This study focuses the current trend of nonperforming loans which are bringing threats on Conventional Banks and bringing high impact on their performances. The study reflects that borrowers face difficulties in paying loans, although their nonpayment of loans or failure in payment or being default or disability to reach on contract or an agreement for 90 days or 3 month that effects the performance of the Conventional Banks. As well as the multiple regressions has also performed to know the final outcome. The interest/markup, discount rate, credit risk, liquidity risk, solvency risk & earning risk has found in a high variation and they are useful to make predictions and the final suggestion regarding nonperforming loans as a preventive measure to reduce, minimize & control NPL's is that the Efficient Loan Appraisal Techniques should be introduce & adopted which is based on risk measurements & conventional investment analysis and the rule of issuance of loan should be in control with the objectives of institution. This study must be review due to recent crises of nonperforming loans (NPL's).
1. INTRODUCTION
A loan which has in default for 90 days or 3 month called Nonperforming loans (NPL's), these loans caused by nonpayment or failure in payment, although it relies on the agreement. Continuously increasing figures in nonperforming loans bringing threats in Banking Sector of Pakistan i.e. the enormous figure of All Banks and DFIs is over Rs. 652,991 million, Net NPL's is Rs. 222,490 million & Net NPL's to Net Loans 6.15% as of June 30th 2012. The Banks are part of financial institutions; it's their function to provide funds against of collateral or non collateral security which conversion of assets from excess to shortage of amount in economy. It is risky in treating or dealing effectively to accomplish their task, which is task oriented. Although cash is a part of an assets, when cash or loan could not be covered, then it effect on liquidity risk and credit growth, which puts the bank into trouble. The high borrowers or long terms borrowers are expected to be defaulters, so the long term or big borrowers should be treated carefully. Banks must have strategy to reduce NPL's. The banks found with highest significance in nonperforming loans are Public sector Bank among all banking industry. Nonperforming loans brings an impact on operating risk, credit risk, monetary policy , market risk, liquidity risk, debt/equity risk, interest rate risk, reputation risk, earning risk, legal risk & solvency risk. Banks must have well structured strategy for the recovery of loan and the Bank must design or apply its own strategy for the recovery of loans. Unanticipated risk and inappropriate credit management could fail the financial institution. Uncertainty in economic condition of Pakistan and in global environment brings the impact in Banking sector. Although there is also a presence of poor strategy and policy, therefore the preventive strategies by managers are appreciated in a banking sector. Conventional Banks are constantly failed in decreasing insufficient performance which is imagined or observed by remarkable business and extraordinary trouble that happens. Customers get dissatisfy while communicating the information during the request or claim that pressurize the recital or routine of the bank. Correct information should be provided by the customer while submitting loan request. The procedure or process of granting loans is a tough step, so the bank should take this step carefully. The management should be highly effective during operations all the activities should be performed with proper documentations and according to the agreement with respect to reach competence. Lending money is risky and it includes risk management of an assets. The strategy of lending and goals should be practical or flexible for accomplishment, controlling assessment and evaluation. Although lending donates of assessing and taking the risk of bankruptcies and the strategies should be present to minimize it. Taking risk is a part of a business especially in banking. The level of achievement for a bank is when the management meet its objectives means the achievement of the bank would be when risks are minimized the net income of the Bank would be in surplus and captures the highest number of stakeholders. Advances and loans are the most important mechanism of Banks assets, these loans could be a threat for a Bank. Several Banks has been solvent due to fail in recovery of loans, it is just because of poor strategies and managing. The Banking industry playing a vital role in the economic development of Pakistan. Earlier studies proved that various banks have found obstacle to meet their objectives due to inefficient of performance causes solvency.
2. Literature Review
Unsettlement of loans or a loan which has been in default for 90 days or 3 month will grow Npl's, these loans caused by nonpayment or failure in payment and unrealized markup will also be added to NPL's. Earlier than the financial crisis of the Asia, finance experts believed that the Bank should be treated as supplementary administration reserves and in order to manage growing liquidity problems & nonperforming loans in the banking system. (Victor Shih, 2004). Nonperforming loans contain principle payments, interest & additional financial data. Loan losses could be increased in future after the after the disclose of loan loss provision and income statement disclosed or revealed as accrued expense. All uncollectable loans supposed to be as loan charge offs which are assets write-off that must be managed separately in financial statement and it can be subsequent from income statement and balance sheet. (Dr. Ishrat Husain, 2002) Every organization builds on its assets and loans are mentioned as receivables in the balance sheet and the unrealized mark up would also be include when these receivables cannot be collected then they will considered as non performing loans. Nonperforming loans bring highly impact on conventional banks.
