ISLAMABAD — Credit default and advances tied up in non-performing loans is on the rise-threatening commercial bank' profitability, financial market analysts warn.
Profits
The banks are in a high profitability boom-mode for the last four years, and still feel secure, but the growing amount of Non-Performing Loans (NPLs) are likely to make a dent into their earnings and profits this year.
The cut in their combined profit is currently estimated between 22 to 25 per cent for the calendar year 2007 which is also the bank year. The latest data indicate commercial banks are facing combined NPLs of Rs187 billion as at June 30, 2007-up from Rs 143 billion in March this year. Seventy-six per cent of these credits are covered by provisioning.
The balance 24 per cent or Rs45 billion which are uncovered is attributed to the bank practice that takes Forced Sale Value (FSV) of collateral out of NPLs value before doing provisioning, industry sources say. Covering the uncovered amount will require Rs37 billion of provisioning for the existing amount. The analysts point out that the average overdue duration of NPLs is 300 days, which translates into 83 per cent weighted average provisioning is required for non-covered NPLs. The new SBP provisioning requirement will eat into the banks' profitability.
NPLs
It's a matter of concern that the new NPLs, emerging during January-June alone total Rs17.4 billion, banking analysts say. At the going rate of default, the NPLs can total up to Rs35 to 40 billion for the whole year 2007. Among other risks to the banking system, these are likely to eat into the commercial banks' profitability.
Banking industry analysts, are already forecasting a Rs24 billion after-tax drop in the industry's overall profits for the year. Its not a very palatable forecast for banks as it is based on the first half of the year. The situation may, or may not deteriorate further by the time 2007 closes December 31. In view of the concern, the NPLs have created, SPB has got into action. It has notified banks that it will enforce 100 per cent provisioning for NPLs, effective December 31, 2007.
Growth
Strong growth of banking and a profit spree has been the hallmark of financial scene, as lending rates, non-interest income and credit growth significantly spurred in last four years.
The bakers, some very young and fresh into the professional never looked backed. The boom also led to less-than-prudent lending, reminding one about the Go-Go Banking in UK in the late 1960s, when finally then Prime Minister Wilson had applied a squeeze. Back in London, this writer had seen the economy, consumers and the bankers groan under the squeeze.
The analysts say, the combined profit of banks listed on the Pakistani bourses that make 90 per cent of the banking sector, rose to Rs49.7 billion a 42 per cent increase during six months to June 30 this year.
During the same period, the Non Interest Income (NII) of banks rose 32 per cent to Rs31.2 billion. There was a 27 per cent increase to Rs16.8 billion in income from commission, fees and brokerage. The capital gains rose 74 per cent to Rs4.3 billion. The dividend income was up 19 per cent, and fees rose 26 per cent to Rs15 billion.
NPLs have to be carefully watched in the context of Pakistani banks because less then prudent lending has put them in trouble on several occasions in the past. The last decade saw NPLs rise to a historic high of Rs 350 billion. It was attributed to lending less-than prudently, on the basis of political patronage and top bureaucracy's recommendations for advances to their favourites and dubious people for unsound or even for projects that existed merely on paper. The governments, too, had launched mega lending projects like Yellow Cab financing which was widely misused by borrowers, who largely defaulted. Banks had to write off billions of rupees in default or borrowers remaining untraced. But, at that time, all Pakistani banks were nationalised and under government control when such default and irregularities occurred. On the other hand, the foreign-based banks which stayed in the private sector, had remained largely unaffected because the government could not force them to lend recklessly.
In contrast to 1990s now, 87 per cent of all commercial banking is in the private sector, largely unaffected by government decisions, and are monitored by an autonomous central bank — SBP. They normally lend prudently, and SBP has enforced intensive banking reforms.
Default
But, recent NPLs problems are of a different nature. Part of the default is in the consumer credit segment. Flush with liquidity, the banks had started going into consumer loans, especially for auto leasing, housing mortgages, household consumer durables, and credit cards, and earned through 15 to 18 per cent or higher lending rates. But recent emerging default is attributed to borrowers undertaking liabilities beyond their repaying capacity, or the businesses going sour. It has alerted the banks which are lending more cautiously, and at still higher interest rates to maintain their high profitability and cover the increased risk.
The warning signal came to the banks this week, as fresh data indicated that NPLs reached a new high of Rs17 billion over-January-June the first half of the current banking and calendar year 2007. It is attributed to "poor risk management of advances". Most NPLs emerged with the commercial banks, as previously. Some banks lack management skills, central bankers say.
SBP, this week, amended the Prudential Regulations covering provisioning for advances. Effective December 31, 2007, SBP will completely withdraw the benefit of Forced Sale Value (FSV) against all NPLs for calculating provisioning requirement.
But, the benefit of FSV against NPLs of Housing Finance will be: For first year from the date of classification at 50 per cent. For the second year 50 per cent. For the third year and onwards at 50 per cent benefit of FSV not admissible.
Regulation
The SBP has also amended Regulation R-8 of Prudential Regulations for Corporate and Commercial Banking , Regulation R-11 or Small and Medium Enterprises Financing and Regulation R-22 for Consumer Financing. The time period for classifying Personal Loans as 'Loss' has been reduced from one year to 180 days.
The 100 per cent provisioning aims at stemming the tide of NPLs. The banks disfavour it will reduce their profitability. A reduced profitability will mean reduced attraction over the stock market where most of them are considered to be a plum of investment.
High profitability has also led, over the last four years, to several bank mergers and acquisition (M&As). The prominent foreign investors included those from Dubai, Abu Dhabi and the Gulf. United Bank was taken over by Abu Dhabi Group, and Habib Bank by Aga Khan Group, besides, big names like Standard Chartered buying Union Bank, ABN Amro buying Prime Bank, and Singapore-based NIB Bank taking control of PICIC Bank and its development finance entity, among others.