Heightened credit risk, rise in infected loans major challenges

[Naveed Yaseen]

* Banks relying heavily on investments in govt papers: SBP

By Mushfiq Ahmad

KARACHI: The asset mix of the banking system further shifted towards investments as banks continued to invest heavily in government papers and bonds of Public Sector Enterprises (PSEs).

The public sector’s demand for bank credit remained high for meeting budgetary requirements and resolving the issues of PSEs’ inter-corporate receivables. Banks’ holdings of government papers as well as the bonds of PSEs registered a strong increase.

The deposit base of the system enlivened during the quarter under review and posted heartening growth of 6.8 percent. A major part of these additional funds was invested in short-term government papers.

Overall earnings capacity of the system has remained fair; however, the earnings are largely concentrated in large and medium-sized banks, as most of the small-sized banks’ bottom lines were either low or in the red.

In the coming quarters, the heightened credit risk and increased portfolio of infected loans will remain major challenges for the banking system. Nevertheless, the results of stress tests reflect the system’s strong capacity to endure extraordinary shocks in major risk factors and avert the emergence of any systemic risk. The traditional slowdown of first calendar quarter is likely to dampen the growth of banks’ lending portfolio and deposits. The tapered growth in deposits coupled with banks’ increased risk aversion and public sector’s high demand for bank credit are likely to shift asset mix further towards government papers.

Banks’ capacity to lend private sector will largely depend upon their ability to mobilise additional funds and retirement of commodity operation borrowings by the government. The aggregate earnings of the system are expected to remain fair and largely immune from heightened credit risk, but banks are likely to experience mixed results depending upon their sizes and relative earning capacity.

The banking system experienced some let up in the build-up of credit risk, which has significantly increased over the last six quarters or so, as the growth in the banking system’s non-performing loans (NPLs) substantially pacified during the quarter under review.

One of the underlying factors for high credit risk is general slackened economic environment showed slight improvement on a few fronts. However, overall economic conditions, power supply situation and security environment remained tenuous.

The asset base of the banking system and its key elements posted strong growth; particularly the deposits base and lending to private sector, which consistently declined over the first three quarters of CY09, showed signs of recovery.

In line with strong growth in both asset base as well as the risk-adjusted exposures, the baseline solvency indicators slightly came off, though still staying in high ranges.

The asset base of the banking system posted a strong growth that was parallel to the levels at the mid of the outgoing decade – a period marked with high economic growth and absence of other structural shortcomings. Deposits of the system, after remaining lacklustre during the first three quarters of CY09, posted heartening growth. On the asset side, lending portfolio also increased, however the distinguishing phenomenon was the pick-up in lending to domestic private sector that had gradually declined during the preceding three quarters.

Moreover, unlike the previous quarter’s skewed growth in power sector, the growth was widely shared by different leading sectors of the economy.

Growth in NPLs substantially decelerated during the quarter under review; 2.5 percent quarterly growth to Rs 432 billion. The NPLs of the system had been showing consistent and fast increase for the last one-and-a-half-year or so and had almost doubled since CY07. The increase mainly occurred in loss category that requires full provisioning coverage, and banks set aside relatively higher amount of provisions. Accordingly the provisioning coverage improved over the quarter and impairment ratio (net NPLs to equity) came down, while increase in lending portfolio further contributed towards the decline in infection ratios.

The slowdown in loan infection rate preserved the banks’ earnings from significant dent, which has been the hallmark of the last few quarters. Though more than proportionate growth in the net mark-up and non mark-up incomes augmented earnings, faster accumulation of operating expenses moderated the Return on Assets.

The indicator, with slight contraction, remained almost stable at the last quarter’s level but significantly higher than last year’s results.

Accumulation of year to date profits, equity injections and growth in revaluation surpluses has significantly raised the equity base of the system. Pick-up in lending to private sector led to substantial increase in risk-weighted assets. Accordingly, risk based Capital Adequacy Ratio of the system also slightly came off, though in comfortable range at 14.1 percent.

http://www.dailytimes.com.pk/default.asp...2010_pg5_9