This Final Research Project Finance Essay - Free Essay Example

Sample details Pages: 30 Words: 8941 Downloads: 10 Date added: 2017/06/26 Category Finance Essay Type Research paper Did you like this example? This Final Research Project is basically focused on the rising Non-Performing Loans Habib Metropolitan Banks Asset Portfolio. The purpose of research was to study the main key factors that are responsible for this rising trend of NPLs. And to find out a solution to this problem that Habib Metropolitan Bank is facing. Don’t waste time! Our writers will create an original "This Final Research Project Finance Essay" essay for you Create order The results show that the Textile Sector is the major contributor in the Non-Performing Loans of Habib MetroPolitan Bank. The bank has not enough diversified its Asset portfolio and has concentrated its lending to just one sector, the Textile Sector, almost 51% of Banks total lending is extended to the textile sector alone which is now causing such high NPLs in the Banks Asset Portfolio. If the bank had properly managed and diversified its portfolio it would not have been facing such problems with its Loan Portfolio. What the bank should do now is to minimize its exposure in the textile sector and should diversify its Portfolio to all the sectors in the economy so that its Exposure to just one sector would not be very significant as compared to the whole Loan Portfolio managed by HMB. Habib Metropolitan Bank Habib Metropolitan Bank, a subsidiary of Habib Bank AG Zurich, was incorporated in Pakistan in year 1992 under Section 160 of the Companies Ordinance, 1984, as a public limited company. The bank started its operations the same year it was incorporated and licensed by the authorities. HMB is placed among the top ten (10th) Commercial Banks in Pakistan and holds a standalone (independent) ranking of 1639th in the world. In October 2006 Metropolitan Bank that operated nationally with a network of 51 on-line branches all across Pakistan finally got merged into Habib Bank AG Zurich and this new entity was named Habib Metropolitan Bank, currently known as Habib Metro Bank. [1] Habib Metropolitan Bank has its operational branches in all the major cities of Pakistan with a Vision to be the most respected Financial Institution in Pakistan by providing excellent quality services which are primarily focused in Trade Financing and Retail Banking. Habib Metropolitan Banks parent company Habib Bank AG Zurich was incorporated in year 1967 and has a standalone International Ranking of 687th in terms of Banks Capital. Habib Bank AG Zurich is an international bank that has a Headquarter in Switzerland (Zurich) and operations in many countries across the globe. Habib Metropolitan Financial Services Ltd, a subsidiary of Habib Metropolitan Bank, is a renowned name in the Equity Brokerage Industry. As of 30th December 2011 the growth in Equity brokerage business remained stable but in the coming years it is expected to grow at rapid pace as the Investors confidence comes back to Pakistani Capital markets. [2] Pakistan Credit Rating Agency (PACRA) a renowned rating agency of Pakistan has maintained the Long term Credit Rating of Habib Metropolitan Bank at AA+ and A1+ for short term rating. AA+ rating is considered to be very safe and signifies that there is almost absolutely no Risk that the Company would default on its outstanding debt. This solid credit rating of HMB for Eleven (11 years) straight years clearly indicates that HMB has a very good reputation and has the ability to pay off the interest payments to its creditors and its probability to default on its debt is very low. [3][4] About Habib Metropolitan Bank Habib Metropolitan Bank is a middle tier bank that is currently ranked as the 10th biggest bank in Pakistan. As of 31st December 2011, HMB has nationwide network of 163 branches operating all across Pakistan with 3,073 permanent employees on its payroll and a total of 123 Automated Teller Machines installed all across the country. Bank has been growing at a very decent pace over the years ever since its inception and had maintained this growth rate even during the last few years that came out to very tough for the Economy. HMB has total assets amounting to Rs 288 Billion as mentioned in its financial statements and its Deposits have reached to Rs 185 Billion. Habib Metropolitan Bank is also one of the leading Tax Payers in Pakistan as it has paid Rs 1.9 Billion in direct taxes during financial year 2011. Being an AA+ rated bank, HMB has a very strong capacity to pay off its timely Interest payments. Reason for Selection of Habib Metropolitan Bank The main fundamental reason to choose Habib Metropolitan Bank is to critically analyze the performance of the Asset quality of a mid size bank, since there has not been much work done on analyzing the performance of mid-size banks in Pakistan. In a way, it would be a great opportunity to dissect the financial performance of this bank amid of poor economic conditions, worsening energy crisis and the ever deteriorating security conditions in the country. The main focus of this research paper would be based on the Non Performing Loans of Habib Metro Bank. Industry Overview Over the last decade, Pakistan has made many financial sector banking reforms, and has been quite successful in liberalizing its Commercial Banking sector. This decade of 2000s, didnt just liberalized the banking sector but it has also modernized the Central Bank of Pakistan to a great extent. In the days of inception Pakistan used to be an Agricultural based economy, but all that changed significantly in the next few decades, and Pakistan became a Service Dominated Economy. The contribution of Service Sector in the total GDP of the country has gone up to 53% as compared to a mere small percentage in the past. It means that the contribution of the service sector in the overall economy is more than the contribution of both Industrial and Agriculture sector. The Service sector is a very broad category which includes many sub sectors like the Telecom Sector, Health care, Education, Financial Sector and many more. The contribution of financial services sector in the overall service secto r of Pakistan has increased significantly during the last decade and has created thousands of jobs in the Commercial Banks, Modaraba Companies, Asset Management firms, Brokerage houses and Investment Banks. Before the privatization of banks and liberalization of banking sector reforms, the banking sector was in dire trouble, the non performing loans, issued by the then nationalized banks were reaching the skies and were making the already dangling economy of Pakistan suffer even more. [5] In 1990s things changed, as the government started to follow the Market based reforms (Demand- Supply), the troubled Banking sector of Pakistan took a u-turn and turned itself from a loss maker to a profit maker and contributed significantly in pumping the economy in upward direction. Today, banking sector is the main contributor in the growth of the Economy; it actually positively affects the economy not just directly but also indirectly as the growth in banking sector means the easy availability of funds to the deficit units from the surplus units of funds. That is how banking sector contributes