A three-member bench headed by Chief Justice Saqib Nisar took up suo motu proceedings initiated in 2008 on press reports that the State Bank of Pakistan (SBP) had allowed commercial banks to write off around 54 billion rupee non-performing loans (NPLs) of 222 companies on political basis under a scheme introduced by the then dictator General Pervez Musharraf. In 2002, the then SBP Governor, Dr Ishrat Husain, had issued circular 29 titled New Guidelines on Write-Off of Irrecoverable Loans and Advances since 1971 onwards that raised serious queries even at that time with critics maintaining that through this circular banks were compelled to write off loans to benefit Musharraf’s political acolytes.

The circular expired in 2003 and by 2011, a three-member bench headed by the then Chief Justice Iftekhar Chaudhry was informed that loans of 256 billion rupees were written off over a 28-year period. It was decided to set up a commission headed by a former judge, Jamshed Ali Shah, to investigate whether political influence was involved in loan write-off decisions during the period in question. However, it is unclear whether the report was actually prepared and if so what became of it.

On May 13 this year, a three-member bench headed by Chief Justice Saqib Nisar directed the 222 companies to clarify their situation and observed that those who had their loans written off must return the amount and, if unable to do so, their assets must be sold. A representative of the National Bank of Pakistan (NBP) and another from a private bank appeared before the court with the former maintaining that SBP is the main party to the case while the latter argued that SBP is a regulatory authority but it is the banks themselves that waived off loans; he however added that the amount in question is from the past but the bank is interested in recovery.

The Chief Justice during the hearing observed that “we have been hearing this case since 2007. We want reports and clarifications over the issue. The money will be recovered from those who got the loans waived off on a political basis.” The operative words are political basis. It is unfortunate that prior to privatisation of banks, the pressure to extend loans on political basis and subsequently write them off was overwhelming. However after banks were privatised in this country the onus of write offs rests with the bank itself and its board of directors. Be that as it may, loans are offered for economic reasons, and the viability of a proposed loan is independently evaluated by bank management, however, there are instances, more so in the case of state-owned banks like NBP, to extend loans on political basis. And based on what the Chief Justice stated it is fair to assume that he was targeting these particular borrowers.

High levels of non-performing loans (NPLs) reduce banks’ profitability and hence their ability to lend including to small and medium enterprises considered to be the engine of growth. NPLs can be attributed to various factors ranging from a recession in the economy with a decline in demand to a particular borrower going under due to gross miscalculation in assessing the market for a product/service or frequent changes in government policy turning their assets sour. Whatever the reason, being in the risk taking business that banking is, banks typically evaluate the opportunity cost while settling NPLs. As long as there is no personal motive of the bankers or political arm twisting/pressure, the write-offs of irrecoverable loans and cleaning up of their balance sheets is the norm for all banks the world over.

The write-offs, in fact, depict recognition of reality where the original asset has diminished in value and therefore needs to be carried on the balance sheet at its realistic value. When banks in Pakistan were in the nationalized sector, the commercial banks and development finance institutions carried NPLs on their balance sheets without recognizing value erosion. They were thus inflating their balance sheets by showing these loans that were essentially NPLs, as part of their asset base. In the absence of write-offs, the banks had to make provisions out of their incomes in their balance sheets. Done on a sustained basis, this significantly eroded their capital. This is precisely why the government, through the State Bank, had to inject nearly 46 billion rupees to make up for the shortfall in Capital Adequacy of United Bank and Habib Bank prior to their privatisation.

It is important to recognize that write-off is essentially an accounting entry that denotes that a loan has become unserviceable and it does not undermine the ability of a bank to proceed against a borrower or collateral in respect of that loan except when a settlement is reached between a borrower and the bank. Pakistan is not unique in writing off loans. In March this year when the NPLs had risen sufficiently to become a source of concern, the European Union announced measures to address the problem of non-performing loans last year which included (i) a directive on credit service providers, credit purchasers and the recovery of collateral; (ii) a proposal for a regulation amending the capital requirements regulation; and (iii) a blueprint on the set-up of national asset management companies.