Feb 13 - 19, 20

Economic coordination committee (ECC) of the cabinet has decided to buy loans of farmers who were affected by the floods, according to the media reports. Clearly, that means commercial banks that have accumulated substantial nonperforming loans in the agriculture sector need not to worry any further since the government has upped the sleeves to foot their bills on behalf of defaulting borrowers.

It was also reported that the government would allocate the amounts for this purpose from the next annual budget 2012-13, the last budget of this term of the PPP-led government. ECC asked the finance ministry in a meeting to take actions in this regard. SBP might have been directed accordingly. However, it is noteworthy that the state bank of Pakistan (SBP) is not authorised to direct the banks to waive loans, as have been misperceived generally.

The central bank has the regulatory authority to ask banks to ensure credit risk management. But, it cannot direct them to write off loans, according to the chief spokesperson SBP. Provisioning is their personal matter, he told PAGE when the Supreme Court of Pakistan was questioning the central bank over the infamous BPD Circular 29, dated October 15, 2002, which was issued by the central bank leading to the write-off of Rs54 billion loans.

It was clearly stated in the circular (available on SBP's website) "the instructions/guidelines do not affect in any way the legal right of financial institutions to recover the written-off loans if they still wish to pursue them legally."

At that time, write-offs were encouraged to clear the books of irrevocable bad assets that were the main barrier in the way of foreign investments in the banking sector and capital market. Declining profitability because of loans in the loss category was bringing down share value of the banks.

At present, economic slowdown is weakening the repayment abilities of the borrowers. The infected assets of banks in the first half of the calendar year 2011 were added by Rs31.4 billion, according to the financial stability review of SBP.

The fresh NPLs were equal to 33 per cent of net profits of the banking sector in six months, it said. In the comparable period last year, nonperforming loans (NPLs) stood at Rs39.8 billion.

Moreover, two waves of floods caused large-scale damages to the agriculture sector. The floods destroyed the major parts of Sindh and Balochistan. Beside infrastructure and property, standing crops were also damaged badly. Over five million people were affected in the two provinces and more than one million homes were razed. According to an estimate, more than 4.2 million acres of land were flooded while 1.6 million acres of crops destroyed.

Food and agriculture organization of the United Nations said the three quarters of the crops in southern Sindh were wiped out on floods causing an estimated loss of Rs163 billion. According to the report, agriculture credit accounts for 71 per cent of loans in terms of volume and 26 per cent by amount in the flood affected areas.

"NPLs in the flood affected areas were already high at about Rs16.1 billion, corresponding to an overall infection ratio of 16 per cent while that of agriculture credit was around 20 per cent at the end of September 2011," noted the report.

It is noteworthy that banks can recover half of post-flood NPLs from insurance companies. "The banks are expected to recover around Rs4.7 billion from insurance companies against damage to collaterals," it added. The devastating floods and heavy downpours led to insolvency of several farmers. Only in Sindh floods gave birth to Rs13 to 17 billion NPLs.

Generally, credit risks of large banks are lower than that of small banks that find it difficult to attract quality borrowers. The financial stability review said the infection ratios of both public sector commercial banks and mid-sized local private banks are substantial. The ratio for public sector banks will continue to increase if the economic conditions stay the same.

"As of 30-June-2011, the infection ratio of five biggest banks was 12.9 per cent as compared to an infection ratio of 25.6 per cent for the banks ranked from 11-20, the report said.

As the general election is nearing, the ruling party is expected to use write-offs as ploy to win the hearts and minds of its electorates, primarily landlords, who have safe seats in rural areas.

Making landlords happy and financially rewarded means a lot in terms of electoral benefits to the incumbent government. The influence on private banks may prove ineffective, however it can use its clouts in banks in which the government has major shareholding to extend amnesty to the defaulters.

Critics seek transparency in loans to be written off on the direct intervention of the government. Small famers who deserve the most out of any such initiative are feared to be deprived of the same.

The history of provisioning is doubtful with unmerited borrowers supposed to have taken away with the financial benefits of write-offs.

Although the banking experts fret over the attempts of questioning judgements of the banks in discerning wilful and accidental defaulters, the incorrect provisioning cannot be overruled completely.

State-run financial institutions face the suspicions for their becoming outlets of extending financial assistances and debt settlements. Last year, the Supreme Court directed the SBP to produce before it records of Rs259 billion loans waived since 1971. Names and identities of borrowers involved were made public.

Experts did not consider it prudent to question judgments related to the settlements of loans. As far as private banking operation is concerned-private banking system sprang up after 1990s-, private banks have freedom of taking actions provided their actions do not impinge on the stability of the financial system. Understandably, profit consideration is inevitable behind each financial decision of a private venture. However, public sector banks can undertake financial transactions at whims of ruling government and therefore their credit risk management needs to be strictly monitored.