Slowdown causes massive rise in NPLs: SBP quarterly report released RECORDER REPORT

KARACHI (December 24 2009): Banking system witnessed slow growth, and a massive increase in non-performing loans (NPLs) during the quarter ended on September 30, 2009, mainly due to the slowdown in economic activities and associated deterioration in business environment. According to Quarterly Performance Review of the Banking System of the State Bank of Pakistan, released on Wednesday.

During the quarter review Return on Asset (ROA), Return on Equity (ROE), deposit base, loans growth, assets growth and equity growth presented negative trend, while massive increase in NPLs has been registered. The Report said that the banking system showed strong capacity to withstand unusual shocks in the major risk factors, and chances of any systemic risk remained contained.

The report said that slowdown in economic activities continued to reflect in slow growth of banking system and increase in NPLs, as the overall macroeconomic outlook with slight improvement on a few fronts remained weak.

The NPLs of the system, after showing some let-up in previous quarter, again increased at relatively fast pace during the quarter under review, the report said. "The NPLs of banking system have mounted to Rs 422 billion in September 2009 from Rs 398 billion in June," it added. The risk to solvency from heightened credit risk and deteriorating asset quality also increased further, the report said.

The deposits base, which grew significantly during previous quarter, contracted over the quarter under review. Overall deposits declined to Rs 4,483 billion in September from Rs 4,563 billion in June this year, depicting a decline of Rs 80 billion during the third quarter of calendar year 2009, the report said.

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 the quarter under review. On the asset side, decline in advances took place in both public and private sector lending, and net advances decreased to Rs 3,119 billion from Rs 3,176 billion, while groupwise analysis showed decline in advances of all groups except specialised banks, the report said, and added that "the asset quality of the banking system further deteriorated during the quarter". The Report said that asset base of the banking system with marginal growth remained stable during the quarter.

The report said that overall profitability of the system 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 profitability of the banking system came under stress due to ongoing macro-economic environment, local security situation; slowdown in credit demand and worsening credit quality. The banking system reported a pre-tax profit for the first nine months of CY09, which was lower by 14 percent, compared with the corresponding period of last year. Banks posted aggregate pre-tax profit of Rs 70.1 billion for the first three quarters of the outgoing year, the report said. 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, the report said.

The baseline indicators of Return on Asset (ROA) and Return on Equity (ROE) with slight contraction over the quarter were also lower than the corresponding period of year, though still higher than entire year results of CY08. ROA ad ROE stood at 1.6 percent and 15.1 percent respectively decline from 1.7 percent and 16 percent. Similarly, equity growth also declined to 4.7 percent to 3 percent in September 2009.

The report said that interest rate risk with slight increase also remained low, as the slight inch-up in interest rates by the end of quarter led to depreciation in the value of fixed income securities, while re-pricing mismatches remained within acceptable ranges. Meanwhile, the risk-based capital adequacy ratio (CAR) of all banks operating in the country improved to 14.3 percent in the quarter. The Report pointed out that accumulation of year-to-date earnings and equity injections raised the equity base of the banking system.

"This growth was also augmented by improvement in revaluation surpluses on equity investments, and the leverage of the system slightly came off," it said, and added that improvement in eligible capital and reduction in Risk Weighted Assets (RWA) as the banks shifted their asset mix from private sector credit to investments in Federal Government papers, improved the risk based Capital Adequacy Ratio (CAR). Going forward, the report said, the heightened credit risk and increase in infected loan portfolio will remain the major challenge for the banking system.

Nevertheless, the system showed strong capacity to withstand unusual shocks in the major risk factors and chances of any systemic risk remains contained. "In the wake of traditional pickup in the economic activity during outgoing quarter, the credit to private sector was likely to gain momentum," it added.

However, slow growth in deposit base, increased risk aversion of banks and public sector's increased demand for bank credit could strain the flow of credit to private sector and slightly shift the asset mix further towards government papers, the report said.

It said: "Even in the face of dampening impact from increasing NPLs, the earnings are expected to remain fair on aggregate basis". However, depending on their size and respective earning capacity, individual banks could post divergent results, it added.

Interest rate risk, ie the risk of change in the value of net worth and earnings of banks due to interest rates movements, is major component of market risk, the report said. The projected increase in NPL ratio will impact both profitability and solvency of the system, as the NPL ratio increases, profitability and capital of the banks are wiped out. In worst case scenario, 8 banks will fail to meet the required minimum Capital Adequacy Ratio (CAR).