Gross NPLs/gross advances and net NPLs/net advances necessarily monitored because they are reasonable and simple. Better quality of loans is issued due to carefulness, these ratios could be decline after a while and assets could be affected. The non-provisioning of NPL's could bring an impact or a threat on the performance of the entire banking system. The higher the provision, the lower the systemic risk will be (Dr. Ishrat Husain, 2002). The banks must monitor the payment series of the borrowers and take some legal action against the defaulters less monitoring could be the reason of nonperforming loans. Nonperforming loans could not be removed from conventional banks but it can be minimize by increasing security requirement, reducing unsecured loans and making restrictions on late payment, the strategy should be flexible and well structured.
The study has shown that high income earners has superior access to property and mortgages while low income earners have inferior (Cheron, 1999). The credit endorsement rates is greater than before for usually discarded households, mostly low income, inflation, taxes non white and younger households (Getter, 1996). Lending methods for low income earners, non white and younger households separate them from the financial system which is not socially acceptable.
The default risk of lenders evaluation depends on the loan arrangement, which is obviously depend on the employment, income and credit history of the borrower at issuing loan, household has connection or linked with marginal risk (Higgins, 1999). Although failure in adjusting the credit risk will increase the loan default risk, hence instant or immediate rising in the cost of financial institution causes decreases the further borrowing of retail credit (Lucket, 1988). In nonprofit organization, the appropriate risk management strategy is more complicated to define, in this situation the managers or bankers have to develop such strategy which decrease the loan default risk in order to recover loan and maintain capital (Eales and Bosworth, 1998). The task is to maintain the loan recover it, reduce credit risk and to reach at a low cost credit it could be achievable or enhanced by ethical risk obstacles that households face while claiming or requesting for a loan. Collateral security requirement control the all risk in a better way. Risk management and this diversified strategy will accumulate the huge demand of credit of different sector of financial system but also minimize the nonperforming loans (Badu, 1999). The bank should have to sanction the loan where chances of risk would be less before assigning loans the credit history of the borrower must be seen. The chances of liquidity risk, solvency risk and earning risk are high during issuance of loans. The new credit culture, certainly, has some negative impact as credit officers have turn into more risk reluctant in recommending new loans and the potential borrowers have turn into more alert in contracting new loans. Turn down in private sector credit can be to some extent recognized to this risk dislike among the bank credit staff. The SBP is trying to lessen this by asking the banks to expand their portfolios and inaugurate new lines of business - consumer.
The current issue in credit & risk management is Nonperforming Loans. The growth of NPL's is a threat on economy as well as which declining trade (Deservigny & Renault, 2004) described that NPL's has got a latest measurement now as an assets, interest rate & credit management. Increasing threats of NPL's bring impact on bank balance sheet and income statement causes constant Banks failures, the Central Bank provides guidelines and services in order to manage credit, overdraft, advances, Bankers approval, commercial documents, leases, guarantees, bills discounted and contingencies are interrelated with credit risk of Banks. The credit activities in provision of repayment and nonpayment could be in assembly of performing and nonperforming facilities of credit (Kassim & shabri, 2010) define the impact of nonperforming loans as: Insufficient credit measurement, insufficient management, false practices, require flexible credit policy, unnecessary stress on profitability, Fault in documentation, Political & economic uncertainty, weak sector, strange competition, Social & political pressure on operations of Banks, inconsistencies in policies and rules (Elaine, 2007) define Credit risk or NPL's could be the reason of loss or default risk, Flexible credit evaluation or assessment of loan is necessary for the creditor (Dorfman, 1996) define bankers need to know the credit principles, the procedure through which the credit value & arrangements are evaluate, assessment method, concession, take notes, crisis decision & credit risk should be successfully manage (Abolo, 2001) define credit's protectionism, appropriateness & effectiveness force the Bankers to come on a track of lending system & policy. Credit is based on a trust; it's not an issue that borrower and lender have trust on each other & it could not reduce the value of loan selection analysis, this trust could be dishonored consciously or unconsciously, its includes sound credit analysis (Nwankwo, 1991) define the procedure of evaluating the business or personal credit risk adjacent to accruable profit from those investments. The profits could be direct or indirect in terms of interest earning & deposit balances essential according to the situation of loan, which is launch or preservation of an association with borrower causes enhanced deposits received by the Bank and insist for a diversity of Bank services. Additional description is that the credit risk evaluation has quantitative and qualitative aspects. The credit officer must have borrower's information & record, identify the actual and accurate reason of borrowing, determine the risk of the borrowers that borrowers face existing & potential of political, economical & approximate the level of assurance concerning the repayment.
