July 20 - 26, 2009

The non performing loans (NPLs) of all the banks are on a hike and with the exception of a few small banks all the banks are exhibiting considerable rise in NPLs. The toxic assets of the banks have become the point of concern for investors as well. NPLs have now become the most painful issue for bankers that slashed their profitability and could further hamper the performance in the upcoming years. As a matter of fact, NPLs increases when economy slumps. The deterioration in macroeconomic indicators is making the credit risk unreasonably high.

According to Quarterly Performance Review of the Banking System for quarter ended March 31, 2009 released by the State Bank of Pakistan, the aggregate Capital Adequacy Ratio (CAR) under Basel-II framework, for all banks improved to 12.9% (13.3% for commercial banks). According to report, the heightened credit risk transpired in significant increase in Non-Performing Loans (NPLs). However, even in the face of constraining factors, the banking system earned before tax profit of Rs 26.2 billion for the March, 2009 quarter that was higher compared with Rs10.5 billion in Dec-08 quarter, though lower than corresponding quarter of 2008.

The report pointed out that Non-Performing Loans (NPLs) of the banking system increased to Rs 379 billion (Rs 313 billion in Dec-08) giving infection ratio of 11.5% and net infection ratio of 3.9%. The loan loss provisions to the extent of 69% cover NPLs, but due to increased loan provisions in absolute amounts, earnings of the banking system came under pressure and remained lower than corresponding quarters of last couple of years. The significance of these ratios is manifold as they determine the financial health of bank's balance sheet. Moreover, any increase in NPLs and provisions thereof dilutes the impact of growth in net interest income (NII) because of increased credit cost.

The tremendous hike in NPLs has been mainly due to the rise in NPLs' of commercial banks including National Bank of Pakistan (NBP), United Bank of Pakistan (UBL), MCB Bank, Allied Bank Limited (ABL), and Habib Bank Limited (HBL). Out of all the banking groups, only the specialised banks registered a slight net decline in their NPLs.

The SBP's monetary policy also looks unsuccessful in controlling resurgence of a potential default culture and mounting non-performing loans (NPL's). In a period of six months only (July-Dec 08) net NPL's of commercial banks and DFI's have increased by Rs83 billion. The banks booked provisions of Rs 14.8 billion during first quarter 2009 in their profit and loss accounts versus Rs 12.8 billion in the same quarter of last year when FSV benefit was not allowed. This shows how much the situation has deteriorated in the last one year in the banking industry


1- Economic recession and financial meltdown is affecting the banking sector adversely. Borrowers are unable to pay off their debts owing to exorbitant deterioration in the economic condition of the country. Most of the bankers are of the view that the fiscal year 2009-10 could be another year of low demand and poor performance for the banking sector as well as economy.

2- Textile industry is consuming one fifth of total bank credit. It has accumulated bad loans of over Rs320 billion. This is mainly the consequence of incessant power outages and global recession. Power shortage tends to increase the production cost many times thereby making local products uncompetitive in the international market. The recent announcement of 17% electricity price hike would badly hit the SMEs (small and medium enterprises) and ultimately it will affect banks. This factor will further reduce exports and demand in the local market. Shrinking business volume is causing industries dishonor their financial commitments with banks.

3- Lending to relatively unaware and less literate segments of industry on floating rates has also been a cause of increase in NPLs. Entrepreneurs do not understand and accept the rise in interest rates with the tightening monetary policy of State Bank of Pakistan and become defaulters. Inefficient and unscrupulous borrowers always try to find out an easy exit to avoid repayment of borrowed money with high interest rates.

4- Bursting balloon of consumer financing has contributed a great deal to the increase in default rates. The policy of government to drive consumption led growth turned upside down and banks are now trapped in a vicious circle of small loans, which are very difficult and costly to recover. The collaterals in the shape of cars or consumer durables are perished or have become worthless for the banks. Consumer financing portfolio has a major contribution in the rising trend of NPLs, which is estimated around one-third of the total NPLs. On the other hand, there is an emergence of loan recovery companies also in all major cities of the country. These companies provide assistance to impound cars of defaulters and hardcore recovery procedure for credit cards and personal loans. These companies are new and a few of them are organized on professional lines and have specialized corporate structure.

5- Exporters are trapped in a liquidity crunch and a slowdown in activity has been demanding extension of payment. Law and order situation is also a serious source of concern for economy, which slashes demands. Buyers prefer to go to India and Bangladesh, instead of coming to Pakistan, due to operation against militants in the northern part of the country.


In the prevailing circumstances, the banks are required to further tighten their credit appraisal scrutiny and monitoring procedures to put a check on the fast increase in their NPLs portfolio. Banks should also evaluate their exposures again in very high-risk sectors. Incessant upsurge in default rates is a big threat to the banking system therefore banks as well as SBP should develop comprehensive policy to curb the rising trend of NPLs.

State Bank of Pakistan is trying to cope up with the situation to take the banks out of this issue. The borrowers of export financing scheme have been allowed by the SBP to defer payment of their loans for one year. In this regard, the central bank has presented a Rs. 12 billion package. However, banks and DFIs will take into account the track record, conduct of account, underlying collateral, financial condition and future outlook, volume of exports and overall risk profile of the borrowers in evaluating their requests for deferred payment facility.

In spite of the grim situation, some analysts believe that next year would welcome some major changes in the wake of several mergers and acquisitions like selloff of Royal Bank of Scotland (Pakistan), merger of Mybank with Askari Bank, Silk and Atlas Bank.