in the growth and development of other sectors. The banking sector of Pakistan provides a great deal of services to its customers both individuals and corporations. Banks are the principal means of remittance flow in the country from all around the world, which is one of the main sources of foreign reserves for the country apart from exports and foreign direct investment in the country. Over the years banking sector has increased the number of services that it offers to its clients. Many services that were not that developed few years back are currently very much developed; credit card service and household lending could be the examples of service categories being matured with the passage of time. As of today, there are more than 35 banks currently working in Pakistan out of which 6 banks are owned by the Government of Pakistan -Public sector banks (Majority of their shares are owned by the Government), 22 are locally licensed Private banks like MCB, HBL, ABL, FBL, UBL, HMB etc, 7 foreign banks which are not fully licensed to work in Pakistan and 4 Specialized banks (micro finance banks). According to the statistics from Year 2010 to 2011 made available by the State Bank of Pakistan, The total assets of banking sector have shown a growth rate of 15% and the total deposits kept with the banking sector have grown at 14.5%. While the deposits have increased in this 1 year time period the Loans issued by the banks have seen a consistent decline, one of the reasons for this declining trend in banking sector lending is Loan Default, in other words Bad Debts. Banks are feeling highly in-secured lending funds out, due to the ever increasing NPLs and because of this very same reason banks are heavily investing into stock and money markets. Now coming to the distribution of banking sector, almost 50% of the total banking assets are contributed by the top 5 banks. These top five banks are MCB, HBL, UBL, NBP and ABL. These 5 banks are not just dominating in the contribution of total assets but they are also dominating in the total investment made by the banking industry and the profits earned by the industry. Almost half of the advances (Loans issued by the banks) extended by the banking industry are contributed by these five giant banks. Area of Interest Focus of this research would be the Non performing loans of Habib Metropolitan Bank. My interest in nonperforming loans is not just because I work for a bank as a Credit support analyst, but to analyze thoroughly the reasons why Habib Metropolitan Bank just like other banks is not able to control its NPLs even by being very responsible in its lending behavior. Banks are now lending lesser and lesser amount as compared to what they used to lend in the past. But still they are not able to bring down the NPLs to a very small percentage. Research Objectives I believe that with the help of this research paper we would be able to highlight the reasons why banks, in spite of being highly responsible with funds they lend, cannot have the complete control over their Bad Debts. These days banks follow many rules and regulations enforced by the regulatory authorities like Basel I, Basel II now Basel III, apart from their own internal systems to keep a check on their credit risk and the quality of their assets, but still there seems to few loopholes that are still existing in the banks lending procedures. These ever increasing NPLs are the reasons why banks are now scared of lending money to the deficit units and are investing heavily into the Government securities. There is no doubt that Government lending is highly lucrative, since it is risk free. However, high levels of Risk Free lending implies losing out on higher profitability opportunities and reducing focus on building long term customer relations (Retail Banking becomes weak eventually). Also, profits from government lending is artificial as Government pays bank by printing money (in Pakistan), which would reduce money value and depreciate the local currency. Eventually, dollar value of profits would fall. Additionally, as savings fall and inexpensive funding sources dry up (Current Deposits); Government lending would become unfeasible as funds would have to be secured at higher rates. With weak retail banking infrastructure, narrow product line few household/corporate customers the middle tier banks like Bank Al-Habib Lim ited, Bank Alfalah Limited, Faysal Bank Limited and Habib Metropolitan Bank Limited etc would quickly start producing heavy losses. Research Question WHAT ARE THE MAIN REASONS WHY HMBs NPLs ARE RISING? Research Methodology The research methodology that would be followed for this particular research paper would be based on both Primary and Secondary Research. The already published data, financial reports and SBP Banking reviews, interviews and information gathered from Questionnaires would be the source of information for this paper. Since this paper is not truly an Academic Research paper but rather a paper that specifically deals with the working and some specific problems of a particular bank the focus would be on the Financial Reports of the Bank and the already published and publically available data. Financial statements and secondary data does not necessarily give all the insights as to why something is happening, therefore to get the deep insights, conducting Interviews were necessary to know about the opinion of bankers as to what is leading to such high NPLs and why the bank is not able to control them. And to actually check whether the findings from Secondary research matches with the findings from the primary research (Questionnaires and Interviews) Primary Research Primary Research would include both Interviews and Questionnaires. The basic purpose of doing a primary research on a topic like this one (NPLs) is to compare the views and general perceptions of Bankers regarding the rising trend in Non-Performing Loans of Habib Metropolitan Bank with that of already published publically available Financial Statements of HMB. Secondary Research As it has been mentioned earlier the research methodology for this Research Project would 70% -80% be comprised of Secondary research. Since we are focusing only on the rising trend of Non-performing loans of Habib Metropolitan Bank, the deep and thorough analysis of financial reports of the company and of the competitors reports along with some yearly Banking sector reviews of State Bank of Pakistan, would be reasonable enough to know the real reasons of these worsening conditions of the Banks Asset Portfolio. Literature Review Siddiqui et al (2012), basically aims to find out why the Non-Performing Loans in Pakistani Banking Sector are constantly on the rise. Their whole research is focused on finding out why is this happening and what are the main factors that are contributing to such high Non-Performing Loans even by taking all the precautionary measures that could possibly be taken, and following all the rules and regulations implemented by the Regulatory authorities like State Bank of Pakistan or Securities and Exchange commission of Pakistan. There are many factors that might be causing the borrowers to go default on their debt obligations but the major emphasis is on the Interest rate volatility and the High Interest rate charged by the lenders