In the approximation of financial portfolio capability, Banks must not bound the analysis at task assessment method without help and the entire credit risk are also assessed which could bring an impact on portfolio (Schall & Haley, 1991) define that loan analysis would be summarize as ability, security, assets, circumstance and personality. Lending creates the assets risk & it's a valuable project for the management of the Bank. The greatest way of earning is receivable and risky task for the Bank. The financial cost of these loans, are valuable and differ with possibility and the crisis extent. (Cortavarria Luis & C. Dziobek, 2000)The main reason of the failure of the Bank is Nonperforming Loans & this NPL's has trim down the values of credit risk management. The soul of credit risk management is the recognition of the accessible and possible natural risk during issuance of loan. The procedures to minimize them is to make a flexible & innovative strategy which could control the credit risk (Deservigny and Renault, 2004) defines that credit risk management procedures involves some guiding principles that causes credit risk. First one is objectives should be increase or decrease the credit risk i.e. strategies on applications, experience, sufficient expansion, issuing loans to associated parties, or over experienced. The second one, which reveals the bank to credit risk i.e. rules of resources categorization. The third one strategies of loan loss provision
3. Research methodology
It is the basic structure of the study. In other word, I have done participative
Survey. It is basically a qualitative and causal research. This study has completed in year 2012. The primary data has collected through questionnaire for which I have made 250 sample sizes but 50 of them have dropped out due to fake or incomplete information, so 200 sample size has chosen as a final sample size. 100 sample sizes have made to collect data from borrowers and 100 made to collect data from Bankers. Borrowers & Bankers would be the sample unit of the research, so the data has collected from 100 borrowers and 100 Bankers. The sample technique that I have used for study is snowball sampling and the secondary data has collected from State Bank of Pakistan.
4. Hypothesis Testing
The main part of the study where I have to test my hypotheses by analysis of T-test and F-test where significance level must be less than 0.05 (P<0.05) which will be the acceptance or rejection of hypotheses and this will be decide on the basis of the significance. I have made three main hypotheses in order to prove my research for which I have created, H1 = Borrowers face difficulties in paying loans which does not create nonperforming loans, H2 = Nonperforming loans do not bring impact on Conventional Banks and null hypotheses H0 = Borrowers face difficulties in paying loans which creates nonperforming loans, nonperforming loans brings impact on Conventional Banks. The primary data which I have collected through survey has Cronbach's Alpha (α) = 0.905 which shows 90.5% reliability.
Table 4.1: Results of Testing H0
Reasons That Create NPL's
Model 1
Constant α0
Coefficient β1
R
R2
Adj. R2
F (P-Value)
Coefficient's P-value
H0 Results
Total Sample
0.970
0.941
0.935
160.007 (0.000)
(0.000)
Accept
Interest Rate/Mark Up
0.350
0.938
0.951
0.903
0.902
917.135 (0.000)
(0.000)
Accept
Income
2.215
0.530
0.600
0.360
0.354
55.182 (0.000)
(0.000)
Accept
Inflation
Taxes
Investment
Discount Rate
Security Requirement
Unsecured Loans
Allowance to Late or Nonpayment
2.268
3.791
3.791
0.696
3.600
4.068
4.104
0.524
0.196
0.196
0.855
0.252
0.137
0.119
0.591
0.266
0.354
0.915
0.343
0.189
0.156
0.349
0.071
0.125
0.837
0.118
0.036
0.024
0.342
0.061
0.116
0.835
0.109
0.026
0.014
52.476 (0.000)
7.450 (0.004)
14.020 (0.000)
503.268 (0.000)
13.105 (0.000)
3.614 (0.060)
2.448 (0.121)
(0.000)
(0.004)
(0.000)
(0.000)
(0.000)
(0.060)
(0.121)
Accept
Accept
Accept
Accept
Accept
Reject
Reject
Table 4.2: Results of Testing H0
Impact Of NPL's On Conventional Bank
Model 2
Constant α0
Coefficient β1
R
R2
Adj. R2
F (P-Value)
Coefficient's P-value
H0 Results
Total Sample
0.915
0.837
0.825
67.548 (0.000)
(0.000)
Accept
Credit Risk
0.696
0.855
0.874
0.763
0.761
315.684 (0.000)
(0.000)
Accept
Liquidity Risk
1.873
0.616
0.743
0.552
0.548
120.896 (0.000)
(0.000)
Accept
Market Risk
Monetary Policy Rate
Debt/Equity Risk
Solvency Risk
Earning Risk
2.098
2.277
1.249
1.465
1.331
0.570
0.532
0.741
0.695
0.724
0.711
0.681
0.778
0.810
0.828
0.505
0.464
0.605
0.656
0.686
0.500
0.458
0.601
0.652
0.683
100.165 (0.000)
84.769 (0.000)
149.843 (0.000)
186.601 (0.000)
214.394 (0.000)
(0.000)
(0.000)
(0.000)
(0.000)
(0.000)
Accept
Accept
Accept
Accept
Accept
5. Data analysis
The primary and secondary data were collected. First I have analyzed secondary data which was provided by State Bank of Pakistan as you can see Table 5.1. This secondary data which is mentioned below, only all banks data of 2011 has analyzed because it's the compilation of the data. In year 2011 the NPL's Of All Banks have increased to Rs. 579.2 Billion, Net NPL's has decreased to Rs. 186.0 Billion and Net NPL's to Net Loans has increased to 5.50%.
