RISING DELINQUENCIES

INCOME OF BANKS IS LIKELY TO COME UNDER PRESSURE DURING SECOND HALF OF 2010.

SHABBIR H. KAZMI
(feedback@pgeconomist.com)
Nov 8 - 14, 20
10

The post flood situation of commercial banks is still not clear. Since this was an exceptional happening analysts are ready to witness major deviations in the financial results of the commercial banks for the third and fourth quarter. However, the best evaluation of the sector is evident from State Bank report for the first half of CY10.

The overall economic environment has been showing the signs of weakness since the later half of 2008. The slowdown in economic activities and deterioration of borrowers' repayment capacity resulted in increased credit risk and significant growth in non-performing loans (NPLs).

Banks accordingly adopted risk-averse strategy of assets allocation that incidentally emerged in the backdrop of high credit demand from the government for budgetary support, commodity operations and inter-corporate receivables of PSEs, and banking system's asset mix gradually shifted away from loans and advances to investments in government papers and public sector lending.

Due to higher loan-loss charges and pressure on profit margins, the earnings of relatively small-sized banks have come under strain. However, after facing a transitory strain in the last quarter of CY08, liquidity profile of banks gradually eased off as their balance sheet composition gradually shifted towards liquid assets.

Though the business conditions remained tenuous, the banking system witnessed some letup in the buildup of credit risk because of deceleration in lending as well as fresh delinquencies. However, banks maintained their risk-averse asset allocation strategy. Due to adequate provisioning charges the aggregate earnings of the system remained stable and in satisfactory ranges. The shift in asset mix towards government papers and assets carrying lower risk weights and decline in risk to capital base from any likely impairment in asset quality led to some improvements in solvency indicators. The liquidity position of the system further eased due to liquid-assets-driven growth that was adequately supported by inflow of deposits.

The asset base of the banking system increased to Rs6,782 billion at the end of June 2010 as compared to a contraction during previous quarter. The increase in asset base, which was well supported by growth in deposits, mainly occurred in banks balances, inter-bank lending, government papers and public sector commodity finance, while lending to private sector came down and moderated the overall growth in loan portfolio. Accordingly, the assets mix shifted towards assets carrying lower risk weights, reflecting the risk-averse strategy of banks that has been in vogue since later half of CY08. Besides SME and consumer, corporate segment also experienced decline in lending rates of banks. However lending to agriculture witnessed some liveliness, while most of the leading sectors of the economy reduced their bank borrowings.

During recent quarters, the NPLs of the banking system had increased at a significant rate i.e. an average quarterly rate of nearly 10 per cent from June 2008 to March 2010 and their level more than doubled since CY07. However, shift in NPLs from categories requiring partial provisioning to loss category, the loan loss charges exceeded the increase in NPLs. Accordingly, provisioning coverage of NPLs improved to over 73 per cent and risk to solvency of banks lowered as the capital impairment ratio came down by 160 bps. Similarly, the loan infection ratios also lowered.

The profit after tax of Rs36 billion for first half of CY10 remained higher than the corresponding period of last year. The Return on Assets (ROA) stayed at last quarter's level, slightly higher than the level of corresponding period of previous year, though over this period the asset composition of the system significantly shifted towards government papers, which carry lower return as compared with loans and advances. The aggregate earnings of the system that have been concentrated in relatively large-sized banks for the last two years or so showed some improvement for individual banks, as the number of banks with positive bottom line remained higher as compared to last year.

In the coming months, the heightened credit risk and increased portfolio of NPLs will be a major challenge for the banking system. The stress test results, however, signify that the system has adequate capacity to withstand any extraordinary, plausible shocks in the key credit as well as market and liquidity risk factors, thus averting the genesis of any systemic crisis from such shocks.

However, recent unusually high floods are likely to influence performance of banks. Though their impacts and economic losses are yet to be precisely assessed, the floods could cause additional NPLs mainly in agriculture sector and affect credit activities in sectors allied to Kharif crop. Increase in government's demand for bank credit is most likely. The inflow of donations, grants and assistance and expenditures on the rescue of flood affectees and rehabilitation of infrastructure are likely to accelerate the growth of monetary aggregates. The banking system in aggregate is expected to post steady profits, however, these profits are likely to remain concentrated in larger size banks having better earning profile and competitive advantage in raising the economical and stable funds.

Though, advances of the banking system increased this growth was largely contributed by growth in public sector's commodity finance which increased by more than 50 per cent. Lending to private sector, after witnessing a slight growth during last quarter came down, reflecting the trend that set in the last quarter of CY08, a gradual increase in public sector credit and contraction in lending to private sector.

Disaggregated analysis shows that corporate, SME and consumer finance segments witnessed a marginal decline of around 2.5 per cent. However, this decline was more than covered by sharp increase in public sector commodity finance that was also accompanied by a moderate growth in lending to farmers.