If you had three guesses to answer that question, your answer would probably be government, power, and textile sector, given the favoritism meted out by banks in lending to these industries. But there is one more industry banks’ love to lend to, and it isn’t remotely related to sovereign guarantees, circular debt, or exchange income.
It is the sugar industry. If Pakistan were a normal country, sugar industry would top the list of banks’ most favored clients. Consider that aggregate lending by commercial banks to the sugar industry is greater than loans to the readymade garment industry. Net of concessionary finance, total outstanding credit to sugar mills is at par with commercial loans to the spinning industry or power generation companies. In fact, sugar industry is one of the top three private sector borrower type for most domestic commercial banks’, with aggregate borrowing that is higher than all of agricultural loans – crops, livestock, dairy, poultry, aqua- and, horti- culture – put together.
And what sets apart sugar from other major borrowing industries? Two things. First, two-thirds of banking exposure to the industry on average is concentrated within short-term lending, 90 percent of which is rupee denominated or pegged. And two, nearly all banking exposure to the industry is fund based with little non-fund-based earning avenues from foreign trade activities.
Why? Because sugar industry is a seasonal, borrower; borrowing to finance nearly all of its raw material procurement on banking credit. Every year, outstanding banking credit to the industry doubles between October and March, as the industry fires up its boilers to process raw material sugarcane, making nearly all of their payments to farmers from cash credit lines extended by commercial banks. Since sugar production is a seasonal business, bank borrowing declines gradually during off-season, bottoming out by October every year.
But why does industry’s unique dynamic make it the favorite borrower of banks? Although on surface, much of the credit risk is concentrated in short term lending – with no trade income – the risk is in fact significantly mitigated. Most – if not all – of bank lending against seasonal cash credit lines is secured against bank pledge, meaning that the collateral/stocks of refined sugar – are placed under banks’ physical custody (or an independent third party muqaddam, literally meaning custodian).
This means that the borrower (sugar mill) can only take custody of the stocks by first posting payment against the drawdown volume (that is, settle bank’s credit proportionate to the quantity of sugar released). Moreover, if the creditor observes abnormal behavior in the account, such as frequent overdue or abnormal price volatility in collateral (sugar) value, it may sell-off the stocks to settle the outstanding loans. And most importantly, per a recent Lahore High Court decision, the ownership of collateralized sugar stocks stays with sugarcane farmers until such time the mill settle its outstanding dues with farmers, even though the liability of financing extended lies with the sugar mill. Thus, making the bank the custodian of farmer’s financial interest.
Unfortunately, Pakistan is not a normal country. This means that sugar industry is viewed as high credit risk, partly due its exposure to politically exposed persons (PEP) among its many sponsors, but partly also because it’s very poor track record of bank defaults. Consider that the fourth largest lender to the industry is none other than Sindh Bank, with over Rs 21 billion is gross advances outstanding. And while Sindh Bank’s share in total lending to sugar industry may be small – at just 7.5 percent – sugar industry represents one-third of total advances outstanding with the Sindh Bank, the highest concentration risk to the industry for any bank.
It doesn’t take any rocket scientist to figure why the Sindh Bank has been overly generous in lending to the sugar industry, or why Rs 12.4 billion or sixty percent of these loans have been provisioned against. The story is similar for National Bank and Summit Banks’ lending to the sugar industry, with up to 33 and 17 percent of lending portfolio provisioned for, respectively.
Sugar industry yields one of the highest banking spreads on short term lending, especially for corporates. If lending decisions were made objectively, it would possibly be the most eligible borrower of credit lines from commercial banks. Unfortunately, that’s not how business is done in Pakistan.
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