from the view point of increasing Non Performing loans in Pakistans banking sector. GARCH and other quantitative techniques were used to closely analyze the volatility trend in the interest rates and their possible impact on the Non-Performing loans. Siddiqui et al research clearly states that there is no significant relationship between the Volatility in interest rates Non-Performing Loans. According to the Authors the Non-Performing Loan trend in Pakistan is constantly on a rise and has witnessed a significant growth over the last few years, but as far as the neighboring countries are concerned like India, Bangladesh etc. Their NPL trend is on its way down, and the major reason that they find out seems to be Interest Rates within the economy. The lending rates in Pakistan are way higher than the Interest Rates in the neighboring countries that brings extra burden on the debtors to pay off their debt. High interest rates combined with low economic development are the main reasons why Pakistan is facing such a positive trend in the growth of NPLs while all other South Asian countries are showing a negative trend. According to the authors of this research article, state Bank of Pakistan has divided bad debts into three categories, namely, Substandard, Doubtful and Loss. These categories basically help the Bank Management and Authorities in identifying the NPLs situation. In a way, this research is one of its kinds, but now it has opened the doors for further research in identifying the main factors that affect the Non-Performing Loans. [6] O. Masood and B. Aktan (2009) focused on the determinants that lead to loan defaults especially of the state owned banks of Pakistan and Turkey. The factors that seemed to be affecting the Non-Performing Loans among the state owned banks within these two countries are of completely different in nature, which was quite unexpected. According to the authors of this research article, reasons that are causing these NPLs in Turkey are basically the Government interventions within the Banks lending business and bad analysis of creditworthiness. But in Pakistan factors like Years of service of credit managers in the banks and Communication facilities provided to the credit analysts basically affects the NPL growth rate among the state owned banks. These NPL issues could only be solved if these above mentioned factors are brought under control, otherwise this rising trend of NLPs would keep on going up. [7] Samreen and Zaidi (2012) explained the concept of Credit scoring in this research article. According to the authors, Non-Performing Loans could be reduced to a great extent if a proper credit scoring model is used by the lenders (Banks) to analyze the creditworthiness of the applicants who have applied for the loans. This way banks would be able to distinguish High credit worthy applicants from the less credit worthy applicants which would ultimately lead to a much more responsible lending and hence there would be less loan defaults. A loan is considered to be a Non-Performing loan, if a borrower has been unable to pay off the principal and interest for over 90 days (90 DPD). (Samreen, 2012) [8] Husain (2012) explains the misconception of rising NPLs among the general public and many bankers in the financial services sector. Husain says its completely wrong to say that State Bank of Pakistan is doing nothing about controlling these Non-Performing Loans. If we compare NPLs in year 1999 with NPLs in 2009, the quantum or the absolute value would be a lot higher in year 2009 even if all the loans that were issued after 1999 didnt go bad. And why is that so? The reason for these growing NPLs is the markup or interest that is constantly being charged and added up on the bad loan that hasnt been serviced for over 90 days. Lets assume a loan, worth 1 Million, was lent out in 2000 on a 20% markup rate with a maturity of 10 years. This loan got defaulted in the same year which means there are no repayments being made by the borrower on the loan that he/ she borrowed but the NPL amount would keep on rising and keep adding up every year as the interest amount due is being added to the d efaulted loan amount every year. In 2001 the NPL amount would be 1.2 million, in 2002 in would become 1.4, and in just 5 years this NPL would be doubled in amount. Another reason why these NPLs seem to be rising is because these loans were issued in foreign denominated currency and not in Pakistani currency, and as the exchange rate changes it would directly impact the NPL amount. Lets assume a loan of 1 million was issued in dollar denominated currency when the exchange rate of Rupee to Dollar is 45 to 1. After 2 years the exchange rate has been changed to 80 to 1 (Rupee to Dollar) and we are assuming that the loan has already been defaulted. Now the quantum of NPL that would be seen by the general public would grow and increase according the change in Exchange rate. [9] Sofoklis D and Nikolaidou (2011) basically tried to identify the determinants that are contributing to Non-Performing loans in the Romanian Banking system. As per their research findings there are many macroeconomic cyclical indicators that are contributing in the growth of NPLs like the inflation rate, interest rate, GDP to External Debt, infrastructure development, Unemployment rate and Investment Expenditure. All these indicators in their separate and unique way do affect the Non-Performing loans in the Financial Services sector. [10] (Shaikh, 2004), Basically explained that determinants that affect the Non-Performing Loans vary with the geographical area, the culture and norms of a particular area, and the laws of a particular country where a particular bank is operating. These variations are basically because of factors like Economic growth of a country, situation of a particular industrial sector, quality of management, Regulatory laws which are different for each country. According to the author of this research article NPLs are majorly arising from the manufacturing sector which includes textile sector, cement, sugar and the Public sector enterprises. When a particular sector is having trouble regarding its performance and growth, the risk of loan defaults in that particular sector increases, which also seems to be a very logical reasoning, as the sector wise loan default data issued by the State Bank of Pakistan clearly states that textile sector is the major contributor in causing Non-Performing Loans withi n Pakistans Financial services sector. Textile sector is going through a lot of trouble and setbacks due to power shortage crisis, natural gas crisis and growing competition from countries like Bangladesh, China and India. Who are producing and exporting textile products at cheaper prices. All these above mentioned factors have badly affected the growth of textile sector which has further contributed in the rising trend of Non-performing loans within the textile sector. [11] (Vassiliou, 2004), Basically analyzed the change in behavior of the regulatory authorities of Asian countries regarding their policies on the non-Performing loans in their financial services sector. The author explains that most countries have changed their policies in dealing with loan defaults (debtors and creditors), lets assume the case of Pakistan, in 