Financial Institutions as Players of Financial System of Pakistan
Table of Contents
Introduction 2
Definition 2
Definition as per State Bank of Pakistan 2
Important Sub-Topics 4
Internal factors: 4
External factors: 5
Relation of Profitability of Banks and Non Performing Loans 5
Practical Study of the Organization with respect to the topic 7
Services offered by The Bank of Punjab 7
Running Finance 7
Demand Finance 8
Cash Finance 8
Consumer Loan Products 9
Profit Analysis of the past four years 10
Provisions of non performing loans 11
Loans written off 12
Conclusion 12
References 13
Introduction
Definition
Non-performing loans, are loans, made by a bank or finance company, on which repayments or interest payments are not being made on time.
A loan is an asset for a bank as the interest payments and the repayment of the principal create a stream of cash flows. It is from the interest payments than a bank makes its profits.
Banks usually treat assets as non-performing if they are not serviced for some time. If payments are late for a short time a loan is classified as past due. Once a payment becomes really late (usually 90 days) the loan classified as non-performing.
A high level of non-performing assets compared to similar lenders may be a sign of problems, as may an sudden increase. However this needs to be looked at in the context of the type of lending being done. Some banks lend to higher risk customers than others and therefore tend to have a higher proportion of non-performing debt, but will make up for this by charging borrowers higher interest rates. A mortgage lender will almost certainly have lower non-performing assets than a credit card specialist, but the latter will have higher spreads and may well make a bigger profit on the same assets, even if it eventually has to write off the non-performing loans.
Definition as per State Bank of Pakistan
Non-Performing Loans (NPLs) are loans and advances whose markup/interest or principal is overdue by 90 days or more from the due date.
Treatment of Non performing loans as per the State Bank of Pakistan
Under the new guidelines and methodology of the State Bank, banks and DFIs will no longer club accrued mark-up with the principal loans & advances. Instead, accrued mark-up on performing loans will be shown under other assets. This is in line with best international practices as the Audit and Accounting Guides issued by the American Institute of Certified Public Accountants (AICPA) categorizes interest receivable under other assets. The banks and DFIs will place their non-performing loans on non-accrual status in accordance with consultative paper of Basel Committee on
Sound Practices for Loan Accounting and Disclosure. Therefore, the un-realized mark-up on such loans will be kept in the memorandum account and will not become part of non-performing loans. The scope of coverage of NPLs data that will be released by the SBP has been enhanced by including NPLs of overseas operations at their current market value in rupees. Further, the rescheduled and restructured loans would now be added and shown as NPLs unless they are reclassified as regular loans on meeting the one year criterion of satisfactory performance.
Due to the nature of this topic and to show that what the government has done in recent times and why we in our country are still a second citizen to army, I am going to compare two banks in non performing loans department the first is Bank of Punjab and second one is Askari Commercial Bank.
The Bank of Punjab was established in 1989, in pursuance of The Bank of Punjab Act 1989 and was given the status of scheduled bank in 1994. The Bank of Punjab is working as a scheduled commercial bank with its network of 272 branches at all major business centers in the country. The Bank provides all types of banking services such as Deposit in Local Currency, Client Deposit in Foreign Currency, Remittances, Advances to Business, Trade, Industry and Agriculture.
Incorporated in October 1991, Askari Bank commenced its operations in April 1992, and has since expanded into a nation wide presence of 155 branches, including 15 dedicated Islamic Banking branches connected online and supported by a shared network of over 2,670 online ATMs covering all major cities in Pakistan supports the delivery channels for customer service. Askari Bank also has an wholesale Banking Unit in Bahrain.
Important Sub-Topics
Granting of credit for economic activities is the prime duty of banking. Apart from raising resources through fresh deposits, borrowings and recycling of funds received back from borrowers ...
This is a preview of the whole essay
Incorporated in October 1991, Askari Bank commenced its operations in April 1992, and has since expanded into a nation wide presence of 155 branches, including 15 dedicated Islamic Banking branches connected online and supported by a shared network of over 2,670 online ATMs covering all major cities in Pakistan supports the delivery channels for customer service. Askari Bank also has an wholesale Banking Unit in Bahrain.
Important Sub-Topics
Granting of credit for economic activities is the prime duty of banking. Apart from raising resources through fresh deposits, borrowings and recycling of funds received back from borrowers constitute a major part of funding credit dispensation activity. Lending is generally encouraged because it has the effect of funds being transferred from the system to productive purposes, which results into economic growth. However lending also carries a risk called credit risk, which arises from the failure of borrower. Non-recovery of loans along with interest forms a major hurdle in the process of credit cycle. Thus, these loan losses affect the banks profitability on a large scale. Though complete elimination of such losses is not possible, but banks can always aim to keep the losses at a low level.
Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by Nationalized Banks.
