The non-performing loans (NPLs) have remained a teasing trouble for financial institutions around the world. The regulators in this aspect are enforcing manifold rules & bindings on lenders to provide shelter to the depositors / investors.

In Pakistan the State Bank Of Pakistan being the regulatory authority in this respect is playing its part and issues various instructions in this regard. Presently the prudential regulations (PRs) are the most significant component in this respect apart from the selective credit control operative simultaneously to other rules.

The selective credit control (SCC) was based on desired economic policy and relies on the security offered by the borrower whereas the prudential regulations (PRs) were time based & relying on Financials of the borrower.

The SCC was result oriented until introduction of new mechanism called interest free banking and also afterwards. But the internal situation in Pakistan, delaying the proper formation of recovery institution, increasing political pressure on the banks and adopting non-commercial policies, injured the health of these commercial institutions.

Feeling it necessary to take corrective measures for the health of these institutions PRs were introduced.

But the increasing portfolio of NPLs is evidence that there are many flaws in regulatory measures including policy & deeds.

There are two schools of thought in respect of lending policy, the one modern or liberal that depend on the financials of the borrowers and are time based, popular in developed countries, the other is called the conservatives that rely on the security and based on the economic requirements. The later being old had been successfully adopted by all the nations even by the developed countries during the era of their early ages until they have achieved and adopted the total infrastructure for new policy.

Now the issue is that which method is appropriate for Pakistan.

Due to low literacy rate the frame work of Accounting standard does not meet with the requirement of modern approach not only that but the judiciary is also not equipped to meet the requirement in this respect. The world famous ENRON scandal is an example to get the lesson from modern policy. Being a developing nation having low literacy rate and loopholes in the system we have no alternate but to adopt the rule for relying on security. One can say that it does not meet the requirements of modern age but it is the only feasible option based on the ground realities of Pakistan.

But the PRs issued in first trench were time & financial based totally neglecting the ground realities and available infrastructure in this respect.

The major rules like:

REGULATION- I
PER PARITY EXPOSURE

The total outstanding financing facilities by a banking company to any single person shall not at any point of time exceed 30 per cent of the bank's unimpaired capital and reserves subject to the condition that the maximum outstanding against fund based financing facilities do not exceed 20% of the unimpaired capital and reserves. In the case of branches of foreign banks operating in Pakistan, the maximum exposure limit of 30% shall be calculated on the basis of their assigned capital maintained under Section 13(3) of the Banking Companies Ordinance, 1962 free of all losses and provisions, provided that maximum exposure on the basis of fund-based facilities shall be 20% of the capital maintained under Section 13(3) of the Banking Companies Ordinance, 1962, or Rs. 12 million which ever is higher.

REGULATION-IV
LINKAGE BETWEEN EQUITY & DEBT

While granting any accommodation, banks shall ensure that the total accommodation availed by any borrower from banks/financial institutions does not exceed 10 times of the capital and reserves (free of losses) of the borrower as disclosed in its Audited Accounts. Every bank shall, as a matter of rule, obtain copy of accounts relating to the business of each of its borrower for analysis and record in the following manner (for the purpose of this regulation, accommodation shall have the same meanings as in Regulation-l above) :

(a) Where the bank's exposure does not exceed Rs. 2 million.	Accounts duly signed by the borrower.
(b) Where the exposure exceeds Rs. 2 million but does not exceed Rs. 10 million.	Accounts duly signed by the borrower and countersigned by the Internal Auditor of the bank or a Chartered Accountant.
(c) Where the exposure exceeds Rs. 10 million.	Accounts duly audited by the practicing Chartered Accountants.
(d) The regulation shall not apply to loans not exceeding Rs. 500, 000/- per borrower

REGULATION- V
CURRENT RATIO

Banks shall ensure that:

(a) Current asset to current liability ratio of the borrower does not fall below the minimum indicated hereunder:

i) Up to 30-06-1998	0.9: 1
ii) As from 30-06-1999	1: 1

Current maturities of long term debt not yet due for payment may be excluded from the current liabilities for the purpose of calculating these ratios. Lease rental receivable within the next twelve months as disclosed in the notes to the annual audited accounts shall be treated as current assets for the purpose of calculating these ratios.

REGULATION - VIII
CLASSIFICATIONS OF ADVANCES ON TIME BASE DEFAULT.
CLASSIFICATION AND PROVISIONING FOR LOANS AND OTHER ASSETS

Every bank shall observe prudential guidelines given hereunder in the matter of classification of its assets and provisioning there against. (see table)

After introduction of prudential regulation the framework provided a base for relying and classifying advances according to age of the default irrespective of the security held.

The Islamic Mode of financing prohibited for charging of return before the expiry period or charging Mark-up on mark-up. Not only that but the loan documents were likewise designed confirmatory to these rules and the legal framework is yet correspondent to the same code, and any violation of this rule will attract the penalty by SBP. But the PRs compels to recover mark-up within 90 days from the borrower, failing which the classification process will be started and the respective loan account will be treated as NPL. These conditions are being contradictory to each other and applicable.

Simultaneously leaving behind no room to lenders for keeping their portfolio in confirmatory to the both rules at the same time.

This time-based table of PRs brought a major portion of advances in the net of NPLs and thus the phrase of engineered default was created.

