Sick units' debt reduction delayed

The State Bank of Pakistan (SBP) has termed judicial process slow and time consuming that delays debt restructuring and further plunges industries into financial distress.

In the SBP Guidelines 2025 for the revival of sick industrial units submitted to the federal government, the central bank has said that for industrial units in financial stress, debt restructuring is hindered by several critical issues.

The judicial process, as the first course of action, is slow and time consuming, "further pushing industries into distress," and secondly, lending to distressed debtors largely depends on the ability of lenders to find uncollateralised assets – an uncommon and discouraged practice, it said.

"Banks remain reluctant to offer new financing to struggling borrowers," the guidelines said, adding that banks face an upfront charge on new funding extended to revive non-performing/stressed units.

Furthermore, public sector banks are restricted from independently writing off debt linked with principal amounts, contributing to hesitancy in balance sheet cleanup.

A leading indicator of financial stress for companies is the ratio and amount of non-performing loans (NPLs). While the NPL ratio slightly improved in 2024, the amount of bad loans remained at a historic level.

Between 2006 and 2015, Pakistan's NPLs showed a rising trend – both in absolute terms and as a percentage of total advances. NPLs increased from Rs177 billion in 2006 to a peak of Rs618 billion in 2012, before slightly declining and stabilising at Rs605 billion in 2014 and 2015. The NPL ratio rose from 7% in 2006 to a high of 16% in 2011, reflecting the deteriorating credit quality.

Meanwhile, the Karachi Inter-bank Offered Rate (Kibor) fluctuated during the period, peaking at 14.2% in 2008 and declining to 6.8% by 2015, which indicated a shift in monetary policy.

The financing for sick units will be applicable to all scheduled banks and development finance institutions (DFIs) operating in Pakistan, with special emphasis on government-owned financial institutions.

The proposed SBP guidelines are projected to eliminate ambiguity by providing a formal and accountable structure. This framework allows government-owned financial institutions to conduct debt restructuring and offer principal haircuts with audit protection, thereby enabling them to support revival of sick industrial units effectively.

These guidelines are consistent with the legal provisions contained in Section 296 of the Companies Ordinance 1984, Section 43 of the Companies Act 1997 and Companies Rules 1999 (for out-of-court rehabilitation forwarded by the bankers' committee) to enable the restructuring and revival of non-performing, sick or dormant industrial units through targeted loan settlements (including principal haircuts where necessary) and structured rescheduling or resumption of debt servicing based on viability.

This is also aimed at establishing a formal mechanism to encourage government-owned financial institutions to participate in debt resolution and cleanup of bank balance sheets, improvement of lending ecosystem and reactivation of idle capacity in the real economy.

A significant proportion of Pakistan's industrial capacity remains underutilised due to financial distress and prolonged loan defaults. While private banks have undertaken loan settlements and haircuts to clean up their balance sheets, government-owned banks have remained risk averse due to audit fears, the lack of enabling guidelines and rigid accountability structures.

These guidelines are envisaged to correct the imbalance by providing clear, accountable and transparent criteria for debt settlement and revival of such accounts.

To become eligible, the borrowing entity must be engaged in a registered industrial or commercial activity (eg manufacturing, agribusiness, logistics, energy and services). It must be assessed as a "sick industrial unit," which is a manufacturing concern that has defaulted on repayments of outstanding debt to banking companies and/or non-banking financial institutions for four consecutive quarters immediately prior to the date of consideration.

The entity's loan accounts must be classified as NPLs for a minimum of 12 months. The unit must have remained closed, idle or operated at less than 30% of its designed capacity for at least one year. Borrowers adjudicated as fraudsters are excluded.

A detailed revival and business viability plan, supported by financial projections, demand analysis and working capital requirements, must be submitted by the borrower, the SBP said.