There are several reasons for a loan becoming npl.
Internal factors:
. Funds borrowed for a particular purpose but not use for the said purpose.
2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
5. In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets.
6. Business failures.
7. Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns.
8. Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-appropriation etc.
9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delay in settlement of payments\ subsidiaries by government bodies etc.
External factors:
. Sluggish legal system
2. Long legal tangles
3. Changes that had taken place in labour laws
4. Lack of sincere effort.
5. Scarcity of raw material, power and other resources.
6. Industrial recession.
7. Shortage of raw material, raw material\input price escalation, power shortage, industrial recession, excess capacity, natural calamities like floods, accidents.
8. Failures, non payment\ over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc.
9. Government policies like excise duty changes, Import duty changes etc.
Relation of Profitability of Banks and Non Performing Loans
Decline in risk-taking capacity due to lack of profitability
The non performing loans decrease the bank's profitability to a great extent. First, non-performing loans incur heavy disposal expenses. Simply making provisions for credit losses (indirect write-off) and postponing the final disposal of non-performing loans would cause additional losses, if the collateral value of land declined. Disposal expenses include such additional losses.
Second, holding non-performing loans for a long time without disposing them would incur costs other than the amount of disposal of non-performing loans. That is to say, by continuing to hold non-performing loans, or assets that do not generate returns, banks would lose returns that they would have earned if they had collected the loans (this is called "opportunity cost".
Decline of the major industries in pakistan
Pakistan major industries including the textile industry is on the brink of a major fall out, which has also affected the banks because mostly small and large organization rely heavily on loans and credit based fundings and due to lack of business profits these companies are unable to payoff their markups.
Stagnant economic situation in Pakistan
Due to the recent terrorism and economic issues Pakistan economic state has suffered some major downfalls, people now fear investing and banks fear lending, also the decline in the profitability of banks and the increasing amount of non performing loans has caused the banks to be very cautious even in the case of major corporations.
Rescheduling of non performing loans
Some banks have opted for rescheduling of loans as an answer for the non performing loans in hope of the betterment of economy. But this have only made them suffer losses over the years.
State Bank Regulations
Some banks to cover up the losses tried to charge markup over markup for the loans which was noticed by the state bank of Pakistan and the banks faced severe penalities.
Government Conspiracies
As Pakistan has always be unlucky to have a corrupt government, in the recent times some banks were also used to give unnecessary loans to politicians and landlords and their relatives. Some of these loans were also used to lure off party members of a political party to strengthen the government. The bank of Punjab is a prime example of this scenario. These loans were first declared non performing and then were simply written off.
Fake Collateral
Some of the corporations have also used the extensive loan facility given by the banks in previous years illegally. They used to take loan to build a business and the declare the business insolvent and there after when the bank tried to recover its losses by selling of the collateral there was no such land which occurred due to poor investigation and bribery offered to investigators. These loans were also first declared non performing and then written off.
Corrupt Management
Some times the management tries to purchase luxury items through the bank loaning schemes for its employees and then try to write these loans off again as in case of bank of Punjab.
Carelessness of current government
The textile industry used to be one of the major exporters and was the most profitable industry. But due to the carelessness of the government of this sector has suffered major losses and most of the industries have been declared defaulters or have closed down their business due to lack of resources. Now as the textile industry was the major credit customers of the banks this has increased the non performing loans and has a negative effect on the bank's profitability.
Practical Study of the Organization with respect to the topic
Services offered by The Bank of Punjab
Following are some of the loan services offered by the bank of Punjab to its corporate customers.
Running Finance
Against Pledge of Shares
This facility is generally extended to companies or individuals on selective basis against pledge of tangible securities such as Shares. Such financing is supportive to secondary Capital Market concept. The facility is required to be adjusted periodically or within the period as specified in the Sanction Advice/DAC. Given that Stock Market in Pakistan is volatile, banks are required to refrain from extending loans to the market players who are engaged in speculations for short term "Gains", which quite often they fail to make, consequently rendering the facility to non-performing ultimately.
Against Government Securities
Government Securities include Defence Saving Certificates (DSCs), Special Saving Certificates (SSCs), Regular Income Certificates (RICs), Behbood Certificates, US Dollar Bonds & NIT Units etc, issued by National Saving Centre Government of Pakistan/National Investment Trust.
Large amount of funds representing "Provident Fund", Benevolent Fund collections are invested in the Government Securities, which are yielding better return compared to placements with Commercial Banks. Banks also extend credit facilities against pledge of "Deposit Certificates" or other instruments of value issued in the name of Individuals, Joint Holders Public Bodies, and Firms, issued by various Government regulated Investment/Saving Organizations, which at the moment are restricted to Maximum of Rupees One Million and are subject to change.