90s the authorities were very strict with the debtors (loan defaulters) and were highly pro creditors in order to keep a check on rising NPLs, the laws were so strict at that time that defaulters were forced into jails. But few years later these policy makers completely changed their policies in an opposite direction. Now the Regulatory authorities are more lenient to Debtors than they are to creditors. [12] (Assessment of Financial Intermediation, 2012) Chapter1 gives the updates on the economic conditions and Financial Services Sector progress. This report also clearly states that Pakistans banking sector does not enjoy the highest Banking Spreads if we compare it with other developing and developed countries, because in cross country analysis factors like financial sector development, Regulatory laws and framework and business conditions. According to World Banks database, Pakistans ranking is nowhere near banking spread of developed countries but as a matter of fact it comes out to be 69th among all other developing and developed countries. [13] Comprehensive Financial Analysis PERFORMANCE BAHL BAFL SONERI SUMMIT HMB ROE 24.33% 15.34% 7.14% -27.90% 17.20% ROA 1.14% 0.75% 0.60% -1.28% 1.43% Pre-Provisions Operating Profit/Avg.Equity 53.24% 45.87% 21.41% -56.84% 35.48% Pre-Provisions Operating Profit/Avg.Assets 2.49% 2.22% 1.81% -2.69% 2.95% Personal Expense-to-Total Net Revenue 45.98% 30.65% 27.38% 327.20% 19.82% Cost-to-Total Net Revenue 46.90% 64.05% ÂÂ   -448.79% 38.21% Other Operating Income/ Total Net Revenue 15.92% 16.15% 10.45% 56.22% 40.25% Taxes/ Pre-Tax Profit 38.07% 35.53% 27.33% -49.50% 25.90% Net Non-Earning Assets/Assets net to Non-Int Lia 7.50% 18.60% 17.46% 25.17% 9.88% ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   CAPITAL ADEQUACY ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   Equity/Total Assets 4.68% 4.88% 7.89% 4.60% 8.41% Adjusted Equity)/ Total Assets 5.23% 5.51% 8.46% 5.20% 8.53% Revaluation Surplus (Deficit)/Adjusted Equity 10.49% 11.39% 6.75% 11.58% 1.37% Capital Adequacy Ratio as per SBP ÂÂ   11.60% 13.53% 7.77% 13.93% ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   LIQUIDITY ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   Liquid Assets/Deposits and Borrowing 70.50% 53.65% 48.78% 39.47% 49.28% Finance/Deposits and Borrowing 36.06% 46.42% 50.72% 43.98% 43.04% Finance/Deposits 39.54% 49.34% 58.58% 64.75% 58.51% Demand Deposits/Total Deposits 25.36% 36.62% 20.65% 19.78% 31.86% Export Refinance/Advances 17.03% 5.25% 25.40% 38.06% 22.24% Fianance(net of Export Refinance)/Deposits 33.20% 46.83% 44.22% 40.11% 46.01% Government Securities/Total Assets 55.00% 33.43% 31.69% 25.83% 44.92% Finance/ Total Assets 33.04% 42.29% 45.04% 40.21% 37.64% Lending to Financial Institutions/Borrowing from Fis 0.00% 50.99% 71.84% 6.37% 5.43% ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   LOAN LOSS COVERAGE ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   Impaired Lending/Gross Finances 2.76% 9.65% 15.85% 48.75% 14.80% Loan Loss provision /Impaired Lending 158.10% 67.70% 64.10% 49.37% 64.97% Net Impaired Lending/ Equity -11.34% 27.01% 31.36% 206.05% 22.30% Net Impaired Lending/ Adjusted Equity -10.15% 23.93% 29.00% 182.20% 21.99% ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   INTERMEDIATION EFFICENCY ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   NIRM (Net Interest/Mark-up Revenue)/ Avg-Assets 2.96% 4.23% 3.75% 0.42% 3.20% Asset Yield (Interest Earned/Average 11.36% 12.45% 12.74% 11.63% 11.93% Cost of Funds {Interest Expense/ Average 7.18% 6.41% 7.81% -8.24% 8.23% Spread 4.19% 6.05% 4.93% 19.87% 3.70% ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   GROWTH ÂÂ   ÂÂ   ÂÂ   ÂÂ   ÂÂ   Total Assets 15.10% 13.78% 20.01% 65.70% 14.28% Gross Finance -13.80% -12.01% 18.53% 38.91% -10.43% Impaired Lending 7.70% 4.24% 26.01% 96.75% 40.75% Investments 49.38% 81.71% 38.32% 93.91% 56.78% Customer Deposits 16.20% 13.34% 21.60% 46.77% 15.54% Equity 9.34% 15.78% 23.10% 53.26% 21.00% Source: https://habibmetro.com/documents/2011/UnConsolidated2011-Final.pdf Source: https://www.soneribank.com/document/url/83/Soneri_AR_2011.pdf Source: https://www.bankalfalah.com/about/download/BALAnnualReport2011.pdf Source: https://www.bankalhabib.com/quick-links/financialReport2011.php [14][15][16][17][18][19][20] Ratio Analysis Ratios of four competitor banks have been calculated using their financial statements available online on their websites for the financial analysis and performance of these banks. These four competitor banks namely, Bank AL Habib Limited, Bank Alfalah Limited, Soneri Bank Limited and Summit Bank Limited are small and middle tier banks which makes them completely eligible for comparative ratio analysis with Habib Metropolitan Bank. Since this research is only being conducted to inquire about the Non-Performing loans of Habib Metropolitan bank, only Impaired Lending Ratios would be covered in the financial ratio Analysis section. 1) Impaired Lending/Gross Finances: Non-Performing loans to Total Gross Finances ratio is a very important ratio with significant usage in financial services sector. It basically explains the percentage of loans that have gone bad from the banks total Loan portfolio. Higher this ratio is, higher the trouble for the bank. Now if we see the figures given above in the table, the ratio of HMB does not come out to be very positive. It is way higher than the industry average. It could be clearly seen that BAHL and BAFL (2.76% 9.65% respectively) have small figures as compared to HMB which is almost touching 15% (14.8% to be exact). These ratios clearly states that HMB is not managing its loan portfolio very efficiently which is why it is having such a high figure for NPLs/Gross Finances ratio while its counterparts are keeping a strict control over it and not letting it to exceed beyond one figure. 2) Loan Loss Provision/ Impaired Lending: this ratio is probably the most important one in finding out the efficiency of Banks management in managing its Loan Portfolio. Higher this ratio is safer a bank would be, because provisions act like cushions for the banks in absorbing loan losses. If this ratio is more than or equal to 100%, it would mean the banks loan portfolio is completely covered with the provisions is not at risk regarding loan defaults. If the provisions allocated by the bank are not enough to cover up the NPLs portfolio completely and supposedly the whole loan portfolio maintained by the bank goes bad, then the banks equity would be at stake, which would ultimately cause trouble for the equity holders (Share holders) of the bank. As per the figures given above all four banks apart from BAHL have their Loan Loss Provision to Impaired Lending Ratio lower than 100%, which means these banks are at the mercy of the borrowers credit worthiness. Supposedly if only 64.97% (H MBs Ratio) of NPLs are covered and the total loan loss as of the total loan portfolio turns out to be 80%, then it would be a serious trouble for the Banks. 