 44.5 35.3 3.4 3.0 17.3 1.2 (1.9)
Capital Adequacy Ratio 10.5 12.3 12.2 14.3 14.0 13.9 13.8
Capital to total Assets 6.7 10.5 10.0 10.5 10.1 9.9 9.9
NPLS to Loans (Gross) 11.6 7.6 10.5 12.4 12.6 12.9 14.0
Net NPLs to Net Loans 3.8 1.1 3.4 4.1 4.1 3.8 4.5
ROA (Before Tax) 1.9 2.2 1.2 1.6 1.3 1.8 1.6
ROE*(Before Tax) 30.5 1.5 11.4 15.1 13.2 17.7 16.2
Liquid Assets/Total Deposits 46.5 45.1 37.7 42.7 44.5 45.3 44.4
Advances to Deposit Ratio 65.8 69.7 75.2 69.6 67.7 63.0 63.1
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-- Based on Average Equity plus Surplus on Revaluation
Note: Growth rates for September-2009, June-2010, and September-2010 are on quarterly basis In line with the established trend for the July-September quarter, the asset base of the banking system contracted by 2.3 percent over the quarter. The Ramadan and pre-Eid withdrawals as well as the increase in currency in circulation (CC) during the quarter led to a narrowing of the deposit base. Banks for the first time since the last quarter of CY08 reduced their holding of government paper, while lending, particularly for commodity trade, also declined.
Additionally, the write-down of goodwill by a bank reduced fixed assets by 9.5 percent during the quarter. Therefore, the asset-mix further shifted towards investments as cash and interbank lending declined at an even faster rate towards the end of the quarter.
The shrinking of the asset base, particularly advances, resulted in a decline in size of the risk-weighted asset (RWA) over the quarter. However, the higher regulatory deductions from Tier 1 capital reduced the eligible capital as well as risk-based capital adequacy ratio (CAR), which deteriorated marginally to 13.8 percent, while staying above the regulatory requirement of 10 percent (see Table 1.2).
The Ramazan and Eid-related enhanced demand for currency, coupled with a slower growth in monetary aggregates and usual passive growth pattern of the third calendar quarter, led to a reduction in bank deposits, moderately straining market-based liquidity. However, the situation reversed in subsequent weeks with the replenishment of deposits forcing SBP to conduct mop ups to check excess liquidity in the market.
In the wake of two consecutive raises of 50 bps each in policy rate, the yield curve gradually inched up and steepened with higher premiums for longer term maturities. The exchange rate depreciated moderately, while equity prices, after following a marginal decline recovered by the end of the quarter. The prices of these financial assets, however, showed contained volatility and owing to banks' limited risk exposures, market risk remained in check.
Going forward, the increased credit risk will remain a major challenge for banks. There is a need for banks to devise ingenious strategies for dealing with the high level of NPLs so that promising businesses, facing transitory difficulties only due to a constrained macro environment, continue to contribute in economic growth and service their obligations in an orderly manner. SBP has responded to the changed and challenging circumstances and rationalised its regulatory requirements on loan loss recognition in respect of advances in flood-affected areas. The usual inventory build up, particularly by Kharif crop-based industries, during the last calendar quarter will create additional demand for bank credit.
Although the banks are expected to remain liquid; the heightened demand for credit from the public sector will mean that the banks ability to finance additional private sector loans will be predicated upon mobilisation of fresh deposits and retirement of commodity finance by government owned agencies, which continues to be extremely high. Banks will need to reduce their large portfolio of government paper and lending to the public sector agencies so as to reduce their sovereign exposure as well as to make credit available to the private sector for maintaining economic growth, and thereby enhance and diversify revenues of the banking system.
Nevertheless, the aggregate earnings of the system are expected to be satisfactory, although these will continue to be concentrated in banks endowed with a wide network and competitively better placed to raise stable and relatively cheap funds. In addition, persistent macro-environment issues will pose a stiff challenge for some banks to enhance their MCR to Rs 7 billion by the end of CY10.
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