Against Hypothecation of Stocks
Industrial organizations have to invest a large sum of money to build stocks of raw material to up keep their manufacturing line. This is apt to create liquidity constraints in the Financial Balance Sheet of the customer. To manage such financial gaps/shortfall in their cash flow they usually resort to borrowings from Banks against Hypothecation of raw material/semi or finished goods held by them in their stocks.
Banks in such cases although do not have a physical custody of the goods, however have a legal Charge/Lien established, thereon, providing a legal recourse to the Bank to take custody of the stocks, in the event the borrowers default to repay the loan or fail to meet their obligations, as agreed. Criteria to merit this facility is provided in the Banks Credit Policy Manual, which is care fully assessed by Risk Managers, while recommending a credit proposal to credit committee.
Demand Finance
Credit facilities extended against registered mortgage of property (i.e, land/buildings constructed or to be constructed) is by nature classified as a Secured Advance. A formal charge on the property is established and recorded with the Registrar Land and Property termed as registered mortgage. Advances are also made against equitable mortgage of property, whereby the original title Deeds, are deposited with the Bank as Security and the charge is registered with the Registrar SECP.
In case the Finance is allowed to Limited Companies, where the original title documents of Land/Building and other Fixed Assets are held by the senior charge holders, our charge (Pari-Pasu or ranking) as approved by Credit Committee, shall be recorded with the Registrar Securities & Exchange Commission of Pakistan (SECP). However, in case of Pari-Pasu Charge, NOCs from the senior Charge Holders shall be obtained before registration of charge with SECP. In case of borrower's failure to liquidate the obligation, or on classification of the advance to "Non-Performing" the Bank has a legal recourse to apply for a decree in a court of law, to sell off the mortgaged property through auction as ordered by the court.
Cash Finance
This facility is generally provided against pledge of goods. Under this type of financial accommodation the facility amount is disbursed in specially opened account for the purpose. The pledged goods are released to the borrower against cash payment only. In case the goods pledged are seasonal in nature, the customer would be required to adjust the facility before the season ends. Rollover shall not be allowed.
Consumer Loan Products
Aasiash Loans
these are the loans offered by the banks to the consumer to purchase durable goods of the consumers choice from the panel of the dealers available on the panel of the bank. The items include e.g. refrigerator, computer, fridge etc.
Quick Cash
Quick cash is available for the salaried consumers who have a account in the bank the loan is offered for educational purposes most of the time. The loan amount can vary from 50,000 to 500,000. The amount of loan provided depends upon the salary of the individual.
Car Loan Facility
This loan can be availed by any salaried person who has an account in the bank to buy a car of his choice the range of loan that can be given is 200,000 to 5,000,000 depending upon the financial position of the customer.
House Loan
This loan can be availed by any salaried person, business man, government employee having an account with the bank to avail loan from 100.000 onwards and for house renovation from 25000 onwards.
Smart Cash Personal Loan
Same as a personal loan it is a personal demand finance facility provide by the bank with condition of having an account with the bank and a limit upto 500,000 Rs.
Profit Analysis of the past four years
The sudden rise in profit can be understood by the major investments the bop made in different projects or was forced to do so by the then government of Punjab. Now have a look at the investments and the lending.
As the number of years has increased the advances and investments showered upon the government members also increased. It should also be noted that these huge figures were artificial because the provision of some of the non performing loans given to some fake companies were not recorded and bank of Punjab also received notices from state bank of Pakistan for that. If these figures would have been recorded the profits would have been much less. Now let us take a look at the analysis of the non performing loans and the provisions of non performing loans.
Provisions of non performing loans
This shows the amount of provisions that were recorded against the non performing loans, again these figures are very small as compared to the real figures if the state bank regulations would have been followed, and the profits would have gone down by a good percentage. In 2007 most of these loans were taken on fake ID cards and fake mills and fake evaluation data. This does not include the non performing advances which were much higher than the loans. Now the bank in its financial statements is showing a lot of profits but in the reality these profits were not due to the investments and the return on those investments but the state bank reports shows that these were a result of bank's term finance certificates. We can also take a look at the bank's loans that were written off in these four years.
Loans written off
Conclusion
The npls and the profitability of banks is closely related. The banks should follow the state bank regulations to avoid any probelm regarding non performing loans. The banks should also take care in evaluating collateral because in case of non performing loans collateral pays an important role in covering the losses. Moreover the banks should learn to differentiate between a defaulting and a struggling customer and should modify according to the customer requirements. Oue economy is passing through a very difficult phase and banks have to play an important role in this regard by recognizing the potential sectors and offering them finance opportunities. Bank should also make the process of evaluation and declaring a party defaulter transparent and should also take into confidence its stakeholders.
References
www.bop.com.pk
www.sbp.gov.pk
Commercial Bank Management
By Peter S.Rose
