Not all commercial banks are created equals. And some are certainly better capitalized than others.

As the economy completes 365 days of above 20 percent policy rate for the first time in history, rising NPLs have become a serious concern among market watchers. Calls for a reduction in the base rate have increasingly picked pace as real interest rates also turned positive for the first time in three years. Are NPLs truly on the rise, and is the industry truly struggling to service outstanding debt?

Not significantly, at least according to the official statistics reported by SBP and the commercial banks. Per SBP, total NPLs for commercial banking industry stood under a trillion rupees against gross advances of over Rs 13.5 trillion as at December 2023. Although the ratio of NPLs against gross advances has increased from 6.5 to 6.94 percent between 2022 and 2023, NPL level is well below historic averages. For context, NPL ratio stayed in early double digits till mid-2010s, back when policy rate was close to 7 percent and inflation within single digits.

That does not mean all banks are doing well or equally poorly. Various small and public sector banks have abnormally high NPL levels, well above industry average. Bank Makaramah and Sindh Bank top the list, with 69 percent and 42 percent of advances portfolio in red, followed by Al-Barakah at 14 percent, National Bank at 14 percent, and Bank of Khyber at 12 percent, respectively. But the loan defaults at these troubled banks didn’t start with the latest monetary tightening cycle. Therefore, high rate of defaults on bad loans made by poorly managed banks makes for a bad argument to reduce markup rates.

To look at whether the banking industry is at any substantial risk of witnessing a series of defaults, it is important to review recent trends in NPLs. In fact, over the last year, five commercial banks managed to lower their NPL to advances ratio, while seven others recorded an increase of three or lower percentage points. No bank recorded an increase large enough relative to its equity to pose an industry-wise contagion. So, what’s all the fuss about?

Turns out, the contagion risk could be sector specific. Although no major banks (except for those chronically troubled) are facing high NPL rates, the ratio of NPLs against loans made to textile industry is on the rise. Annual financial reporting by major commercial banks indicates that while total industry NPLs rose by Rs 98 billion during 2023,of these Rs 28 billion pertained to textile.

Historically, textile’s share in banking sector advances has averaged at 16 percent, with ratio of NPLs in credit to textile averaging at 18 percent all of 2012-2018 on industry wide basis. 2022 was the first time in recent memory when share of NPLs in credit exposure to textile rose above 20 percent, which reached 21.5 percent as at December 2023. Textile NPLs are on the rise, but is the pace significant enough?

Here too, context is helpful. Not all banks are equally at risk, but some have been facing these risks for much longer than others. Trade oriented banks, such as Al-Habib and Metro, historically have an over weighted share in lending to textile as a share of total advances – at 32 percent and 41 percent respectively, against the industry average of 16 percent. However, more recently, the share of textile NPLs (in total NPLs) for these two banks has also increased dramatically, with textile NPLs accounting for 67 percent of total NPLs for Metro, and 38 percent for Al-Habib.

But are these banks in trouble? Not so much. Infection ratio in the textile portfolios of the two Habib families’ banks is still well below ten percent, meaning that despite an over indexed credit exposure to textile industry for either bank, most of their borrowers are still timely servicing their loans. Meanwhile, things don’t look so good for Allied Bank, where ratio of NPLs in lending to textile rose from 7 percent to 11 percent in 2023, with textile NPLs accounting for 80 percent of the banks’ total NPLs. But the country’s fifth largest conventional bank cannot exactly be in trouble when the infection ratio against gross advances is well under two percent, with only a marginal increase over last year.

In absolute terms, however, some banks recorded significantly larger amounts as classified than others. While an increase of Rs 7 billion in textile NPLs for HBL doesn’t account for much at a bank with gross advances closing in on two trillion rupees, Al-Habib and JS recording rise of Rs 8 billion and Rs 6 billion, respectively in a single year should at least raise eyebrows of shareholders. While Al-Habib may be the largest lender to textile industry – its cousin and close second, Metro – only recorded NPL increase (to textile) of under Rs 0.7 billion. Surely, an abnormal rise in the quantum of textile NPLs at some banks looks more like a result of bad credit decisions (or credit decisions gone bad), than an outcome of industry wide slowdown or portending of any contagion risk.

In conclusion, does the rise in textile NPLs pose a systemic risk to the banking industry? The latest official statistics from commercial banks do not paint a very bleak picture. Credit for which must be laid at the altar of sponsor/relationship lending concentrated largely to big business groups, and the moral hazard called the TERF scheme, which substantially lowered the weighted average markup rate for the textile industry, never mind the historic Kibor of twently percent plus.

Are some banks more in the red than others? Definitely. But that’s called business risk. It may not be such a bad idea after all if the banking industry finally reacquaints itself with its primary business called lending, and the pitfalls of concentrating exposure in selected sectors or industries.

Does this mean some banks will perform worse than others? Sure, but that’s for the shareholders to judge, not the regulator. Don’t use rising provisioning at some banks as an excuse to influence policy decisions that should in principle be purely based on economy wide fundamentals.