Rising defaults

Loan defaults has always been a major problem for the banking industry in Pakistan despite State Bank's efforts to contain their level within reasonable limits during the last few years. According to the latest "quarterly compendium" released by the SBP, total amount of defaults has risen further by Rs 26 billion (on a monthly average of Rs 8.6 billion) during January-March, 2011 to reach Rs 573.5 billion by the end of the quarter.
More worrying was the fact that out of this, Rs 436.5 billion were in the loss category or without any hope of recovery. It was also sad to note that almost all-important sectors of the economy were accumulating defaults at a high rate. Textile sector had the highest outstanding advances of Rs 737 billion, out of which 24 percent were infected. Individuals had defaulted to the extent of Rs 72.7 billion and their default rate was 17 percent.
Cement sector's infected portfolio was Rs 17.6 billion, with the default rate of 18.7 percent while automobile and transportation sector had defaulted to the extent of Rs 11.5 billion and its default rate was 23.5 percent. Default rate of electronics was the highest at 37.3 percent, and the infected amount in this sector was Rs 22.3 billion. The sugar sector which was the prime focus for the last four years, mainly because of its cartel-style operation, borrowed a very heavy amount of Rs 65.8 billion in just three months from January to March, 2011, but its infected portfolio was reduced from 19.4 percent to 10.3 percent during the quarter.
The swelling of loan defaults could be attributed to a number of factors. There is no doubt that continued poor performance of the economy and high interest rates must have contributed to the rising defaults in a big way. Many industries and enterprises are reported to have gone under or suffered losses due to overall slowdown in the economy and high interest rates, rendering them uncompetitive and resulting in lower recoveries and increase in non-performing loans. Political uncertainty, poor law and order situation, acute shortage of energy and the overall culture of avoiding repayments to the banks by the borrowers must have also contributed to the problem. The most depressing aspect is that most of these impediments are not likely to disappear anytime soon and, therefore, the level of loan defaults may continue to rise, with all the attendant negative consequences for the economy.
In particular, in an effort to avoid further defaults, banks would find greater motivation in investing their loanable resources in risk-free government paper and curtail credit to the private sector. This would retard the growth rate of the economy and increase unemployment in the country. The problem has been further compounded by higher availability of T-bills etc in the market due to increasing borrowings from the banking system by the government to finance its budget deficit. Obviously, it makes ample sense to the bankers to invest in short-dated government paper like T-bills at the rate of around 13 percent per annum and pay the depositors far below this rate to make handsome profits, rather than going through the tedious route of finding borrowers in the private sector and increase their risky portfolios.
However, it needs to be pointed out that although the rising level of defaulted loans is a matter of concern, yet it is still manageable and does not constitute a big threat to the solvency of banks. In order to avoid an ugly situation in the future, both the banks and the government need to be careful and review their policies. While the banks and DFIs have to improve their credit appraisals and monitoring standards and reevaluate their exposures in high-risk areas, the government needs to reduce its fiscal deficit and also find alternative sources of finance in order to reduce its reliance on the banking sector and induce the banks to increase their advances to the private sector.
Of course, the best guarantee for containment of infected loans is a thriving industrial base, a vibrant economy and a reasonable level of interest rates but all these variables are subject to so many imponderables that it is not easy to forecast their behaviour. We could, therefore, only hope that the government and the State Bank would give utmost attention to the problem of defaulted loans with a view to reducing their level over time and maximise the role of financial intermediaries in the development effort of the country. The productivity of credit to the economy is the optimal when it is utilised by the credit sector, is repaid in time and keeps revolving between various productive units over time.