Table 5.1: NON PERFORMING LOANS
(End Period 2010-11: Billion Rupees)
BANKS
Nonperforming Loans
Net NonPerforming Loans
Net NPLs to Net Loans (%)
CY 2010
CY 2011
CY 2010
CY 2011
CY 2010
CY 2011
All Banks
547.8
579.2
287.3
186.0
5.44
5.50
Commercial Banks
515.4
543.9
170.6
171.6
5.24
5.21
Public sector
Commercial Banks
164.2
166.9
75.4
77.1
12.01
11.21
Local Private Banks
344.2
370.2
94.3
93.7
3.68
3.70
Foreign Banks
7.0
6.7
1.0
0.8
1.44
1.10
Specialized Banks
32.4
35.3
116.6
14.4
12.46
15.54
5.2 ReasonS
The study has conducted to know the reasons that create the problem for the borrowers in paying loans that's why I have to collect primary data from the borrowers. The main objective is to the grasp the actual variable which creates the trouble for the borrowers in paying loans; loans are actual pay by the borrowers. First I have designed a model in which I have taken nonperforming loans as a dependent variable and interest/markup, income, inflation, taxes, investment, discount rate, security requirement, unsecured loans & allowance to late or nonpayment's have taken as an independent variable. The Pearson's correlation coefficient and regression equation has analyzed to covariances and relationship among the variables to know the variables that creates the problem for the borrowers in paying loans, their nonpayment of loans change into nonperforming loans.
NPLit = α0 + β1* INT + εit ----- eq. (1) (Model 1)
NPLit = α0 + β1* INCit + εit ----- eq. (2) (Model 1)
NPLit = α0 + β1* INFit + εit ----- eq. (3) (Model 1)
NPLit = α0 + β1* TXit + εit ----- eq. (4) (Model 1)
NPLit = α0 + β1* INVit + εit ----- eq. (5) (Model 1)
NPLit = α0 + β1* DRit + εit ----- eq. (6) (Model 1)
NPLit = α0 + β1* SRit + εit ----- eq. (7) (Model 1)
NPLit = α0 + β1* ULit + εit ----- eq. (8) (Model 1)
NPLit = α0 + β1* NPit + εit ----- eq. (9) (Model 1)
NPL is nonperforming loans, INT is interest, INC is income, INF inflation, TX is taxes, INV is investment, DR is discount rate, SR is security requirement, UL is unsecured loans & NP is allowance to late or nonpayment's.
5.2 Impacts
The task is to know the variable that brings impact on conventional Banks, and to design a model that could find out them. This study focuses on the performance of the Conventional Bank but also focuses on improving and making them better. First, I have designed second model in which I have taken nonperforming loans as a dependent variable and I have taken credit risk, liquidity risk, market risk, monetary policy rate, debt/equity risk, solvency risk & earning risk as an independent variable. The Pearson's correlation coefficient and regression equation has analyzed to covariances and relationship among the variables to know the variables that brings impact on Conventional Bank.
NPLit = α0 + β1* CR + εit ----- eq. (10) (Model 2)
NPLit = α0 + β1* LRit + εit ----- eq. (11) (Model 2)
NPLit = α0 + β1* MRit + εit ----- eq. (12) (Model 2)
NPLit = α0 + β1* MPRit + εit ----- eq. (13) (Model 2)
NPLit = α0 + β1* DERit + εit ----- eq. (14) (Model 2)
NPLit = α0 + β1* SRit + εit ----- eq. (15) (Model 2)
NPLit = α0 + β1* ERit + εit ----- eq. (16) (Model 2)
NPL is nonperforming loans, CR is credit risk, LR is liquidity risk, MR is market risk, MPR is monetary policy rate, DER is debt/equity risk, SR is solvency risk & ER is earning risk.
