Jan 28 - Feb 03, 2008

The State Bank's much publicized tight monetary policy played little part in curbing credit expansion as its market based policies exerted no influence on money supply which recorded a much high growth during the same year. The SBP market based policies were aimed at checking inflation through price stability objective. To our dismay, neither the objective of price stability was achieved nor could the inflation be brought down. On the contrary, during 2007, we saw the worst food inflation and price hikes. The reasons for the slump in credit growth will, therefore, have to be found somewhere else.

The political turmoil during the year under reference threw the economy in a tailspin. Business and industry, in general, did not risk fresh investment. The ailing textile sector also took a back seat and postponed any recovery measures to some more opportune times. The real estate sector after touching a high during the last few years is also in a state of inertia. Very few fresh house loans are being signed due partly to the market conditions and partly to bank's reluctance to entertain such requests. The speculative forces have also taken a day off and busy in restructuring their balance sheets and waiting for the time for fresh assaults. This is evident from the movement of stock exchange indices which are hovering around a certain level since June last. The recent State Bank directive to directly charge to each year's profit and loss account the respective non performing loans (NPLs) is another factor as the banks have, perhaps, become over cautious in judging the quality of a proposed loan. They can take the initial brunt as their balance sheet bellies are bulging with illegitimate profits earned through the courtesy of an almost double digit spread, but in the long run the only way out for them will be the development of a good quality loan portfolio. The average credit growth recorded by the banking sector during 2003 to 2006 was a high 25 per cent. During the first three quarters of the calendar year 2007, the credit expansion shrank to a meager 2 per cent which later shot up to 10 per cent during the last quarter due to the seasonal demand factor. So, 2007 was probably the year for every one to restructure one's balance sheet. This is one good thing about the sluggish credit growth in 2007.


A traditional question for the investors looking for good investment is, want to eat well or sleep well? To be more civilized to our bankers, we can ask, Want to dine well or sleep well? The Supreme Court has taken sue motto notice of Rs.54 billion write off by the banks to different segments of borrowers during the last few years. This is another good reason for the bankers to wake up and put on their prudence cap at least till such time that the new elected set up forces them to take it off as a sign of respect!

The development of a good quality loan portfolio should be the mainstay of a bank's policy design. Now, what a good quality loan is?

Possibly, a loan collateralized in such a fashion as to ensure, in a default scenario, hundred per cent recovery within the shortest possible time. That sounds quite logical, but only in the case of personal loans. When it comes to commercial or industrial loans, it is imperative for the lending bank that, besides sound collateralization, it ensures the agreed end use of the money. An industrial loan must be invested in the industry. A commercial loan must be used in business. Unfortunately, this is the area where our banks have not only faltered but are found to be conniving with the commercial and industrial borrowers in facilitating the diversion of borrowed funds to the sectors for which they were not meant. This combine of banks and industrial borrowers has done, in the recent past, a colossal damage to the economy when the loans to industry and business were misused in the speculative sectors of stocks and real estate. The State Bank governor once remarked that any worthwhile growth in the textile sector or export was not witnessed despite heavy use of SBP concessionary financing. . May be, the sue motto action by the Supreme Court reminds the banks of the true definition of a good quality loan.


The total credit size in an economy is a function of money supply that is currency plus demand and time deposits held by the banking system. Banks create deposits much in excess of the circulating currency through lending process. This deposit and loan continuum culminates in a balloon like blow-up both of deposits and loans. In certain developed economies, the ratio of actual currency has had been as low as 3 percent of the total money stock; the rest being the money created by banks. This may give one an inkling of the unbridled power of the banks to control an economy. In our case the ratio of currency to the bank deposits is quite high. We are presently having one trillion of currency in circulation as against Rs.3.6 trillion of deposits. Courtesy the growth in net foreign assets (NFAs), the bank deposits during 2007 recorded a growth of 19 per cent as against 13 per cent in 2006.

Based on the size of deposits and State Bank's reserve ratio requirement, the banks develop their investment portfolio. They must invest a certain minimum amount in government securities namely bonds, treasury bills etc. They may also invest in stock exchange up to a certain limit. The major portion of their deposits remains invested in loans to business and industry (and individuals) and this portion of bank deposits together with the loan portfolios of non bank financial institutions determine the economy's credit size at a particular point in time. Our loan portfolio reflected a gross amount of Rs.2.65 trillion as at the end of 2007.

The sluggish credit growth during 2007 did not match the deposits growth during the same period. This gap created excess liquidity at banks which was directed to a safer investment avenue that is government papers. At the end of 2007, banks investment in government securities stood at Rs.1.2 trillion. This marked a shift in the investment policy of banks that at present seem inclined to sleep well.