Rising incidence of NPLs

The rising level of non-performing loans (NPLs) of financial institutions continues to be a great source of anxiety to the monetary authorities of Pakistan. According to a news item in Business Recorder of 13th January, 2011, NPLs of the banking system reached an all-time high level of Rs 508.8 billion in September, 2010 from Rs 475.9 billion in June, 2010.
The major reason for the increase in NPLs was their poor recovery rate, which witnessed a significantly slow pace as it registered a noticeable decline of 43.39 percent during the quarter ended September 30, 2010. Banks and DFIs, according to the State Bank, could recover only Rs 10.6 billion in July-September, 2010 as against Rs 18.8 billion in the preceding quarter, depicting a decline of Rs 8.2 billion. While banks' recoveries slumped to Rs 10.3 billion, those of DFIs declined to Rs 351 million from Rs 422 million, showing a decrease of 19 percent in the third quarter of 2010.
According to certain analysts, a number of factors could have contributed to the recent rise in the level of NPLs. A major reason during rising the quarter could be the unprecedented floods in the country and the consequent poor recovery rate on bank advances provided to the agricultural sector. The State Bank had estimated Rs 48 billion NPLs in the flood-hit areas. Other factors contributing to the rise in NPLs and decline in loan recoveries could be the economic slowdown, rupee devaluation, high inflation and political uncertainty in the country.
Businessmen, in particular, are insistent that high lending rates, due to a tight monetary policy adopted by the State Bank, have dampened industrial activity in the country, resulting in slow recoveries and increase in NPLs. However, such arguments are not time-tested as the graph of NPLs, whatever the conditions on the ground, has generally shown an upward trend over the years. For instance, according to the latest SBP's annual report, the level of banks' NPLs, which was Rs 173.2 billion in CY06, increased uninterruptedly to about Rs 460 billion by CY10, raising the percentage of net NPLs to net loans from 2.10 to 3.81 in these four years. The percentage of gross NPLs to gross advances also soared significantly from 6.9 to 12.9 during this period. The argument of high interest rates to justify low recoveries and high NPLs also does not seem to be very convincing.
Yes, the law and order situation in the country, a severe shortage of energy and a significant slowdown in economic activity could be very potent factors behind the slow pace of recoveries and the problem could have been magnified by the overall culture in society to equate the non-payment of bank loans with the level of prestige and power enjoyed by the borrowers. The frequent write-offs announced by the President/Prime Minister or Chief Minister of a province for certain calamity-hit areas also seem to have added to the tendency of non-payment of loans as borrowers paying their repayment instalments in time would have felt stupid to behave in an honest manner after such announcements.
However, whatever the reasons, the rising incidence of NPLs and deteriorating asset quality has emerged as one of the main challenges for the banking industry in recent years. This is despite the fact that the SBP has been quite vigilant about the situation, insisting upon higher provisioning requirements against infected portfolios to keep the financial system viable and solvent. Adequate provisioning, however, could adversely affect the profitability of banks, reduce the deposit rates and have a negative impact on the saving rate in the economy, but is essential for the survival of the system.
While the State Bank must continue to impress upon the banks/DFIs to contain their NPLs within reasonable limits through an appropriate policy framework, financial institutions themselves also need to redouble their efforts to control this problem by revisiting and improving their credit appraisal and monitoring standards. It is fortunate that Pakistan has not faced the sort of financial crisis witnessed in a large number of other countries, but the continuously rising level of NPLs suggests that there is no guarantee that its banking sector would continue to be sound on a longer-term basis. It is, therefore, better to erect the necessary safeguards before the risk becomes too great to be easily manageable.