Ballooning NPLs

EDITORIAL (August 23 2010): According to a report released by the State Bank on 19th August, non-performing loans (NPLs) of banks and development finance institutions have risen to touch the highest ever level of Rs 473.9 billion at the end of June, 2010 from Rs 471.9 billion at the close of March, indicating an increase of Rs 2 billion over the quarter. However, this increase was significantly lower than the rise of Rs 19.6 billion in the first quarter of 2010 and Rs 16 billion in the fourth quarter of 2009.

Out of the total NPLs, the NPLs of banks posted an increase of Rs 2.6 billion, while those of DFIs registered a decline of Rs 0.6 billion during the quarter. Interestingly, the public sector banks, including the NBP, BOP, BOK and the First Women Bank performed better during April-June, 2010 quarter, as their NPLs decreased by Rs 4.3 billion. Private sector banks, which are the biggest loan providers to the private sector, on the other hand, witnessed the largest accumulation of NPLs. A worrying aspect of the NPLs was that these continue to grow despite the reluctance of the banks to extend loans to the private sector during the past two years. Credit to the private sector grew only by Rs 17 billion during FY09 and Rs 113 billion, in FY10, which was far below the average private sector growth during the first seven years of this decade.

The swelling of the NPLs to a record level of about Rs 474 billion could be attributed to a number of factors. Bankers are generally of the view that a consistent increase in NPLs was due to the poor performance of the economy and the high interest rates. Many industries and enterprises have gone under, or suffered losses due to the overall economic slowdown in the economy, with the result that banks were unable to recover their loans in time. High interest rates raised the cost of production, which rendered some of the industries uncompetitive and reduced their sales, resulting in slower recoveries and increase in NPLs. Political uncertainty, poor law and order situation, high inflation, rupee depreciation and acute shortage of energy also contributed to the problem.

Besides, the declining trend in share prices added to the woes of the banks. The most depressing aspect is that the level of NPLs is expected to increase sharply in the coming months, due to massive floods in the country, which are certain to have a significant negative impact on the economy and greatly undermine the prospects of loans recoveries. The reaction of the banks to such a situation would naturally be to curtail credit to the private sector and ensure adequate liquidity. Resorting to these options could be highly damaging for the economic revival of the country, due to smaller flow of credit to the private sector.

It needs to be pointed out, nonetheless, that although the rising level of NPLs is a matter of concern, yet this does not constitute a big threat to the solvency of the banking system as a whole, because the ratio of net NPLs to the loan portfolios is still manageable. However, in order to avoid an ugly situation in the future, it would be advisable for the banks and DFIs to tighten their credit appraisals and monitoring standards and to reassess their exposures in relatively high-risk areas. The government and the State Bank could play a useful role by reducing the supply of government paper in the market and indirectly diverting bank credit to the private sector.

Such a change would, of course, involve an improvement in fiscal management of the country and realignment of the interest rate regime. However, the best guarantee for the containment of NPLs within reasonable limits could only be a vibrant economy and a thriving industrial base, which is presently handicapped by a number of factors. We would, therefore, like the government to give utmost attention to this particular aspect in order to save the economy and its financial system from the growing risks it is facing today.