09 a tough year for banks due to

economic slowdown, rising NPLs

Saturday, December 26, 2009
By Jawwad Rizvi

LAHORE: The Pakistani banking sector has faced a tough year due to general slowdown in economic activities and associated deterioration in the business environment.

The continued slowdown of economic growth has reflected on banking system causing an increase in the non-performing loans (NPLs), as the overall macroeconomic outlook with slight improvement on a few fronts remained tenuous.

The NPLs that had shown some decline in the second quarter of the calendar year were again on the rise at a faster pace during the third quarter while in the last quarter some hope was seen for the banking sector after the apex court’s decision to recover all the loans from the defaulters since 1997.

The NPLs accumulated at relatively faster rate of 6.0 percent in the third quarter of 2009 and reached to Rs422 billion. Due to a reduction in loans and advances, the infection ratio deteriorated. The inflow of fresh NPLs occurred mainly in OAEM (for agriculture) and loss categories. Due to zero provisioning requirements for former category as well as the Forced Sale Value (FSV) benefit in provisioning requirements, the provisioning coverage of NPLs slightly receded to 69.7 percent and capital impairment ratio inched up to 19.9 percent for the banking system (17.6 percent for commercial banks).

Due to growth in capital as well as further decline in risk-adjusted exposures, the base line indicators of solvency improved. However risk to solvency from heightened credit risk and deteriorating asset quality has further increased in the year.

The asset base of the banking system showed marginal growth during the calendar year while the deposits base were grow significantly in the second quarter of the year were in the last half.

The bank had made secure investments despite the high interest rates as it had grown the advances and loans to the government projects.

On the asset side, decline in advances took place in both public and private sector lending. However, lending to private sector corporations in power and energy sector actually showed significant growth. As the funds realized from the retirements of loans and advances were mainly invested in federal government papers and the bonds of public sector utility corporations, the overall asset-mix further shifted from loans and advances to investments.

In the third quarter of 2009 banking system the investments posted a strong increase of 13.1 percent - mainly in the government papers followed by bonds of public utilities and a marginal increase in equity investments.

Due to low aggregate demand in the economy as well as abroad, high borrowing costs on account of tight monetary policy, unresolved political and security issues, and the heightened credit risk in the economy, banks’ lending to private sector has reduced significantly since the inception of the outgoing year.

The corporate sector, specifically the private sector corporations in energy & power sector, has in fact increased the bank borrowings; while reduction in overall advances portfolio mainly came from SME and consumer sectors. The loans to corporate sector were almost 61 percent of the overall portfolio in the third quarter.

The significant increase in loans loss provisioning moderated the earnings of the system; year to date profits grew at slightly slower than the proportionate rate and their level remained lower in Q3 than the corresponding quarter of the last year.

The overall profitability of the system has remained fair, however, the earnings were largely skewed towards large and medium-sized banks as the bottom line of most of small sized banks was low or in negatives.

The reduction in deposit base during the Q3 of calendar year 2009 was accompanied by concomitant decline in advances and increase in short-term federal government papers, thus slightly improving the fund-based liquidity indicators of the system.

However, reduction in deposit base and slow growth in monetary aggregates (M2) coupled with banks’ increased investments in government papers kept the market liquidity under strain for most part of Q3CY09. However, the market risk of the system remained subdued. The deposits of the banking system had declined marginally by 1.7 percent.

Advances to the sugar, textile, automobile & transportation, financial, and other sectors decreased during the Q3FY09. In the backdrop of current sugar crises, banks have recovered outstanding loans from sugar mills, whereas textile sector is currently faced with the electricity and gas shortages and lower export demands. The slowdown in business activity has also resulted in lower demand for loans within financial sector thus creating a considerable decline. The auto assemblers were effected by low demand due to shrinking auto loans, continued inflation and declining rupee value in relation to Japanese Yen and US $ which made their imported parts more costlier.

The Consumer Loans continued their downward slide with increasing NPLs as banks are avoiding the risks associated with these facilities, the rate of interest on these loans remain high and inflationary pressures restrained the purchasing power of the consumers.

The profitability of the system came under stress due to ongoing macro-economic environment, local security situation; slow down in credit demand and worsening credit quality. The banking system reported a pre-tax profit for the first nine months of 2009 lower by 14 percent compared with the corresponding period of last year. Increased provisions, lower non-interest income and high administrative expense are the few straining factors.

Analysis of the components of the profit and loss shows that net-interest income and non-interest income as a percentage of total assets have increased over time.

The banking system has posted consistent improvement in risk-based capital adequacy ratio (CAR) since the introduction of Basel-II framework, though the framework also requires additional capital charge for operational risk. The system’s CAR has gained 2 percentage points since 2007. In the third quarter CAR improved by 0.8 percentage points, and the quality of capital also improved, as the system on aggregate basis posted profits and built up core capital.

Accordingly, due to relatively marginal growth in asset base, the capital to total assets ratio also improved.

Analysis of Minimum Capital Requirement (MCR) shows that 28 banks including 5 foreign banks are fully compliant with the MCR. Remaining banks are in process of meeting the MCR either through fresh capital injection or merger and acquisition with other banks. As such most of the LPBs are expected to comply with the Capital Adequacy and MCR in coming quarter. Four other banks with major public sector share are under the process of restructuring/privatization.

The Islamic Banking Institutions (IBIs) maintained their profitability in the year 2009. The growth in assets remained higher than that of the conventional banks, thus increasing share of IBIs in the system.

Analysis of uses of funds shows a consistent increase in investments of IBIs. During the quarter under review, investments registered a healthy growth of 21 percent. Most of the increase in investments resulted from 4th auction of Government Ijara Sukuk of Rs 14.4 billion in September, 2009. Periodic issues of Ijara Sukuk have contributed towards the resolution of key issue i.e. lack of alternative avenues for Islamic banks. So far government Ijara Sukuk of Rs 42.2 billion have been issued, which now represent 65 percent share in investments of the Islamic Banks.

The composition of financing shows a substantial increase in share of Ijarah and a moderate increase in Istasna. Other modes of financing declined in the third quarter, with considerable decline in Mudarbah and Salam.