New Financial Services research report from Business Monitor International is now available from Fast Market Research

Boston, MA -- (SBWire) -- 06/29/2012 --BMI View: The commercial banking sector's problem of rising non-performing loans (NPLs) will unlikely ease in the immediate future despite the State Bank of Pakistan's interest rate cuts, given the stickiness of debt servicing costs. Furthermore, the banks' heavy exposure to Pakistan's struggling manufacturing sector should keep the risk of high NPLs acute. Given the dim fundamental picture, Pakistani financial stocks are set for continued underperformance. One of the key issues that Pakistan's commercial banking sector will have to contend with as the year marches along is the steady rise of non-performing loans (NPLs). As seen from the accompanying chart, the percentage of net NPLs to net loans has been on a secular uptrend since 2008, with the latest data showing a multi-year high of 6.2% in Q311 (up from 5.2% in the previous quarter). Below, we highlight our thoughts on why NPLs are likely to remain elevated, at least for the time being. Debtors Yet To Benefit From SBP Cuts Firstly, despite the State Bank of Pakistan's (SBP) 200 basis points (bps) worth of interest rate cuts in its current loosening cycle, it appears that the banking sector is still under stress given its apparent reluctance to bring down debt servicing costs in line with the central bank's easing. As such, debtors have yet to fully realise the SBP's dovish stance, with interest payments largely unchanged from the peak. It is therefore Pakistan Commercial Banking Report Q2 2012 © Business Monitor International Ltd Page 34 unsurprising that the central bank's cuts have done little so far to stem the rise of NPLs. In comparison, while interest rates on gross disbursements have fallen by 139bps from their peak (to 13.23% as of December 2011), interest rates on outstanding loans have fallen by only 35bps to 13.46%. At the moment, the spread between the interest on outstanding loans over the SBP's reverse repo rate stands at 146bps - well above the historical average of 35bps (see chart). Substantial Exposure To Struggling Manufacturers Secondly, the banking sector's huge exposure to Pakistan's floundering manufacturing sector, plagued largely by a seemingly intractable energy crisis, also keeps the risk of a prolonged bout of high NPLs acute. As seen from the chart below, at 57.4%, the majority of loans made to private sector businesses are made specifically to the country's manufacturing sector. Unfortunately for Pakistani banks, manufacturers are struggling to maintain any kind of growth momentum. The quantum index of large-scale manufacturing (QILSM) has largely disappointed since April 2011 (see chart), with growth having fallen from the March peak of 12.5% y-o-y to -0.5% by November, according to the latest data. Furthermore, not only have most loans made their way into a fragile manufacturing sector, but a significant portion of these loans have gone into Pakistan's critical textile industry, which is currently suffering from subdued cotton

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