Talking business

If it weren’t for Moody's, we would never have found out banks are vulnerable to ‘an event risk in B3 sovereign level’

Let’s hear it for Moody’s.  If it weren’t for the investor services firm, we would probably never have found out that our banks are vulnerable to ‘an event risk in the B3 sovereign level.’

A little history is instructive here.  Recall the steps taken by the State Bank of Pakistan in response to the crisis of Fall 2008.  Two sets of actions were taken by the central bank.  One set sought to make banks more liquid, while the other aimed to protect them from systemic risk.

Steps to increase liquidity included, amongst other things, a relaxation on what assets could be used to meet the stipulated statutory liquidity ratio (SLR) criterion.  Specifically, the use of treasury bills to meet SLR requirements was allowed, making the banks more liquid while indirectly increasing the appetite for government debt.

Steps to check systemic risk included, amongst other items, strengthening provisioning requirements.  The mountain of non-performing-loans (NPLs) left behind on bank balance sheets from those days was threatening the solvency of the entire banking system, a fact noted by the State Bank in its quarterly performance review of the banking system in March 2009.

The mountain of NPLs that spooked bankers and regulators alike in those days has left behind a legacy of extreme risk aversion.  Bankers feel that creditworthiness has become extremely difficult to assess and have increasingly fallen back on more primitive forms of determining whether a client can be trusted with a loan or not.

Bankers felt, and many complained, that many of the non-performing loans were in fact wilful defaults as borrowers took advantage of difficult times and reneged on their obligations even though they had the capacity to pay.

As banks moved towards lending only to parties who were personally known to top levels of management, systemic risk reared its head once again in the form of growing concentration of exposure to a limited number of parties.

Thus the spate of circulars trying to wean banks away from the growing credit concentration, from placing limits on exposure allowed to a single party (BPRD Circular 1 of January 2009), or placing an additional processing burden on credit to parties whose exposure was larger than Rs10 million as in Circular 3 that followed a few weeks later. Despite efforts of the central bank to use a mixture of coercion and persuasion to discourage credit concentration, the trend continued unabated.  By May this year, for instance, Moody’s had sounded the alarm that credit concentrations in one of the local ‘big five’ banks made a rating downgrade necessary, saying that financial distress amongst a few large corporate borrowers, or a deterioration in the government’s fiscal position, could do further damage to the particular bank’s credit rating.

Pakistani banks may have survived the massive credit contraction and liquidity crisis of Fall 2008, but the ghosts of that near debacle still lurk around.  Two legacies of that time are now stalking credit ratings of the big five, as made clear by Moody’s last week.

The sharp rise in lending to the government means that banks have absorbed the government’s credit outlook into their balance sheets.  The results of all T-bill and Pakistan Investment Bond (PIB) auctions since budget day 2010 show that the banks are acutely aware of the risks they are taking on by going strongly pro-sovereign in their aversion to private sector risk.

The deterioration in fiscal health of the sovereign that has overtaken the government this year is now creating a contagion for the banking system.  Banks are not willing to restart lending to the private sector on a large scale until they are better able to determine creditworthiness, and better able to see viable business ventures lining up for loans.

Their experience with the growing NPLs, and the limited help the law afforded them in that era, weighs like a millstone around their necks.

Growing credit concentrations and sovereign exposure are the natural result of this pullback from private sector lending.  There is usually very little to be sentimental about in any discussion concerning banks, but in this case it’s sad that news of this dilemma has been brought to us by Moody’s and not the State Bank.

The writer is Editor Business and Economic policy for Express News and Express 24/7

Published in The Express Tribune, December 13^th, 2010.