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Non-performing loans and their recovery in the banking system

Perhaps one of the stingiest problem for the banking sector is that of non-performing loans (NPL). The phenomenon is more widespread in the Asian financial sector than anywhere else, as incidents of advancing loans on criteria other than pure meritocracy remains rampant in the Asian financial sector.

At the close of 2016, total non-performing loans in the financial sector stood at Rs619 billion. The largest chunk of the pie rested with the local private banks which held 61 percent share of the NPL portfolio. Next in list were the public sector and specialized banks, which held 31 percent and 6 percent of the total amount respectively.

Out of the six major segments that receive advances, namely corporate, agriculture, consumer, SME, commodity financing and staff loans, the highest infection ratio was reported in the SME sector.

The infected portfolio of the corporate sector has been increasing for the last three quarters. In absolute terms, non-performing loans (NPLs) of the corporate sector are already the highest among all segments. The corporate sector was followed by the small and medium enterprise (SME) sector. Infected loans as a percentage of total loans of the SME sector are the highest among all segments. Despite strong support from the government and the SBP, the performance of the SME sector failed to improve, as the percentage of infected loans remains the highest among all segments.

NON-PERFORMING LOANS (DOMESTIC & OVERSEAS OPERATIONS) (Rs. in Million)
Sep-16
Dec-16
BANKS/DFIS
NPLS
NET NPLS
NET NPLS TO NET LOANS (%)
NPLS
NET NPLS
NET NPLS TO NET LOANS (%)
All Banks & DFIs
646,230
112,947
2.21
618,550
93,497
1.68
All Banks
631,326
109,123
2.16
604,666
90,399
1.64
All Commercial Bank
591,777
88,837
1.81
568,446
72,323
1.35
Public Sector Banks
205,011
47,148
5.00
189,091
35,111
3.39
Local Private Banks
383,764
41,697
1.06
376,391
37,219
0.87
Foreign Banks
3,002
(8)
-0.02
2,963
(7)
-0.02
Specialized Banks
39,550
20,286
13.98
36,220
18,076
12.23
DFIs
14,904
3,825
6.15
13,884
3,098
4.51
CASH RECOVERY AGAINST NPLS
BANKS/DFIs
FOR THE QUARTER Sep-16
FOR THE QUARTER Dec-16
All Banks & DFIs
15,490
29,894
All Banks
15,345
29,481
All Commercial Bank
13,325
15,890
Public Sector Banks
2,069
5,350
Local Private Banks
11,253
10,501
Foreign Banks
4
39
Specialized Banks
2,020
13,592
DFIs
145
412

Within the corporate sector, textiles remained the top defaulter with NPLs of over Rs197 billion. Most textile companies are over leveraged due to which they have high financial charges and low net profit. These companies have short term credit terms for longer period assets. In recessionary cycle, the companies are unable to meet their liabilities leading to financial distress. The low value chain in the textile industry is the major reason of current crisis in the sector. There is lack of balancing modernization and rehabilitation (BMR) in the sector due to which operating efficiencies are not available during recessionary environment. The fluctuation in raw material, especially cotton and yarn could be curtailed by introducing commodity hedge futures. A sector-wise breakdown shows individuals constitute the third biggest defaulter group. Advances to this sector were also the third highest owing to lowest interest rates in 43 years. The agribusiness was the second biggest defaulter with NPLs of over Rs58 billion.

Instead of looking at bad loans in absolute terms, such loans should be seen according to their share in total advances of the banking sector. Therefore, the current stock of NPLs poses a minimal threat to the banking system because its share in the total outstanding loans remains thin. Owing to a significant decline in interest rates in the last one year or so, investment in government papers has become a little less attractive for banks, which is pushing them to lend more to private businesses. Therefore, higher advances are resulting in a reduced infection ratio in the short term.However, whenever any sudden increase in advances occur, it usually leads to an uptick in the NPLs over the next few months or years.

The solution lies in having tighter a regulatory framework built around sound credit policies, a proactive rather than a reactive role by the central bank and an efficient recovery system. Mercifully, after a downturn of several years, the banking sector appears to be on a road to recovery, thanks mainly to some bold steps taken by the government. One hopes that the efforts of the government would continue in bringing down the NPL’s amount to what can be considered as a “non-hazardous level” for the banking sector in Pakistan.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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