4) Net Impaired Lending / Equity: Non-Performing loans to Total Equity ratio basically represents the percentage of Non-performing loans over the banks Total equity. Higher this ratio is, worst the scenario would be for the bank. As far as figures in the above given table are concerned Habib Metropolitan bank has a very decent ratio as compared to its competitors. Lower this ratio is, safer the bank would be. Financial Analysis Over the years Habib Metropolitan bank has witnessed a very significant growth in its deposits, total assets, and total number of branches, investments, profit before tax and profit after tax. All these factors are the main indicators of a banks growth (growth or decline). In a period of just one year (FY10 to FY11) Habib Metropolitan Banks total assets grew from Rs 252 Billion to Rs 288 Billion which is a very significant figure. Similarly, Investments made by the Bank (Stock Markets / Government Securities) also grew from Rs 100 Billion to Rs 147 Billion which is also a very significant (increase) change in banks investment portfolio. These figures clearly shows that HMB is focusing and channeling its funds more towards Investment side (Government securities, Stocks, Bonds etc) rather than focusing into Advances. Over the years Bank has reduced its Advances portfolio due to the bad performance of Loan portfolios and diverts those extra funds towards investments which are the main r eason why Advances figure have seen a dip while the Investment figure has witnessed a jump (growth). Overall the bank is earning profits but the profit growth rate figures have reduced in the recent years, the reason for that is HMB is playing safe and in investing in Government securities which are a safer option of getting returns on its funds, rather, lower returns as compared to what Bank gets by lending these funds to some credit worthy borrowers which might earn bank higher returns. Now since the economy is in recession and most probably all the sectors are suffering from it, banks are very reluctant to release (lend) and channel their funds in the economy by lending their surplus funds to the deficit fund borrowers. Primary Research Questionnaire Analysis A sample size of 25 questionnaires was chosen for the collection of data essential to conduct this research and to come up with a significant conclusion on what Bankers and General Public think about the Non-Performing Loans condition in Pakistans Financial Services sector, what according to them is the trend being followed by the NPLs, upward or downward, and what factors do they actually think affects the creditworthiness of the outstanding Loans held by the debtors. The data that would be collected using this survey would be very useful in comparing what the real reasons are and what the Bankers think are the reasons behind the loans going bad. Question No: 1 Out of a total sample of 25 Individuals to whom this questionnaire was floated to 18 responded with Yes and only 7 individuals replied with a No. This means that majority of the individuals have or had borrowed money from banks at some part of their life. This pie chart shows that 72% of the respondents have themselves experienced a life of lending and borrowing from the financial services sector and 28% of the individuals have never taken a loan from a bank. Question No: 2 This question is very important in a sense that it will provide us with a feedback from the bankers (respondents) about what they think of Banks lending decisions and whether these banks follow proper rules and regulations while lending funds to the borrowers or not. Out of a total sample of 25 respondents, 15 responded with a Yes and remaining 10 responded with a No that means majority of the respondents believe Banks take all the necessary measures in their lending decisions and to make sure they lend to the responsible creditworthy borrowers and not to irresponsible and less credit worthy borrowers. In percentage terms 60% of the respondents believe that the banks are very careful in making lending decisions while only 40% believe this not to be the case. Question No: 3 This question is also a very important one for this research. All 25 respondents were asked about their views on the trend of Non-Performing Loans within the Banking sector and what they think is the direction of this trend, either its rising, declining or consistent. The response that was received was not unanimous at all. Its amazing how only 44% of the respondents believe NPLs are on a rising trend and 40% think they are following a declining trend and only 16% respondents believe that there is no significant change in the trend and is being quite consistent. The result shows that majority of the respondents dont even know the trend being followed by Non-Performing Loans in the banking sector which could be easily seen in the State Bank of Pakistans publications and each banks Financial Statements. In numeric terms only 11 out of 25 respondents think NPLs are rising in the banking sector while 10 out of 25 think NPLs are decreasing and only 4 respondents think the trend is being c onsistent. Question No: 4 This question had some trickiness hidden inside; the basic purpose of asking this question was to find out the understanding of lending and borrowing processes among the low level bankers and credit analysts. 76% of the respondents believe Banks could put a leash on this rising trend of Non-Performing loans occurring within the banking sector and only 24% of respondents believe stopping NPLs from rising is inevitable, the probability of loans going into default could not be controlled because you would never know when a creditworthy borrower might become a less creditworthy defaulter. There might be so many unknown determinants that could affect the creditworthiness of a borrower and could turn him into a defaulter. In numeric terms 19 out of 25 respondents said the probability of loans going bad could be reduced while only 6 out of 25 said it could not be controlled (Probability of default could not be reduced). Question No: 5 This survey question is just a follow up of the previous question. In the previous question respondents were asked whether the probability of loan default could be reduced or not, and the majority of the respondents replied with a Yes, and then a follow up question comes up, asking, how? 28% of the respondents said by applying more Checks in the banks lending processes, 24% said by restriction in lending to declining economic sectors e.g. Manufacturing, Textile, and Agriculture etc. 20% respondents said by giving more communication facilities to the Credit Analysts. 16% said by restriction in lending to particular geographical regions (areas where concentration of defaults is very high). 