Second wave raises threat of defaults

SBP projects profitability of banking sector to come under stress in second half of 2020

Banks in Pakistan remained resilient and profitable during the Covid-19 period, however, the second wave of the pandemic in the country poses a threat of increase in borrowers defaulting on returning loans to banks.

The challenging time would largely discourage private sector to borrow more from banks to set up new businesses and/or expand existing production lines.

The strong demand for credit from the government to overcome the shortfall in its budgeted expenditures and taking care of businesses and households during the current testing times would keep the banking sector largely safe and profitable amid the Covid-19 outbreak.

“The re-payment capacity of borrowers could weaken that and may lead to a further rise in NPLs (non-performing loans; meaning borrowers are near to default or already having defaulted)…during the second half (July-December) of the calendar year 2020,” Pakistan’s central bank said in a report released this week.

The non-performing loans (NPLs) ratio increased from 8.6% in December 2019 to 9.7% as of end June 2020, the State Bank of Pakistan (SBP) reported. To recall, the central bank agreed with commercial banks to defer loan payments by businesses and households for one-year (till December 2020) in March to help them cope with the pandemic and avert defaults. The borrowers, however, were asked to continue paying interest money, going forward.

Accordingly, the banks deferred loans worth Rs650 billion and rescheduled another Rs184 billion so far during the health crisis time, the SBP reported in September. Had the banks not adopted the strategy to defer and reschedule the loans, the default cases would have been significantly higher than the recorded during the first half (January-June 2020).

The central bank said earlier this week that the performance of the banking sector in the second half of 2020 depends upon the trajectory of Covid-19, economic recovery, and the evolving policy environment.

While financial conditions in the form of interest rates and asset prices remain supportive, the recent uptrend in virus infections presents a challenging scenario. Globally the situation also remains uncertain, especially in key trading economies such as the United States, Euro area, and the Middle East. In this backdrop, the outlook for the private sector advances presents a mixed picture. The large-scale manufacturing (LSM) index has increased by 3.66% (on a year-on-year basis) during July-August 2020.

Furthermore, seasonal uptick during the second half may stimulate demand. “However, the downside risks remain due to the possibility of another wave of the disease that may trigger re-imposition of strict lockdowns. Similarly, looming uncertainty about the timing of recovery in the foreign markets could subdue demand from export-oriented sectors such as textiles,” the central bank stated.

“Banks’ investments (in government securities, which are a way of the government borrowing from banks) are likely to remain strong during the second half of 2020,” it said.

The profitability of the banking sector may come under stress in the next half of the year, mainly, from the prevailing low-interest-rate environment. However, revaluation gains on government securities, if realised, may offset the impact to a certain extent and the rise in zero risks weighted government securities will likely strengthen Capital Adequacy Ratio of the banking sector.

Published in The Express Tribune, November 15^th, 2020.

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