These Regulations are not being implemented in letter & spirit resultantly banks accommodate their customers violating these rules, and the others are compel to adopt the orbit to secure the business in the competitive atmosphere.

The Auditors of SBP usually conduct their audits in the Head Offices and the authorities there, accommodate them for their pleasure and thus all the exercise do not bring any improvement in the situation.

Resultantly rising trend of NPLs harmed the balance sheets and ratios of almost all financial institutions and this sector was showing worst picture but this was not real reflection of the financial matters and ratios. Most of the advances were very much secured and recoverable and could be considered good on every scale but they classified as NPLs on the scale of PRs and were provided the provisions from the reserves causing heavy damages to the equity, profitability, solvency and efficiency ratios of the banks subsequently.

At this stage the international donors came for the rescue and restructural adjustments were made, causing serious & manifold economic threats.

In 1997 the Remission package for defaulters was announced without getting feed backs and examining the recovery process in letter & spirit. Advances having adequate securities were paid off by the defaulters in response to this policy and huge amount in millions were allowed as remission wiping out the Reserves of Banking sector. The actual termite of bad loans is still crippling the sector.

To show positive results a major change in the policy of PRs were made and the instructions of classification according to the available and reliable security were issued resultantly the advances classified earlier on the basis of Time Frame were kept out of the orbit of NPLs and artificial achievements of the consultants were on the board.

The regulation No: XIX under the heading of half yearly data on financing facilities under automated performance appraisal system (APAS):

Effective from 1st July, 1996, particulars/information regarding financing facilities, both fund- based as well as non-fund based, involving a sum of One million rupees or above shall be recorded at the APAS Unit. Banking Policy & Regulations Department, State Bank of Pakistan;

Accordingly, each bank and development finance institution is directed: (i) that it shall report to the State Bank, particulars of any financing facility that it has extended as per the prescribed Returns, on half-yearly basis as at the close of 30th June, and 31st December, each year }.

Now it requires identification of the persons responsible for Bad Debts, but no preventing measures are taken to keep the Banking System free from these apprentices even no arrangements are made for their training and specialisation in the field of credits but there are proofs that such persons are being honoured with awarding still leading positions for their wrong doings resultantly frustration among the able staff is witnessed and brain drain is harming the total sector particularly NCBs.

The current ratio is made mandatory 1: 1 where as if the working capital is allowed to the client for purchase of stocks the marginal requirements, are 10 to 75% and the cushion must be available in current ratio to meet the marginal requirement, but no such instructions are conveyed leaving behind the loophole.

The Companies Act makes it mandatory for limited companies to appoint their Auditor and the accounts of the company must be audited by that Auditor only, the Income Tax Authorities do not abide these rules particularly in case of Private Limited Companies, the banks are left free to accept balance sheets signed or audited by any chartered accountant. The CAs are not abiding the International Accounting Standard, even the Balance Sheets of leading Banks are being revised by New Management on their taking over to suit their own requirements.

In an atmosphere like that how can the lending be secured on relying the Financials of the borrowers.

The banking sector in Pakistan has developed trend to bring in the front line the Marketing Staff instead of the competent & professional one. No doubt the marketing staff is the backbone of this sector but lacks the managing ability & professional know how.

The PRs grip starts from Rs: 0.500M, the limit was fixed in 1988 when the rupee dollar parity was around Rs: 26/- now the parity is around Rs: 60/- but the limit is not revised, resultantly the business on small scale has been curbed.

The firms are marked defaulters instead of the Managers of these firms. Actually the Managers be made defaulters who are actually responsible for their wrong doings not the entities.

Timely relaxations and corrective measures are not announced for the uplift of the ill health sectors instead of wait until fall policy is adopted.

Mushroom growth in any one sector is not timely curbed to maintain the desirable level for better results but after the excess than viable level, unprofessional curbing measures are adopted to put the running units on ground.

For the better results, feed backs, seminars, workshops, may held in addition to establishing an active strategic economic division at SBP level and Credit Personnels be examined and licensed from SBP as professionals for smooth working and desired results.

(i) Guidelines for Classification of Short Term Facilities:-
Classification	Determinant	Treatment of Income	Provisions to be made
1. OAEM (Other Assets Especially  Mentioned)	Where mark-up/ interest or Principal is overdue (Past due) by 90 days  from the due date.	Unrealized mark-up / interest to be put in Suspense Account and not to be credited to Income Account	Provisions of 2% of the difference resulting from the outstanding balance of principal  less the amount of liquid assets realizable without recourse to a Court of Law.
2. Substandard	Where mark-up / interest or principal is over due by 180 days or more from the due date.	As above	Provisions of 25% of the difference the outstanding balance of principal less the  amount of liquid assets realizable without recourse to a Court of Law.
3. Doubtful	Where mark-up/ interest or principal is over-due by one year or  more from the due date	As above	Provision of 50% of the difference resulting from the outstanding balance of principal  less the amount of liquid assets realisable without recourse to a Court of Law.
4. Loss	(a) Where mark-up/ interest or principal is overdue beyond two years from  the due date	As above	1[Provision of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law.]
	(b) Where Trade Bills (Import/export or inland bills) are not paid/adjusted within 180 days of the due date.	As above.	As above.