Dealing with Non-Performing Loans of Banks

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, Dealing with non-performing loans of banks
ISHRAT HUSAIN
A lot of confusion and misunderstanding has been created by several commentators on the issue of non-performing loans (NPLs) of banking system. They take the absolute amount of such loans at the current point of time and compare it with the quantum of such loans in October 1999 and make a hue and cry that the situation has deteriorated because the quantum of NPLs has gone up. Such a simplistic approach creates doubts in the minds of common people about the commitment of the government and the State Bank of Pakistan towards recovery of these loans and distorts the true picture about this important issue. The aim of this article is to inform the public about the exact magnitude of the problem, the trend over time and the measures the State Bank of Pakistan is taking to tide over this problem.

The State Bank of Pakistan (SBP) is dealing with the NPL issue in a comprehensive manner through (a) improvement in coverage and reporting of NPLs (b) a proactive treatment of the existing stock of NPLs (c) stemming flow of new NPLs and (d) improving the policy and regulatory environment.

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It should be realized that the stock of existing NPLs will always grow over time even if all the new loans being granted are fully serviced. This will happen because the declared amount consists of principal and mark up. By its very

definition, if the loan is not being serviced and is overdue by 90 days then the unrealized mark up will continue to be added up to the total amount of NPLs. For example, if on October 1999 the principal amount due on a NPL was Rs 1 million and the contracted mark up rate was 20 percent, then this amount will grow to Rs 1.2 million in October 2000, Rs 1.4 million in October 2001 and Rs 1.6 million in October 2002.

So it can be seen that if the principal amounts overdue to the banking system in October 1999 were Rs 160 billion and these loans fell in the category of NPLs then three years later they will swell automatically to Rs 256 billion, assuming that the contracted mark up rate was 20 percent per annum. Thus, one can expect that 60 percent increase will take place in the total quantum of NPLs after a three year period, even if every single new loan is performing well.

The second complication arises if the NPL is denominated in foreign currency which is the case with 13 percent of all NPLs. These were granted by the foreign branches of NBP, HBL, UBL and Allied Bank.

Assume that these
loans were granted when the rupee-dollar exchange rate was Rs 46 to $ 1 and suppose the principal amount overdue was $ 1 million.
At the time

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the loan was granted, its value on the books of the bank was Rs 46 million. Today, when the exchange rate is Rs 59, the same NPL will be shown as Rs 59 billion i.e. 28 percent higher than the original value declared in October 1999. This excludes the mark-up overdue which will also move up and if this mark up is included the same NPL will be at least 40 percent higher in value in October 2002 (as the dollar mark up rate has been lower than the rupee mark up rate). Thus it should be seen that without any fault of the bank its aggregate value of NPLs (denominated in foreign currency) has escalated by 40 percent. (a)

Improvement in Coverage and Reporting.
The SBP Inspectors have begun to apply more rigorous standards of classification. In September 2000, the SBP inspectors detected that some of the public sector specialized banks were reporting only default or overdue portion of their non-performing loans instead of total outstanding amount of such loans. This led to an upward revision in the volume of NPLs reported by these banks and resulted in addition of Rs 47 billion of loans classified as non-performing which were not shown as such in the period prior to September 2000. the

total volume of declared NPLs rose by Rs 47 billion.
Thus overnight
The SBP has also
revised the valuation method of collaterals underlying the...
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