KARACHI – With unprecedented floods and rains intensifying an already fragile macro-economic environment of the country, the non-performing loans (NPLs) of the banking system surged by 7.4 percent to Rs 494 billion during July-September 2010.
According to the State Bank of Pakistan (SBP), the persistent macro-environment issues would pose a stiff challenge for some banks to enhance their minimum capital requirement (MCR) to Rs 7 billion by the end of calendar year 2010.
The SBP asked the banks to devise ingenious strategies for dealing with the high level of NPLs besides reducing their large portfolio of government paper and lending to the public sector agencies to decrease their sovereign exposure.
Recent unprecedented floods and torrential rains in the country had, to some extent, intensified the effects of an already fragile macro-environment with the banks’ bed debts growing at a faster rate during the said quarter, the State Bank said in its quarterly performance review issued on Monday. It said that the increased credit risk would remain a major challenge for the banks.
Also, the central bank said the asset base of the banking system had contracted by 2.3 percent over the period under review conforming to an established pattern for the third quarter marked with slow growth and the end of operating cycle of major kharif crop-based industries. It said that while the country’s macro-environment was already tenuous for the last two years or so, factors like slackened economic activities, power shortages, security concerns and higher inflation
had squeezed profit margins and the repayment capacity of the borrowers. “The fiscal situation also deteriorated and the public sector borrowed heavily from banks for budgetary support, financing needs of Public Sector Enterprises (PSEs) and commodity operations,
” the bank observed. Accordingly, there was a shift in the banks’ asset-mix towards credit to the public sector along with increased preference for top rated corporations over small and medium enterprises (SME) and consumers that are generally less resilient to economic slowdown and fragility in the operating environment. “The heightened credit risk is reflected in a noticeable and persistent increase in NPLs – doubling over two years by the end of CY09,” it added.
This, it said, coupled with over-the-quarter decline in lending portfolio amplified the deterioration in infection ratios. However, since these fresh NPLs required only partial provisioning coverage, the system’s baseline earning indicators remained positive, it added. The State Bank said with the banks’ asset base contracting by 2.3 percent the Ramadan and pre-Eid withdrawals as well as the increase in currency in circulation (CC) had led to narrowing of the deposit base during the quarter.
The bank said that the shrinking of the asset base, particularly advances, resulted in a decline in size of the risk-weighted asset (RWA) over the quarter.
“However, the higher regulatory deductions from tier one capital reduced the eligible capital as well as risk-based capital adequacy ratio (CAR), which deteriorated marginally to 13.8 percent, while staying above the regulatory requirement of 10 percent.” It said the Ramadan and Eid related enhanced demand for currency, coupled with a slower growth in monetary aggregates and usual passive growth pattern of the third calendar quarter, led to a reduction in the bank deposits, moderately straining market-based liquidity.
However, the situation reversed in subsequent weeks with the replenishment of deposits forcing SBP to conduct mop ups to check excess liquidity in the market. “In the wake of two consecutive raises of 50 basis pints each in policy rate, the yield curve gradually inched up and became more steep with higher premiums for longer term maturities,
” the banks said, adding that the exchange rate depreciated moderately, while equity prices, after following a marginal decline recovered by the end of the quarter. The prices of these financial assets, however, showed contained volatility and owing to banks’ limited risk exposures, market risk remained in check.
The SBP also urged the need for the banks to devise ingenious strategies for dealing with the high level of NPLs so that promising businesses, facing transitory difficulties only due to a constrained macro environment, continue to contribute in economic growth and service their obligations in an orderly manner.
According to SBP, the usual inventory build up, particularly by Kharif crop-based industries, during the last calendar quarter would create additional demand for bank credit. Although the banks were expected to remain liquid, the heightened demand for credit from the public sector would mean that the banks ability to finance additional private sector loans would be predicated upon mobilization of fresh deposits and retirement of commodity finance by government owned agencies,
which continues to be extremely high, it said.
“The banks would need to reduce their large portfolio of government paper and lending to the public sector agencies, so as to reduce their sovereign exposure as well as to make credit available to the private sector for maintaining economic growth, and thereby enhance and diversify revenues of the banking system”. Nevertheless, the SBP said, the aggregate earnings of the system were expected to be satisfactory although these would continue to be concentrated in banks endowed with a wide network and which are competitively better placed to raise stable and relatively cheap funds. The persistent macro-environment issues would pose a stiff challenge for some banks to enhance their MCR to Rs 7 billion by the end of CY10, the State Bank said.