8% said all of the above options would help in reducing the probability of loan defaults and only 4% respondents said none of the above given options would result in a lesser probability of loan default. Question No: 6 This question is basically the crux of this research. Respondents were asked that which of the following determinants causes Non-Performing Loans within the banking sector. Almost 36% of the respondents said that lending to low growth economic sectors of the economy is the main factor that causes NPLs, 20% respondents each voted for Lending based on contacts and Poor Credit Analysis, 12% respondents said that fluctuating interest rate is the main factor which causes NPLs, 8% of the respondents said, all of the above mentioned factors do have their negative impact on NPLs, and only 4% respondents said there are other unknown factors that affects the Loan Portfolios of the banking sector (NPLs). Question No 7 Respondents were asked about their views on the Non-Performing loans with respect to the Economic conditions of a country. Almost 84% of the respondents responded to this question with a Yes which means that according to them Economic conditions within a country do affects the creditworthiness of the debtors. Only 16% respondents responded with a No, which means they dont believe Loan Portfolios of banks within a country gets affected by the Economic conditions within that particular country. In numeric terms 21 respondents out of 25, responded with a Yes and only 4 respondents out of 25 responded with a No. Question No 8 This question is basically looking for a link between the defaulted loans of a bank and the outstanding External Debt of that particular country where that bank is functioning. Almost 13 out of a total sample size of 25 respondents said No, external debt of a country does not have any impact on the NPLs of that countrys banking sector. 9 out of 25 respondents responded with Yes which means they believe Loan Portfolios maintained by the banks of a country gets affected by the External debt of that particular country. Only 12% respondents said they dont know either External Debt of a country have any impact on the NPLs or not. Question No 9 This question is about the impact of changes in Exchange Rate on Loan portfolio of the banking sector. Almost 64% of the respondents said that changes in exchange rate has absolutely no impact on the Non-Performing Loans within the Banking sector, 20% believe that changes in Exchange Rate affects the Non-Performing Loans (Asset portfolios of the banks) within the Banking sector. And only 16% of the respondents said, they dont know either change in Exchange Rate have any impact on the Non-Performing Loans or Not. In numeric terms 16 out of 25 respondents responded with a No, 5 responded with Yes and only 4 of the respondents said they dont know. Question No 11 This question is probably the most important one in this entire survey. It is basically the crux of this whole research. All the 25 respondents were asked to pick any of the below mentioned sectors which they think are the main cause of growing NPLs and are contributing more towards the Non-Performing Loans within the banking sector. 40% of the respondents think NPls are more concentrated within the Sugar industry, 32% respondents said NPLs are more concentrated in the Textile Sector, 12% of the respondents think its the power sector and only 8% respondents think its Cement sector where NPLs are more concentrated while remaining 8% respondents think other sectors are causing these NPLs. Question No 12 This question is basically to inquire about the impact of Credit Managers Performance and competence on the Loan portfolio of the Banks. Almost 64% of the respondents responded with No, 20% responded with Yes and only 16% of the respondents responded with May be which means they dont know either it has any impact on the NPLs or not. In numeric terms 16 out of 25 respondents said No, 5 responded with a No and only 4 respondents responded with May be Question No 13 This research question is about the impact of High Interest Rates on the Non-Performing Loans within the Banking sector. According to 52% of the respondents High interest rates within the Economy leads to high Non-Performing Loans in Financial services sector, 24% of the respondents think High interest rates dont have any impact on the NPLs while the remaining 24% respondents are not sure whether it has any impact on the Non-performing loans in the banking sector or not. Question No 14 The last question in the Primary survey questionnaire is about the impact of Government intervention on the Loan Portfolios of the banks. Majority of the respondents believe that Government Intervention in the banks lending decisions leads to high Non-Performing loans within the banking sector, 12% respondents believe Government intervention has nothing to do with the rising NPLs in the Banking sector while only 4% of the respondents responded with May be which means are not sure about the impact of Government Intervention on NPLs. Cross Tabulations NPL * FACTORS Cross tabulation FACTORS Total 1.00 2.00 3.00 4.00 5.00 6.00 NPL 1.00 2 3 6 11 2.00 3 2 2 2 1 10 3.00 1 1 2 4 Total 5 5 9 3 2 1 25 NPLs 1 Rising 2 Declining 3 Consistent Factors 1 Poor Credit Analysis 2 Contacts 3 Declining Sectors 4 Interest Rate 5 All of the Above 6 Others 6 out of 11 respondents who believed NPLs are rising think its because of concentration of Banks lending within few (manufacturing or Service) sectors of the Economy. While 3 out of 11 respondents believe its because of lending based on Contacts or in other words lending to a person or company not based on its credit worthiness but on somebodys request that might have influence on the Banks management or its operations, like politicians or people with authority. And only 2 out of 11 respondents who voted for the rising NPLs believe its because of poor credit analysis of the individuals or corporations applying for loan, by the Credit Analysts of the Banks. None of the 11 individuals who think NPLs are rising think Interest rates have anything to do with the alarming Non-Performing advances situation in Pakistan which is rather odd response to get, because many top level executives of Banks who were interviewed for this research said High Interest rates within the economy is also a ve ry important contributor in causing NPLs. NPL * ECOGROTH Cross tabulation ECOGROTH Total 1.00 2.00 NPL 1.00 11 11 2.00 8 2 10 3.00 2 2 4 Total 21 4 25 NPLs 1 Rising 2 Declining 3 Consistent Economic Growth 1 Yes 2 No The response gathered from the individuals regarding the cause and effect relationship between the Economic Growth of a country and the Non-performing Loans within in the banking sector, was quite unanimous, almost all of the respondents who voted for a rise in NPLs agreed that Economic growth within a country does affect the Loan portfolios of its banking sector NPL * EX.DEBT Cross tabulation EX.DEBT Total 1.00 2.00 3.00 NPL 1.00 8 2 1 11 2.00 1 7 2 10 3.00 4 4 Total 9 13 3 25 NPLs 1 Rising 2 Declining 3 Consistent External Debt 1 Yes 2 No 3 Dont Know This table is a cross tabulation between the trend in NPLs and the effect of External Debt taken by the country on the Non-Performing advances in the banking sector of that particular country. 8 out of 11 respondents who think NPLs are following a rising trend believes External Debt has a positive impact on the Non-Performing Advances of the banks, while only 2 out of 11 responded that there is no cause and effect relationship between the NPLs and the external debt of a country. NPL * EX.RATE Cross tabulation EX.RATE Total 1.00 2.00 3.00 NPL 1.00 4 6 1 11 2.00 1 8 1 10 3.00 2 2 4 Total 5 16 4 25 NPLs 1 Rising 2 Declining 3 Consistent Exchange Rate 1 Yes 2 No 3 Dont Know The above given table basically gathers up the response from all the respondents and helps in making patterns out of this raw data. This cross tabulation basically shows that according to the respondents there is not much of a cause and effect relationship between the exchange rates and Non-performing loans. This conclusion is representation of the numbers given above in the Cross Tabulation table as only 4 out of 11 respondents said there is a cause and effect relationship between these two while 6 out of 11 responded there is no relationship between the two. NPL * SECTOR Cross tabulation SECTOR Total 1.00 2.00 3.00 4.00 5.00 NPL 1.00 5 4 2 11 2.00 3 5 2 10 3.00 1 2 1 4 Total 8 10 2 3 2 25 NPLs 1 Rising 2 Declining 3 Consistent Sectors 1 Textile 2 Sugar 3 Cement 4 Power 5 Other This table basically aims to establish a cross tabulation between the rising Non-Performing Loans and the various declining sectors of the economy (Services Manufacturing). The response gathered was pretty much limited to only three sectors namely Textile, Sugar and the Power sectors. 