PAKISTAN'S BANKS FACE DETERIORATING CONSUMER AND SMALL

UNCLAS ISLAMABAD 000229

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ECON EINV PGOV PREL PK
SUBJECT: PAKISTAN'S BANKS FACE DETERIORATING CONSUMER AND SMALL
BUSINESS PORTFOLIOS, PROTECTED FROM GLOBAL CREDIT CRISIS

REF: LAHORE 0014


1. (SBU) Summary. The banking sector in Pakistan has been largely
shielded from the international financial crisis by a regulatory
framework that has limited its foreign currency and securities
exposure. Although there were no major losses in calendar year
2008, local bankers are expecting problems to surface in the
troubled consumer and small business loan sectors in the coming
months. The high interest rates (required by the IMF Standby
Arrangement),while still lower than inflation, have hit the
troubled textile sector - which accounts for over 20 percent of the
banks' portfolio - particularly hard. Banks are working out payment
schedules with customers to prevent large defaults, but several
large corporations are in serious trouble. Lowering inflation, and
consequently interest rates, is critical to Pakistan's speedy
economic recovery. Local interlocuters are expecting at best a
stagnant rate of growth for FY 2009, rather than the 3 percent
predicted by the Government of Pakistan. End Summary


2. (SBU) Local banking representatives have given us a pessimistic
picture for the coming year, in particular for their small business
and consumer loans (which account for over 40 percent of banks'
portfolios). Although there have been no major losses or defaults
in Calendar Year 2008, it appears that this will change in 2009.
Over the past several years, credit grew by over 25 percent
annually, with a corresponding decline in the creditworthiness of
borrowers. These at times marginal borrowers have been hit hard by
rising interest rates. With a 15 percent discount rate, banks
routinely charge 20 or 21 percent interest; in a country where the
average per capita income is under $1,000, repayment is becoming
difficult.


3. (SBU) As lending to large corporate entities became less
profitable, banks diversified into the commercial and small and
medium enterprise (SME) sector, which now accounts for about one
third of their portfolios. SME's are traditionally thinly
capitalized and have low operating margins. Textile companies in
the SME sector, such as knitwear, bed linens, and home textiles,
depend on bank borrowing for their working capital, and have been
extremely hard hit. With profit margins of only 9-10 percent, they
have been unable to repay their working capital loans at the end of
a product cycle (which banks normally require),and have been
running up ever larger balances. Eighty percent of one large bank's
textile loans have been downgraded. Even large companies are in
trouble. One local source believes that Dewan Salman Fiber, LG
Electronics, and Chenab Textiles may be close to default [protect].


4. (SBU) That the banking sector is not even more troubled is
largely due to effective regulation by the State Bank of Pakistan
(SBP),according to one local banker. Capital adequacy ratios were
raised to nine percent, and banks now average 13 percent. When the
SBP raised capital requirements recently, many smaller banks were
forced to merge, while those with foreign parents received capital
injections. (The SBP plans to increase the minimum capital
requirement again, to $300 million by 2013.) Since banks are not
allowed to borrow offshore and are required to hedge their open
foreign currency positions with the SBP, they were not exposed to
foreign exchange risk as the rupee plummeted in value. The SBP also
limits banks' exposure to equities to less than 15 percent of their
capital, which has shielded them from the recent stock market
volatility.


5. (SBU) Comment. The monetary tightening required by the IMF's
Standby Arrangement, as well as the GOP's previous extensive
borrowing (which has crowded out the private sector),have had a
debilitating impact on Pakistan's small businesses - especially in
the perennially troubled textile sector, which is also battling high
energy prices and declining demand. The banking sector will have to
monitor its portfolio over the next two or three quarters carefully
and work out payment arrangements with its troubled customers to
avoid large numbers of defaults. Until inflation is brought under
control, with a corresponding drop in interest rates, the
manufacturing sector in Pakistan will continue to struggle, and a
robust recovery will be unlikely.

PATTERSON