Toxic loans: cause of concern

A high level of non-performing loans is blamed for the growing reluctance of financial institutions to extend credit facilities to the private sector in the country. A crucial concern is that despite tepid growth in advances during the past three years, the industry is hard put to peter out growth in toxic loans, as lenders are still wrestling with a fresh influx of toxic loans. The combined toxic loans on the industrys balance sheet swelled by 12 percent during the first nine months of CY11 to Rs613 billion at the end of September, 2011, while advances have eased down by 1 percent. This lifted the industrys infection ratio (NPLs to total loans) by around 2 percentage points during the first nine months of CY11 to 16.7 percent at the end of September, 2011. Battered by the energy crisis, along with a higher interest rate level that has jacked up the cost of operations for small and medium business, the segment-wise NPLs data published by SBP suggests that SME sector was the worst affected by poor economic conditions across the country, with an infection ratio close to 35 percent at the end of September, 2011. In an earlier interview with BR Research Atif Bokhari, President UBL also accentuated the negative impacts arising from power crisis on the performance of SME sector. "SMEs can sustain a 14-18 percent interest rate environment because of high margins. What killed them was not the banking industry but lack of power and gas, adding that the SME default rate to the banks is over 20 percent", according to Bokhari. The advances data of the corporate sector - which is considered the favourite borrowers by banks (in the private sector) accounted for nearly 64 percent of the industrys advances base as of 30th September, 2011. But this sector also has a sob story to tell, given that the sectors infection ratio increased by around 1.8 percentage points during the first nine month of CY11 to 17.7 percent at the end of September, 2011. The data complied by BR Research suggests that it is mainly smaller banks who have fallen prey to toxic loans, with infection ratio close to around 20 percent and 18 percent for Tier 3 (asset base less than Rs272 billion) and Tier 4(asset base less than Rs62 billion) banks. This is down to a high cost of operations and deposits, which compels the smaller lenders to take exposure in high premium assets and expand presence in areas which are not currently targeted by the bigger banks. Expansionary monetary policy would likely curtail growth in toxic loans down the line, which in turn would restore the banking industrys confidence in the private sector. Moreover, lower discount rate would also compel banks to the tilt their asset portfolio towards advances, which compensates the lenders with higher returns compared to investments in sovereign instruments.