5 out of 11 respondents said textile sector is the main contributor in the Non-performing advances of the banking sector, while 4 responded in the favor of the sugar sector and only 2 responded in favor of Power sector. NPL * I.RATE Cross tabulation NPLs 1 Rising 2 Declining 3 Consistent Interest Rate 1 Yes 2 No 3 May be I.RATE Total 1.00 2.00 3.00 NPL 1.00 10 1 11 2.00 2 5 3 10 3.00 1 1 2 4 Total 13 6 6 25 The response as per the figures given in the above table was somewhat unanimous. 10 out of 11 respondents who voted for rising trend in NPLs believe Interest Rate is a major factor that causes Non-Performing Advances in the banking sector, while only 1 out of 11 respondents responded with a May be which means he is not hundred percent sure if the NPLs are affected by the Interest Rates or not. Out of a total 25 respondents, 10 of whom responded that NPLs are declining, only 5 believe there is no cause and effect relationship between the NPLs and Interest Rates within the economy. NPL * GOVT.INT Cross tabulation GOVT.INT Total 1.00 2.00 3.00 NPL 1.00 10 1 11 2.00 7 2 1 10 3.00 4 4 Total 21 3 1 25 NPLs 1 Rising 2 Declining 3 Consistent Interest Rate 1 Yes 2 No 3 May be Almost all of the respondents who think NPLs are rising also think Government Intervention is the main factor that causes Non-Performing advances. 10 out of 11 respondents believe Government intervention in the Banks lending operations is one of the major factors why a consistently growing percentage of Advances given out by the banks to the individuals or the corporations end up in bad loans or Defaults. 10 out of 25 respondents who responded In favor of declining NPLs, majority of them also believes NPLs are caused by Government intervention but the trend is now declining the passage of time. Interviews Interviews are a great tool for getting in-depth insights for research purposes from the people who are the real experts in their particular fields. 12 interviews were conducted with both top level executives and middle level Credit Analysts in order to get their perspectives on the alarming Non-Performing loan situation within Pakistani Financial Services sector. The focus was not just on the whole financial system but it was also on Habib Metropolitan Bank. But, the question is, why are we even concerned with whats going on in the system and not just focusing on Habib Metropolitan Bank? The logic for that is quite simple and straight forward, what affects the whole system affects the entities that are working or operating within it. If the situation of Non-Performing Loans within the financial sector is correctly analyzed, it would be of great help in analyzing the trends and reasons of NPLs that are incurred by Habib Metropolitan Bank. Interviews were conducted both internally and externally. All the external Interviews were conducted with the employees of HMBs competitor, Faysal Bank Limited, and all the interviews conducted internally are with the Top level and middle level executives of the Bank. Internal Interviewees Fateh H Shamsi Senior Vice President Habib Metropolitan Bank Naveed Akbar Manager Operations Habib Mertopolitan Bank External Interviewees Muhammad Amir Sheikh AVP-Regional Manager CIU Verification-Central Faysal Bank Limited Hassan Credit Analyst Faysal Bank Limited Ahmar Credit Analyst Faysal Bank Limited Kamran Credit Analyst Faysal Bank Limited Syed Nadeem Ahmad CIU-Unsecured-Manager Faysal Bank Limited Tariq Raza CIU-Secured-Manager Faysal Bank Limited Mohsin Umar Verification Manager Faysal Bank Limited Sabah Sajjad Data Entry Manager Faysal Bank Limited Ali Senior Credit Analyst Faysal Bank Limited Fawad Senior Credit Analyst Faysal Bank Limited Key Findings Mr. Amir Sheikh, a MBA graduate from Lahore School of Economics, currently working as an Assistant Vice President Regional Manager CIU Verification -Central at Faysal Bank Limited, started his career as a Trainee with Prime Bank which was later on acquired by ABN-AMRO Bank, which also recently got acquired by Faysal Bank Limited, one of the fastest growing banks in Pakistan. According to Mr. Amir who has been working in the lending side of the Banks for the last 13 years, there are many factors that affect the Asset Portfolios of the Banks, which includes lending based on very high interest rates to both retail and corporate borrowers, slow economic growth, relaxed lending practices, poor credit analysis of potential borrowers, large amount of lending concentrated in few declining sectors of the economy, interest rate volatility, Depreciation of currency, External debt taken by the Government and the Intervention of Government in the Banks lending businesses. Almost similar response was given by Mr. Fateh H Shamsi, Senior Vice President of Habib Metropolitan Bank, who started his career in banking 34 years ago, and is now among the top Executives of the Bank. According to him Non-Performing Loans of Habib MetroPolitan Bank are constantly on a rising trend, even though they are not as high as they were used to be in the era of Nationalization, when the Government intervention in the banks lending businesses resulted in great losses to the Banks, as these interventions by the Governments, made banks to lend funds to less credit worthy borrowers who wouldnt have been able to get these loans themselves on the set criteria of the Banks. Even though Banks have recovered from that stage (Nationalization Era) this rising trend in Non-Performing Loans have started once again but the main factors causing it are different from those that were causing it in the Era of nationalization. Now the banks are following strict rules and regulations imposed b y the regulatory authorities such as State Bank of Pakistan and Securities and Exchange Commission of Pakistan to protect and safeguard the rights of the investors and the creditors of the Banks. Mr. Shamsi said our Bank is a subsidiary of Habib Bank Zurich which is a big multinational bank with a great reputation, and the way we are running our bank is very much equivalent to international standards, we are following the rules and regulations suggested by Basel Committee which means we are sincere and doing everything we can to further improve our banking operations and efficiency in our work. According to Mr. Shamsi One major reason that is causing NPLs in Habib Metropolitan Banks asset portfolio, is the alarming energy crisis prevailing within the country, which has also adversely affected the Textile sector of Pakistan where the Banks have heavily concentrated their lending. Now