Recovery of bad debts can help boost economy

NPLs lead to wastage of resources, high inflation and slow growth

ISLAMABAD: Financial institutions of a country are very important. Fiscal strength of these institutions determines the strength of the economy.

However, just like other institutions in Pakistan, previous governments failed to pay attention to their improvement. Now, the responsibility is on the new Pakistan Tehreek-e-Insaf (PTI)-led administration, which has so far remained undecided about how to handle financials of the country.

Among these financial institutions are banks which channelise idle resources from surplus units of the economy towards deficit units. The basic purpose of commercial banks in any economy is to advance loans by accepting deposits from the general public.



However, by accepting deposits, the commercial banks are liable to return them in future on the demand of depositors.

Here lies the problem, because the banks can only return the money to a depositor if they get interest on loans. We are pointing out the problem of non-performing loans (NPLs) in Pakistan in comparison to other economies in the region.

NPLs are loans that borrowers have failed to repay and there is almost no possibility the borrowers will be able to pay back the loan in future as well.

Non-performing loans give rise to a host of problems that could prove disastrous for the economy. These include decreasing confidence in financial institutions, lack of willingness of banks and other financial institutions to give loans, indirectly raising inflation and ultimately hindering a nation’s economic growth.



In order to observe the situation of NPLs in Pakistan, the data has been obtained of NPLs as a percentage of total loans from the World Bank for the period 2005 to 2017. A descriptive analysis of the data indicates that on average 11.19% of the loans were NPLs in the period.

This percentage is quite high as compared to 4.92% in India and 3.77% in Malaysia. Even in Bangladesh, the percentage of NPLs is less than that in Pakistan.

From 2007 to 2011, Pakistan had the highest percentage of NPLs. The reason is the overall poor performance of macroeconomic indicators in this period.

NPLs in Pakistan and India are high as compared to Malaysia and Thailand. In India, as compared to Pakistan, NPLs are only high in the last two years. Although the NPLs in Pakistan have been declining for the last few years, their declining rate is much slower than that in Malaysia and Thailand.

The State Bank of Pakistan (SBP) acclaims that the country’s banking sector is efficient and well-protected against various risks. However, the performance of Pakistan’s banking sector is less impressive as compared to other emerging markets.

One reason for this is that majority of the banks in Pakistan are under political influence.

Banking spread

Moreover, Pakistan is one of the countries where banking spread is high. This is because banks either pay no return or pay a very low return to the depositors while on the other hand they charge high rates of interest from borrowers.

Thus, due to the lower cost of funds, banks in Pakistan are indulging in careless and expensive lending to maximise their profits that ultimately result in bad loans.

NPLs are not only wastage of the country’s resources but they also increase inflation and slow down economic growth. In the current scenario, Pakistan is not in a position to afford wastage of resources, high inflation and decline in economic growth, as sooner or later we have to stand on our feet.

Here, the job of the government is to not only bring back the looted money from abroad, but also to recover the forgiven loans and declared bad debts of banks inside the country.

This raises a question mark over the role of the central bank as a watchdog of the economy. It is the job of the SBP, as a custodian of national resources, to monitor the NPL situation of each bank in the country and to force commercial banks to adopt stringent credit policies and tune their credit policies in line with the macroeconomic situation.

The writer is an assistant professor at the Department of Finance and Investment NUST Business School

 

Published in The Express Tribune, October 1^st, 2018.

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