6. CONCLUSION
This study describes the reasons & impact of Non-performing Loans on Conventional Bank in Pakistan. This study defines that the correlation of interest/markup, income, inflation & discount rate with Nonperforming loans, to know the reasons of Nonperforming loans are strongly positive. The correlation of credit risk, liquidity risk, market risk, monetary policy rate, debt/equity risk, solvency risk & earning risk with Nonperforming loans, to know the impact of nonperforming loans on conventional banks are strongly positive. The correlation of taxes, investment, security requirement, unsecured loans & allowance to late or nonpayment's with Nonperforming loans, to know the reasons of Nonperforming loans are weakly positive. Among all the independent variables, interest/markup, discount rate, credit risk, liquidity risk, market risk, monetary policy rate, debt/equity risk, solvency risk & earning risk can be significantly explained variation while rest of the variables are insignificant. The outcome defines that taxes, investment, security requirement, unsecured loans & allowance to late or nonpayment's cannot significantly be the reason of nonperforming loans and cannot bring an impact on conventional banks. . The Non-performing Loans is created due to high interest rate & discount rate which affects the credit risk, liquidity risk, market risk, monetary policy rate, debt/equity risk, solvency risk & earning risk that brings highly impact on conventional banks.
To get final outcome I have to perform multiple regression which is use to know the combine effect in reasons of nonperforming loans which is the reflection of total sample as you can see in (Table 4.1) and the combination of equation (from eq.1 to eq.7) where data has collected from borrowers which has predictor i.e. interest/markup & discount rate. R = 0.970 which is highly correlated this predicts nonperforming loans very well and R represents multiple correlation coefficient and R square = 0.941 means 94.1% of the variance in nonperforming loans can be predicted by the combinations of interest/markup & discount rate. The adjusted R square = 0.935, F9,90= 160.007 with p = 0.000 means the significance level is less than 0.05 (p<0.05).
NPL = 0.186+ 0.601INT + 0.326DR ----- eq. (17)
To obtain final outcome of impact of nonperforming loans on conventional Banks I have performed multiple regression which is the reflection of total sample as you can see in (Table 4.2) and the combination of equation (from eq.10 to eq.16) where data has collected from Bankers which has predictor i.e. credit risk, liquidity risk, debt/equity risk, solvency risk & earning risk. R = 0.915 which is highly correlated this predicts nonperforming loans very well and R represents multiple correlation coefficient and R square = 0.837 means 83.7% of the variance in nonperforming loans can be predicted by the combinations of credit risk, liquidity risk, debt/equity risk, solvency risk & earning risk. The adjusted R square = 0.825, F7,92 = 67.548 with p = 0.000 means the significance level is less than 0.05 (p<0.05).
NPL's = 0.700+3.447CR-0.048LR+1.717DER-1.704SR-2.588ER - eq. (18)
7. Recommendation
This study will provide guideline to the conventional bank, sufficient provisions for Non-performing Loans is not to unsettle the banks in credit measurement; balance sheets, income statement, suitable intensity of tradeoff and risk-reward for collective actions, the bank credit policy will get into account, thus managing the economy, reshaping it to grow and the performance of credit; and implementation of Efficient Loan Appraisal Techniques depend on risk measurements & conventional investment analysis. The biggest issue of the economy and government is nonperforming loans. On the other hand, there are tools and preventive measures are present to handle, minimize and reduce the growth of non-performing loans. The Conventional Banks must contain following methods in their procedures (1) approximation of non-performing loans and assign it to the subsequent borrowers although always imagine regarding nonpayment of loans or uncovered loans, how their transaction are performed, in the way of increase principal outstanding, and (2) Approximate that the interest are received, except of receivable, and same with the interest payable, in this way nonperforming loans will not be affected. While the difficulty or obstacles that bring impact on non-performing loans is related with the procedures of the Banks, there must be destructive loan collection strategy. The absence of destructiveness is admired in the developing & developed countries and this is supposed as the Banks definite aspect and adds to the crisis of nonperforming loans. The competencies of the Banks should be maintained and increased until they improve their selves and cover a common procedure. Since the economic uncertainty, depression/recession in the global surroundings must be handled to control the domestic circumstances. Because the economic uncertainties are not in a control of Banks, then they should permit the government to design its own strategy. The qualities and abilities of the managers to control the supply and the rising demand of the customers can be the trouble that could occur in the workforce. Thus, inconsistencies in policies & strategies should be present in case of failure in evaluating the qualities and abilities of the entities or individuals.