that the Textile Firms are not getting enough electricity to operate on their full capacity, their pr ofits have taken huge hits, which have caused most of them to default on their loans. Since most of the textile firms are export oriented and are generally dependant exports for generating profits, but the rising competition in international markets from countries like Bangladesh, India China is posing real threats to Pakistani Textile Sector and its profitability, which has resulted in more loan defaults from the firms in textile sector. The employees in the middle management and lower level management like Senior Credit Analysts, Credit Support Analysts or the Verification Managers, who work in backend offices of the banks also referred to as, the assembly lines of the Banks, and who are in direct contact with their clients also known as Relationship Managers, were not very interested in looking into a bigger perspective, putting it in simple words, they liked to evaluate such issues (NPLs) on a Micro level rather on a Macro level, according to majority of them, Poor Credit Analysis, poor infrastructure and above all, lack of documented information available to them are the main reasons why NPLs (especially in Retail Lending) are increasing in the banking sector. In corporate lending most of them believed Government intervention in banks lending decisions and lending concentrated in Textile and other manufacturing sectors are the main causes of this rising NPL trend. Majority of them were not able to make any cause and affect relationship between Exchange rate and Non Performing Advances of the Banking sector. According to Mr. Hassan who is a Credit Analyst, banks have set certain rules and criteria and defined each company and the employees working in it according to that set criteria, but this categorization is not updated on a frequent basis that is why the Credit Analysts who are evaluating the company for its credit worthiness are not able to identify the current situation of that company, which ultimately leads them in lending to less credit worthy borrowers who were once credit worthy which would ultimately cause Higher NPLs for the Bank in the future. Analysis Over the last few years Habib Metropolitan Bank has witnessed a jump in its deposits. This significant increase in its deposits is due to an increase in inflow of remittances from Pakistanis living abroad, and increase in the total branch network of HMB. On one hand the deposits of the bank are increasing while on the other hand the asset portfolio maintained by the bank is also deteriorating, as the Non-Performing Advances have increased in number (Not only in numbers but also in percentage terms, as the Provision to Non-Performing Loans ratio in 2011 has decreased as compared to the ratio in previous years). One of the reasons for rise in HMBs NPLs is, the top 5 (bigger banks) banks in Pakistan holds the majority of credit worthy borrowers while the smaller bank, including HMB, have to go for much risky borrowers to increase their network and extend their Loan Portfolios. The Credit risk of HMB has increased due to the Power Crisis, High Inflation Rate and Poor Economic Condition of the country. HMB has a very organized system for managing all kinds of risks its exposed to, because HMBs management considers the effective risk management as a tool for long term profitability and banks operating efficiency. As per the data given in the Financial Statements of Habib Metropolitan Bank, 51% of the total Advances in HMBs Advances Portfolio are extended to the Textile sector which is the main contributor in the Banks Non-Performing Loans. The remaining 49% of the advances are diversified in various sectors of the economy to reduce the credit risk from Loan defaults, caused by the macro factors like Power shortage, inflation, fluctuating interest rate, External Debt, Exchange Rate, poor economic growth and Government intervention. Trade and sale segment constitutes only 0.7% of the banks NPLs while the remaining 99% is constituted by the commercial banking. The Asset quality of Habib Metropolitan Bank is not good. Banks NPLs arising from the Textile sector alone have surged the NPL to Gross Finances Ratio to 14% (FY 2011). The provisions kept by HMB are not sufficient enough to NPLs which has further deteriorated the asset quality of the HMB and has made it vulnerable to unforeseen losses. ÂÂ   2011 2010 2009 Gross finances 108,486,293 125,988,840 115,035,839 NPLs 15,427,848 10,961,145 6,364,335 Provisions 10,022,934 7,522,371 4,629,476 NPLs/Gross Finances 14.80% 9.42% 6.33% Provisions/NPLs 64.97% 68.63% 72.745 Net NPLs/Equity 22.30% 16.41% 9.18% [21] Source: https://habibmetro.com/documents/2011/UnConsolidated2011-Final.pdf The main objective for conducting both the primary and secondary research was to evaluate and analyze, what the Bankers from all three hierarchical levels (Top, Middle Lower level) think, are the reasons for such high NPLs in the Asset portfolio of Habib Metropolitan Bank and what the Financial Reports of the Bank and other publically available published data and information in various research papers say. The main factor that is affecting the NPLs of Habib MetroPolitan Bank is the concentration of its Asset Portfolio within one sector of the economy, the textile sector. 51% of its asset portfolio is extended to the Textile sector which is also the main contributor in loan defaults. This is the reason why HMB is having problems with its Asset Portfolio; there is not enough diversification in its asset portfolio. Other questions might arise that Textile sector is taking this hit due to other Macro economic factors like energy crisis, inflation, Interest rate volatility, High Interest rate, Exchange rate volatility, poor economic situation and poor credit analysis. But the fact is, these factors are same for the whole financial sector, they are not just affecting HMB alone, they are affecting all the banks in the financial services sector. Moreover these factors could not be controlled by a single entity; they are a part of External Environment, which the bank cant change. The HMB could only change what is in its control (Internal environment), and that is Diversification in its asset portfolio and Good Credit Analysis. Recommendations The major reason why Habib Metropolitan Bank is not able to control its ever increasing Non-performing loans is the Non-Diversification of its asset portfolio. One basic rule which is taught in the basic foundation courses of finance is diversification. Dont put all your Eggs in one basket [22] Diversification means, one diversifies its money (Investments or advances) not just in one area but in a lot of areas. Hypothetically, if a bank lends all its funds to a single borrower and some days later that borrower goes bankrupt, then how would that bank get its money back? The money that the bank has lent to that borrower is gone as soon as that borrower is not able to pay back its obligation. This is the risk involved in Non-diversification. That is why in the world of finance diversification is considered to be very important, because Diversification reduces risk. If one borrower goes bust others are still alive and paying back their obligations to the bank on time. Habib Metropolitan Bank ha