NON-PERFORMING LOANS ON THE RISE
SUBDUED ECONOMY AND HIGH INTEREST RATES ARE THE TRIGGERS
SHABBIR H. KAZMI
Mar 8 - 14, 2010
The asset quality of the banking system has been deteriorating giving rise to the quantum of net non-performing loans (NPLs). This increase coupled with decline in advances has increased the infected portfolio. The analysis by size of banks show the infection ratio of large banks is below the industry average, while the medium and small sized banks have higher infection ratio which is impacting the overall ratio of the system. Increase in infection ratio in small sized banks indicates inverse relationship between the strength of the bank and infection ratio.
Category-wise breakup shows that substantial part of the overall increase in NPLs occurred in loss category, reflected by higher provisions. NPLs in OAEM, which nearly doubled over the quarter, represent flow of fresh NPLs in agriculture sector. This increase in OAEM category indicates that in case banks are not able to recover these loans, they will have to provide for additional provisions in periods ahead, thus bringing earning under stress.
It would be relevant to highlight that the central bank enhanced the benefit on forced sales vale from 30 to 40 percent, which will impact the infection indicators in multiple ways; decrease provisioning requirements, reduce NPLs coverage ratio and increase net infection ratio (net NPLs to net loans). Another obvious impact would be the increase in capital impairment ratio, which has already increased by 90 bps about 20%. Nonetheless, the benefit of collateral value for making provisions is an international norm. Further, keeping in view the present downturn, the move will facilitate banks in improving their performance.
Ancillary development is the interim instructions issued for facilitating the rescheduling/restructuring of those loans which are facing delinquencies due to economic recession. As banks are already rescheduling/ restructuring loans, these instructions will provide further incentive for keeping those promising businesses alive, which are facing problems only due to macroeconomic conditions.
According to details available with the central bank the loans to corporate, representing over 60% of the overall portfolio, observed a negligible decline over the quarter. Increase in lending to electronics and transmission of energy increased the share of corporate sector in overall advances. Increased demand of loans for establishing power project to meet the power shortfall explains the increasing share of energy sector.
The chemical & pharmaceuticals and cement were other key sectors which gained some share because of increasing cement export and demand for fertilizers and pesticides to support agriculture.
Advances to sugar, textile, automobile & transportation, financial and other sectors were on the decline. In the backdrop of sugar crises, banks were instructed to recover outstanding loans from sugar mills, whereas textile sector faced electricity and gas shortages and lower export demands. The slowdown in business activity also resulted in lower demand for loans within financial sector thus creating a considerable decline. The auto assemblers were affected by low demand due to shrinking auto loans, continued inflation and declining rupee value in relation to Japanese Yen which made their imported parts costlier.
While infection ratios of chemical & pharmaceutical, cement, automobile & transportation and transmission of energy declined infection ratio for sugar sector increased. However, the textile sector due to its constraining factors continued to have the highest NPLs both in terms of infection ratio and absolute amount.
Segment analysis shows increase in advances and share of corporate, and agriculture and commodity finance. However, overall segment concentration remained in line with previous quarters with minor changes. Infection ratio increased for all segments except commodity finance. A considerable deterioration occurred in agriculture, where infection ratio exceeded 20% percent. Increase in NPLs of SME remained main area of concern as infection ratio got close to 23%.
Consumer loans continued downward slide with increasing NPLs as banks are avoiding the risks associated with these facilities. The rate of interest on these loans remains high and inflationary pressures restrain the purchasing power of the consumers. The consumer credit is contracting but its infection ratio increasing. The deterioration mainly took place in secured consumer loans.
The end-use analysis of advances (net) shows increase in fixed investments (long term loans) for corporate sector which depicts some signs of capital intensive activity. However, the working capital financing has shown declining trend in corporate and SME sectors. The movements in the end-use of loans can be further explained by a major increase in long-term loans which were taken up by energy sector. Accordingly the infection ratio for fixed investment declined largely on account of improvement in corporate sector capital formation, while it continued to increase for working capital loans.
Comparison of actual NPL ratio with forecasted NPLR over the last six quarters shows that forecasts were close to the actual observed ratios. However, there has been a significant deviation in CY09, primarily due to abnormal recognition of NPLs by some leading banks, which led to lower than projected value. Given such data limitation some deviation is a natural phenomenon. The projected increase in NPL ratio will impact both profitability and solvency of the system. As the NPL ratio increases, profitability and capital of the banks are wiped out. In worst case scenario, many banks failed in meeting the required minimum CAR.
In recent quarters, considerable volatility in short-term overnight interest rates had remained a significant challenge for both the central bank as well as the market. However, recently introduced mechanism of Interest Rate Corridor seemed to have helped in stabilizing the short-term interest rates.
There has been a gradual depreciation in exchange rate since mid of last year. IMF package and improvement in external account have somewhat stabilized the exchange rate. Banks have effectively responded to this exchange rate scenario by generally maintaining a long NOP position.
The analysis of the banking system's market risk exposures and dynamics of key risk factors indicates a subdued risk profile. In order to assess banks' resilience to unusual shocks in risk factors, they have been subject to seven different market risk shocks. The result of these stress tests also indicates the strong capacity of banks to withstand unusually severe movements in market prices. This capacity emanates from both strong capital adequacy positions of banks as well as their contained risk positions.