In two and a half months of this fiscal year, banks lent Rs900 billion to the government, but made no net fresh lending to the private sector. The private sector retired Rs116bn worth of bank credit on a net basis.

Compare this with the two and a half months of the last fiscal year and you get some clues: in that period, the government retired about Rs1.24 trillion bank credit on a net basis and the private sector had made a net borrowing of Rs16bn from banks. During the first quarter of every fiscal year, demand for private-sector borrowing remains subdued owing to the cyclical nature of our capital requirement. Demand starts increasing from the second quarter and peaks in the fourth. So it makes perfect sense for banks to invest as heavily as possible in government debt securities in the first quarter to avoid sitting on excess liquidity. But during the first quarter of this fiscal year, it is not just low demand that is keeping them from net fresh lending to the private sector. Fears of loan defaults have also made them extra cautious.

Banks’ non-performing loans (NPLs) went up to Rs768bn in June this year from a little less than Rs624bn in June last year — a net addition of Rs144bn in 2018-19 when economic growth fell to 3.3 per cent from 5.2pc in 2017-18. The loan infection ratio or NPLs as a percentage of banks’ total advances also increased from 7.9pc in June 2018 to 8.8pc in June 2019.

Apart from the economic slowdown, a sharp rise in interest rates can also be blamed for the build-up in NPLs

Now this has alarmed both the State Bank of Pakistan (SBP) as well as commercial banks. From the central bank’s point of view, the build-up in bad loans isn’t good because it can lead to failure of individual banks with unmanageable loan infection ratios.

From the banks’ point of view, generous lending to the private sector isn’t possible amidst a rising loan infection ratio. An increase in this ratio means the need to set aside more funds for provisioning and an extra cost on the recovery of bad loans as well as on the assessment of credit worthiness of borrowers. So banks have tightened procedures for fresh loan approval and disbursement. They have accelerated efforts to make cash recoveries and persuade customers with bad loans to regularise the repayment of loans. All this is done on a quarterly basis. Clearing of a bad loan does not immediately entitle the customer concerned to net fresh borrowing. Nor does a bank accelerate lending to the private sector without first examining its infection ratio. So apart from credit demand, what else would determine the banks’ pace of private-sector lending in the future is the level of success they achieve in containing their bad loans portfolios.

The loan infection ratio shot up in 2018-19 largely owing to a slump in industrial activity as banks channelled 81.7pc of fresh advances to the corporate sector. Banks’ advances to the private sector increased by Rs853bn of which Rs697bn went to the corporate sector. Large-scale manufacturing saw a negative growth of 3.64pc and companies of all sub-sectors, including textiles, food and beverages, iron and steel and pharmaceuticals, had to borrow excessively from banks just to stay afloat. But the economic downturn was so pronounced and domestic demand so low that many industries failed to service old and fresh debts properly with the result that the infection ratio of the corporate-sector loans jumped from 7.9pc in June 2018 to 9.1pc in June 2019.

This increase in the infection ratio of corporate loans resulted in a rise in the infection ratio of overall advances from 7.9pc (same as that of the corporate loan infection ratio) in June 2018 to 8.8pc in June 2019.

So it seems that banks’ excessive fondness for corporate lending landed them in trouble. Had they made larger fresh lending to other sectors like agriculture and SME, they could have avoided a sharp rise in the overall infection ratio. But then, bankers argue that these two sectors are already notorious for their very high infection ratio — double the overall infection ratio — and making larger fresh lending to them could have been equally riskier. Even with nominal fresh lending to these two vital sectors, the infection ratio of agriculture-sector loans surged from 19.4pc in June 2018 to 21.4pc in June 2019. The infection ratio of SME loans rather slipped from a high level of 17.8pc in June 2018, but was still at 17pc in June 2019.

Apart from the economic slowdown in the last fiscal year, a sharp rise in interest rates earlier and within that year can also be blamed for the build-up in bad loans. However, interest-rate tightening was required to tame inflation and mitigate the effects of the depreciation. Now the SBP has put its key policy rate on hold at 13.25pc. The rupee gained 2.4pc value against the dollar in the first quarter of this fiscal year (up to September 25). If inflation witnesses a significant decline in coming months, we can expect the central bank to go for a gradual easing of interest rates. And if the external account continues to improve then the rupee may gain more value in the future. In that case, industrialists will find some breathing space and hopefully start managing their bank loans more prudently. Only then banks can see a contraction in the growth of bad loans. But these ‘ifs’ are attached to some serious ‘buts’. One can only hope for the better.

Published in Dawn, The Business and Finance Weekly, September 30th, 2019